Tuesday, 13 July 2010

Freemium - The Business Model of the 21st Century

Have you always wondered what the secret of  Google, Yahoo, and Facebook is? How a company that essentially offers all of its products for free, has managed to turn itself into a multi-billion corporation? The answer comes in Free by Chris Anderson

Chris Anderson, born in 1961, is the editor-in-chief of Wired, an American magazine and on-line periodical, which reports on how technology affects culture, the economics, and politics. He has a degree in Physics from the George Washington University. His first book, The Long Tail: Why the Future of Business is Selling Less or More argues that products with a low demand or low sales volume make up a market share that rivals or exceeds the few current bestsellers and blockbusters, if the distribution channel is relatively large. His newest book Free: The Future of a Radical Price examines the rise of an economic system, where products and services are given for free. By exploring this new business model Anderson proves that Free is the only possible future and a future that offers endless and unlimited possibilities to improve and share.

The main distinction Anderson draws is that the 20th century model is about the economics of atoms, while the 21st century one - about the economics of bits. With the development of bandwidth, storage, and processing technology has become faster, better, and cheaper. The marginal cost of reaching another user online is close to zero; in other words it is too low to meter. The reason that digital costs degrease at a faster rate is that most of their inputs are in fact intellectual - ideas propagate virtually without limits and without cost. Thus, the incentive to turn things digital is because they operate faster and they are quickly accelerating. Bits have the property of making everything cost less and do more. Information becomes cheaper because the cost of extracting it gets lower and lower (take Wikipedia as an example). In the 21st century economics model information wants to be free and unrestricted. Abundance thinking is the new trend; that is people must embrace waste in the digital world, because the cost of distribution is very low to even matter.

You might ask: how to make money on something that is essentially free? Anderson gives a clear answer - it takes creativity and innovation to adapt to this new business model, because it is the model of the future. Companies look at their portfolio of products and services and price some of them at a cost of zero (or close to it) to make other products on which they make healthy profits more valuable. The 20th century is full of such examples. Gillette started giving away razors for free only to stimulate demand for the blades, without which the razors were useless. Think about free cell phones, which come with a monthly contract, cheap video consoles with expensive games, or free fancy coffee makers at offices, which require superior coffee sachets. If we get to think about it, free is everywhere around us. The biggest challenge is how to make it work in our advantage.

The idea behind freemium is pretty obvious, once you come to think about it - a few paying customers subsidize a large group of non-paying.  At some point people realize they have more money than time; hence ready to pay for something to get it more quickly then to wait for a while and get it for free. The risk of producing it yourself is that you are not even paying yourself the minimum wage and you might not get what you want at the end. And all the other customers, who do not wish to spend the money, benefit for free. A media model of Free is also very popular - a third party (the advertiser) subsidizes content (the media); the listener or the viewer gets it at no charge. This relates not only to TV and radio, but also to paid media (newspapers, magazines, cable TV) allowing them to be much cheaper than they actually would be.

Of course, one of the biggest losers in the 20th century used to be the music industry. The profits from selling CDs fell dramatically with the availability of music online. However, enterprising producers found a way to generate profits - they made all the music available online, thus increasing awareness, reputation, and attention. They earned money from merchandizing, advertising, and concerts. And the biggest music fans still continued to buy CDs.

Google is the biggest corporation that built a working economic model around free - essentially all of its services, from search, e-mail, to Google Maps are free. So how does Google management succeeded in turning it into a multi-billion corporation? First, it introduced countless new and free services to increase attachment to the company. And second, it used customized advertising to reach the relevant customer market. Google's data costs are lower and fall faster than any other company due to economies of scale; thus the more free products and services they offer, the bigger their profits are. Even we, as free users, contribute to Google's success - every blog post improves Google search, every click on Google maps tells more about consumer behavior, and every sent e-mail is a clue to a human network of connections. In addition, the Google Ads program ensures that advertising messages reach the relevant customers. Clever and simple.

Chris Anderson's book offers much more interesting examples, pros and cons around the concept of Free and its future. I strongly recommend it to all those of you interested in business, economics, and marketing. For those of you not that passionate about the area, I still believe it will be an intellectually stimulating reading. Of course, as the title of the book, I downloaded it for free from scribd.com. Regardless of the free online copy, the hard $29.99 copy of Free:The Future of a Radical Price debuted as number 12 on the New York Times Best Seller List. Proving Anderson's point that business can actually make money on Free; it just takes bravery and creativity.

If you get to think about it, even with my blog post Anderson is getting free advertising, which increases attention and awareness about his book and works well for his reputation. Only one of the many examples how Free can be used to generate profits. Something to think about if we are to become the future leaders of tomorrow.


  1. Nothing new, we have always gotten things for free or at a reduced rate, for example, the top 1%! of high earners contribute 24%! of the total income generated from taxs and the next 9% of high earners contribute 29% of the total income generated from tax. You might be shocked by how much the state depends on the rich, but that might just confirm your belief that what's unfair is not the tax people pay but the incomes they begin with. It can also be put in other words, the rich can't really complain because they rely on the poor to provide them with the infrastructure to generate such wealth in the first place.

  2. You are absolutely right. In addition to these statistics, for the company I work 80% of the revenue comes from only 20% of the customers. Meaning that the model of freemium indeed has found its way into the contemporary world. However, I believe that for a business model to be built on the idea of freemium, the corporation must be large enough; in addition, its products must be very well exposed to the customers. This will create a small base of very devoted customers, who will subsidize the rest.