May 25, 2008

What’s Strategically Interesting About Free

Filed under: Incentives,Observations,Strategy — admin @ 7:01 pm

Chris Anderson has started a lot of discusstion about free in “Free! Why $0.00 Is the Future of Business“.

Although, I didn’t see him mention it (and maybe it will be in his upcoming book “Free”), there’s something strategically special about free. Simply, it’s as if producer incentives are as they would be in perfect competition.

What do I mean? Let’s take, for example, Google Analytics (a free service offered by Google). We certainly can assume that Google offers the service for free because it indirectly increases the quality of advertising on search results. But offering the service for free has costs (labor, technical support, etc..). Let’s imagine that it wouldn’t take much cost to turn the service into a losing venture for Google.

Now, Google could charge a price for the service. They’ll lose market share, but it would more certainly make the service sustainable. BUT because Google has some market power, we could speculate that the incentives of the developers would be to lower the quality of the product in order to make more money. For instance, if the service charged per minute of use, we might expect the developers will create interfaces that are a bit more complicated and take more time to use. This would normally be tempered in perfect competition (but, hey, we don’t have an infinite set of web analytics producers). Google could pay users to use the service. Obviously, we can expect that would distort incentives such that users would only use the service to get a bit of money.

What’ left? Exactly, free. When offered for free, Google increases market share as much as possible (and increases the utility derived indirectly from search). Consumers consume as much as they want. More importantly, the developers of the service have a huge incentive to decrease the cost of production as much as possible. We might speculate that decreasing costs correlates with increasing quality. For instance, less demand for technical support (a cost) means that the service is of higher quality.

Simply, Google Analytics is competing against themselves! And competing against one’s self looks a whole lot like perfect competition.

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