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Call It Free, But It Will Cost You

By James Ledbetter
Sunday, May 24, 2009

In the late 1960s, two groups -- the Diggers in San Francisco and the Yippies in New York -- began operating "free stores." These were places where people could come to get things they needed -- food, medicine, clothes and, in some cases, cash -- for free. These were designed simultaneously as parodies of, and alternatives to, the usual American materialism. The stores were not around for long, partly because people would come in and simply take everything they could put their hands on.

Now, four decades later, comes Chris Anderson, editor of Wired and author of The Long Tail, whose new book proclaims that giving things away for free is the "radical" new business model of the future. According to Anderson, there are a variety of ways businesses can and should do this. They can charge for other goods and services to make money. They can use one class of customer to subsidize another; they can give away a certain type of service (such as photo sharing) and charge for another (such as storage space). Anderson does not claim that any of this is new, although he does propose applying it in ways that seem unprecedented. Basically, he says that if you don't begin giving some key part of your product away, you're going to have to sooner or later. Which is odd because if he followed his own advice he'd be out of a job.

The problem is that -- outside of a handful of examples, almost all of which are Internet- or digital-based -- giving things away does not work in any significant way. Here's why: Just about any activity that merits the title "business" has a cost of producing its goods or services. Take the oil-and-gas business. It costs a huge amount of money to extract petroleum from the ground (more now than it used to in many places), as well as refining the stuff, storing it, shipping it and so on. Those costs may or may not justify the price of a barrel of oil or a gallon of gas, but neither do they justify a price of zero.

It's exceedingly difficult to envision a way in which the oil industry could recoup its expenses without charging for its product. Apply this lens to almost any nondigital business -- pharmaceuticals, manufacturing, law, banking -- and the same problem emerges. Businesses need to recover labor and capital costs, and giving things away for free doesn't meet that need. Even in the digital world, there are plenty of cases in which "free" hasn't worked. Back in the dot-com boom, the Internet services provider NetZero promised "free Internet forever." The company is still around, sort of, in the form of United Online, except that it doesn't really provide free Internet access anymore, and it doesn't make money. Ditto Vonage, a "freemium" voice-over-Internet-protocol phone company that also loses money.

Of course, it's not Anderson's fault if most established businesses ignore his diagnosis and prescription. But what about the one business over which Anderson presumably has the most influence -- Wired magazine? Why should I have to pay $4.95 for a copy of Wired since, if Anderson's thesis is correct, the magazine would be better off giving itself to me for free? Indeed, if I subscribe for free, the magazine should be, at least according to Anderson, better off still!

Cynics might argue -- and Anderson himself suggests -- that at $10 a year for 12 issues, Wired is already a loss-leader; the problem with that is that Wired owner Condé Nast is taking the loss without leading its readers to anything that generates sales. No, the reason that Wired still charges you lies in the somewhat magical economics of advertising. Condé Nast could presumably build the circulation of a free Wired magazine so high that it could then charge advertisers even more and not only make up for lost circulation revenue but exceed it.

But here's the rub: Condé Nast doesn't want those readers. It charges a very high price to advertisers -- in Wired's case, about $90,000 a page, according to Publishers Information Bureau, though in reality much less. The only justification for such enormous sums is the notion that advertisers will reach a select -- Condé Nast really likes the word "prestigious" -- group of readers. Expand that reader pool too much, or in the wrong direction, and the prestige justification evaporates. It's a hoary, almost certainly apocryphal story, but the rationale that Bloomingdale's chief executive Marvin Traub supposedly gave to Rupert Murdoch for not advertising in the New York Post still makes the point: "Your readers are our shoplifters."

Which brings us back to the free-store dilemma, but in reverse. The reason Anderson cannot run Wired as a store that gives everything away is not on the demand side (i.e., shoplifters); it's on the supply side. If advertisers won't pay and the magazine loses money on its subscriptions, where will the money come from to create the goods that Wired gives away? Which just raises the ultimate question: If the free model would ruin Anderson's own business, why does he think it's so great for most other businesses?

James Ledbetter is editor of The Big Money.

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