The Grand Unified Theory On The Economics Of Free

from the have-fun-with-it dept

Ok. I'll be the first to admit that I've taken the long way around in going through my series of posts exploring the economics of goods when scarcity is removed. What I had thought would be a series of 5 or 6 posts, turned into something much longer -- but each week people came up with new questions or discussions or objections, and so I tried to spend some time digging down on various pieces of the economics at hand. However, what I haven't done is tie it all together in one single spot. In the last couple of weeks there's been tremendous confusion among people from Scott Adams to CNN to various others that have made it abundantly clear that the one thing I've failed to do is put the whole concept together in a single place. That's resulted in people being confused about what I'm actually saying -- where they only pick up a tiny piece of the argument or confuse it with the arguments made by others. So, while I still think it was important to go through the details, now is as good a time as any to pull the whole theory together (with some links back to the previous articles in the series).

First off, and this is key, none of what I put forth is about defending unauthorized downloads. I don't download unauthorized content (never have) and I certainly don't suggest you do either. You may very well end up in a lawsuit and you may very well end up having to pay a lot of money. It's just not a good idea. This whole series is from the other perspective -- from that of the content creator and hopefully explaining why they should encourage people to get their content for free. That's because of two important, but simple points:
  1. If done correctly, you can increase your market-size greatly.
  2. If you don't, someone else will do it correctly, and your existing business model will be in serious trouble
If that first point is explained clearly, then hopefully the second point becomes self-evident. However, many people immediately ask, how is it possible that giving away a product can guarantee that you've increased your market size? The first thing to understand is that we're never suggesting people just give away content and then hope and pray that some secondary market will grant them money. Giving stuff away for free needs to be part of a complete business model that recognizes the economic realities. We'll get to more details on that in a second.

From a high-level perspective, though, the reason that giving non-scarce products away for free will increase your market size goes back to the same Thomas Jefferson quote that we kicked the series off with:
If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of every one, and the receiver cannot dispossess himself of it. Its peculiar character, too, is that no one possesses the less, because every other possesses the whole of it. He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me.
What Jefferson noted is the wonderful feature of a non-scarce, or infinite, good that it is effectively a free resource. Once created, it costs nothing to give to someone else, and you still retain the original. In fact, economists have finally realized that this is the very key to economic growth and progress. The infinite resource known as an "idea" that improves what was already there is what increases the size of a market. Or, putting it another way, that infinite resource of a new idea makes an existing scarce resource more valuable. It's easy to understand that when it's an idea applied to, say, a machine making it more productive -- but it also applies to any infinite resource appropriately bundled with any scarce resource.

The way it works is actually quite easy and fits in with the same basic economics that's always been in place. Knocking down the barriers of artificial scarcity opens up tremendous new opportunities -- just as knocking down the artificial scarcity known as "protectionism" helps to grow markets by creating new opportunities. In this case, those new opportunities have only increased in number as we've gone digital, making more content infinite in nature. Where some people have trouble is that those new opportunities may be in different places than the existing opportunities -- and those new opportunities may not all be capturable by the creator of the content. Indeed, there will be some externalities created by the free flow of an infinite resource. However, the total amount that any content creator can capture is still much larger than it was before. It's one of those cases where getting 20% of a huge pie is much better than getting 90% of a tiny pie.

You just start by redefining the market based on the benefits of what you're providing, rather than the specific product you're selling. If you're focused on selling the benefits, then discovering a better way to sell those benefits is seen as a good thing, rather than a threat. You then break down the different components that make up those benefits that you're selling -- and you begin to recognize that every bundle of goods and services that make up the benefit you're selling has components that are scare as well as components that are infinite. In fact, if you look closely enough, you realize that any scarce product you buy actually has infinite components while any infinite good you see also tends to have scarce components.

Once you've broken out the components, however, recognizing that the infinite components are what make the scarce components more valuable at no extra cost, you set those free. Not only do you set those free, you have every incentive to create more of them, and encourage more people to get them. You break them into easily accessible bites. You syndicate them. You hand them out. You make them easy to share and embed and distribute and promote. And, yet, all the while, you know exactly what scarce resources those non-scarce goods are tied to, and you're ready to sell those scarce resources, recognizing that the more people who are consuming the infinite goods, the more valuable your scarce resource is.

So, the simple bulletpoint version:
  1. Redefine the market based on the benefits
  2. Break the benefits down into scarce and infinite components.
  3. Set the infinite components free, syndicate them, make them easy to get -- all to increase the value of the scarce components
  4. Charge for the scarce components that are tied to infinite components
You can apply this to almost any market (though, in some it's more complex than others). Since this post is already way too long, we'll just take an easy example of the recording industry:
  1. Redefine the market: The benefit is musical enjoyment
  2. Break the benefits down (not a complete list...): Infinite components: the music itself. Scarce components: access to the musicians, concert tickets, merchandise, creation of new songs, CDs, private concerts, backstage passes, time, anyone's attention, etc. etc. etc.
  3. Set the infinite components free: Put them on websites, file sharing networks, BitTorrent, social network sites wherever you can, while promoting the free songs and getting more publicity for the band itself -- all of which increases the value for the final step
  4. Charge for the scarce components: Concert tickets are more valuable. Access to the band is more valuable. Getting the band to write a special song (sponsorship?) is more valuable. Merchandise is more valuable.
What the band has done in this case is use the infinite good to increase the value of everything else they have to offer. They've increased their marketsize by recognizing how they can use the infinite goods as a free promotional resource and made the value of the overall ecosystem around them more valuable. Rather than playing small shows in tiny clubs that don't pay very well, they get to play large venues with bigger covers. It's certainly true that there are some externalities -- where some people will enjoy the music for free without ever taking part in paying for the scarce components. But, when done right, you've increased your market so much that it more than covers the difference. Compare this solution to that of a band that sticks to the old way: they are then limited in the audience that will hear them -- especially as more and more bands give their music away for free. Fewer people will be interested in going to their concerts or buying their merchandise or joining their fan clubs -- when the benefits are so much greater for following other artists that actually give their music away for free. The end result really is a much bigger market with much greater benefit by expanding the market by using infinite goods to make the scarce goods more valuable.

So there you have it. After many months, one single summary of the economics of "free" and how it can be used to anyone's advantage. It's not about defending unauthorized downloads. It's not even about getting rid of copyright -- just recognizing that copyright holders can actually be better off ignoring their own copyrights. It's very much about showing the key trends that are impacting all infinite goods -- and pointing out a clear path to benefiting from it (while making life more difficult on those who refuse to give up their old business models). And we're giving it to you all... for free. So, enjoy.

If you're looking to catch up on the posts in the series, I've listed them out below:

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  1. identicon
    Market me this, 31 Jan 2008 @ 7:38pm

    Although I am no economist, I have been a musician for over fifteen years and I am acquainted with what goes on when it comes to making music as a viable business model.

    There is a major problem with your theory Mike, although I much appreciate your effort and time to talk about this. The problem as I see it is surprisingly absent from your critics, suggesting to me they don’t understand how the music industry actually works.

    You seem to be making the mistake that if songs are distributed for free that somehow that makes the demand for the artist (and his/her scarce product) proportional (even at low percentage) to the level of that distribution. Nothing could be further from the truth.

    You can have your song on a million web sights; you might even get people who have never heard of you to download one of your songs in the 10,000 others they have. But you will only get those people who download a bazillion songs anyhow, your chances of them actually giving your song a chance is next to zero.

    The point is that marketing is king in the music industry. I will take James Stevens who posted above as a perfect example. Were did he hear this “new music” that he downloaded? What avenue was responsible for his “hearing” the music? You guessed it: Radio. I don’t like to be a pessimist, but when it comes to music people are sheep like they are in almost no other arena. It’s ALL about marketing, and viral marketing for Indie bands. A person like what they think is good, and what is good has for the most part been constructed by the record companies. The vast majority of people do not get their music tastes and “likes” from browsing the internet. They cant, there is too much content. There are hundreds of thousands of bands and artists with content on the net, yet none of them are making it “big”. Why? Are they all that bad?

    The facts are people can only really like music by about 10 bands/artists at any one time. The human mind can only handle this much, having 10,000 songs really doesn’t matter because most of that stuff is old, already created not new, and the rest wont be listened too. Even if you had 10 new bands that you liked every month (a huge leap, it’s more like 1 every year, if that, for most people) where are you going to hear them? Do you think people are going to wade through miles of junk to get the ten bands they are going to like? Not likely.

    So this comes back to marketing. To be successful under your model, its not enough to have your songs for free everywhere, you have to have your songs making an impact, rising above the crowd. The general public, and even many musicians and music critics are under the false “supernatural” idea that the business is driven by this unseen hand of meritocracy. This simply isn’t the case; the best music doesn’t rise to the top, the marketed (and slickly produced) rises to the top, just think Spice Girls and Brittany Spears, as sad as that is. Every once in a while in the industry you have a “saviour” like a Nirvana or the like, an exception to the rule, but this only happens once in a blue moon and its not the norm. And even Nirvana had to make a music video, how much did that cost?
    My point is that, without marketing, none of this matters. The only real way to market a band (assuming they have the songs to deliver) is to spend $$$. Where, now that there is no money from the actual recorded music are artists going to get this money from? It’s a catch twenty two, something that occurs all the time in this great “free-market’ economy of ours. It’s a basic investment principle: without the cash to invest in marketing your group you’re never going to make the cash to invest in marketing your group. Record companies have been the traditional vehicles for doing this, like the great music VISA card, and they have made their money on physically recorded media. Now that their revenue stream is dried up, guess where they are turning? Yep, the poor artists. So then in order to get popular you now have to sell even more of your soul to the record company, because they want revenue from you concerts, and your t-shirts and every other thing they can get their hands on, because their traditional revenue streams have gone.

    This is the point that is missing. Distribution means nothing. Marketing is everything. Marketing costs $$$. Cash that the traditional record companies used to be able to afford, and now they cannot. What will fill the void?

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