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>> ANDERSON: Free, the future of a radical price. First, it is a bizarre experience talking
about Free here at Google which I think of in many way as the citadel of Free accompany
that is, in many ways, if I can mix metaphors horribly, you know, a poster child for making
money around Free, or something that many people find paradoxical and impossible. I
should also say that Howell has taught me everything I know about Free and that was
only a tiny fraction of what he knows about Free. And I should also say that my attempt
to sort of formalize and put Free in the historical and economic context is simply looking in
the rear view mirror at what the engineers here and in other companies had internalized,
had sort of intuitively understood about the dynamics and economics of digital networks.
And it is--it goes, too, without saying. A lot of things that feels so wrong and counterintuitive
and mysterious to people in my industry and people in traditional industries are not only
self-evident to engineers and to people who live in the digital world, but also self-evident
to my children who grew up in the digital world. So, this--the paradox of my life is
that, you know, my book about what's different about digital economics and why Free goes
from a gimmick to a business model is seen as incredibly obvious and, you know, self-evident
to my children. They say, "You're kidding, dad. You wrote a book about how things online
could be Free." And incredibly impossible and counterintuitive to people of my generation,
they're like, "Don't you know, there's no such thing as a free lunch?" Somewhere between
"the" and "no way" struck me as the right subject for a book. I'm going to sort of plow
through about 30 minutes of just an overview and I'd really want to turn to the Q and A
which I think will be more fun. But the history of Free... So, I would argue that Free is
the most misunderstood--one of the most misunderstood words in the English language. It is a word
that is semantically complicated, it has two meanings. It is a word that is changed in
meaning over time. It is a word that is--that we fear and yet longed for. It is a word that
fills us full of, you know, psychological trauma and attraction. We field tricks by
it and yet we fall for it every time. Free started as a--in the marketing context, in
the late 1800s. You probably thought of King Gillette and the razor and blades as being
the first user of Free as a business model. You give away the razor, you sell the blades.
It actually was pre-dated by three or four years by this guy, Frank Woodward, who...
At the beginning of the--at the end of 1800s, this is the beginning of the packaged-goods
food industry. Before then, food was largely produce and meat and sold in green grocers
and local merchants. And you would have--it would have been as a fresh produce and you're
just beginning to see the first foods in boxes, and these first foods in boxes were almost
entirely powders. There were yeasts, baking soda, some sugars, and things like that. Now,
in those days you didn't have shells, didn't have isles as you walk through. Everything
was behind the counter of the merchant himself and you had to ask for it by name. And so,
the origins of branding and the origins of advertising coexisted with the origins of
packaged foods. Food without a brand was hard to ask for. You need to say, "I want, you
know, that one, the red one," and, you know, the easier you could put a name to it, the
easier it was for people to call that from across the counter. The problem... This guy,
Frank Woodward, had bought a recipe for powdered gelatin, it was called Jell-O. Now, gelatin
had two problems. One problem was that it was an unfamiliar commodity. Before this time,
gelatin was something you made yourself. You boiled cow's [INDISTINCT] or fish bones for,
like, an afternoon, and it was smelling horrible and disgusting. And you did that to extract
the gelatin. However, they'd figured out how to do is to take gelatin and to create a sheet
of it and then powder and then grind that sheet up into a powder. But then the notion...
And then you would reconstitute it with water. But the standard American home in those days
didn't use gelatin either as a dessert or a salad topping, and so it was unfamiliar
concept; you know, you could use gelatin in any meal. Then there was the effect of the
branding, Jell-O, which was also unfamiliar. So, they had a--they had a demand-generation
problem. They also had--because it was a part of a larger food company, Genesee Pure Food,
is they had this fleet of trucks. Now, this fleet of trucks was largely to serve the local
merchants to deliver boxes of foodstuffs. But they thought, "Well, maybe what we'll
do is we'll just go door-to-door and we'll sell--we would explain to people what this
gelatin thing is door-to-door." The problem at that time was that there was a--to sell-door-to
door in late 1800s, you need a license. That license cost money and took time. They didn't
have the time or the money, so they're like, "Okay, there must be a loophole," and there
was. The loophole was that you could--you need license to sell door-to-door but you
need no license to give away things door-to-door. This was allowed--this was so that a few could
give out religious pamphlets. No doubt, they came out on some free religion rules. So,
what they said is, "Okay, so there is the trick, we need to give something away. What
should we give away?" And so, what they eventually came up with was this; a recipe book. They
invented this beautiful book of how to cooking with Jell-O, and some of the greatest illustrators
of the day, including Norman Rockwell and others, created this, you know, this pamphlet,
initially, and then a book that was sold or was given away by the millions. So what they
would is that they go door-to--door, hand out this book. Now, the book is useless without
the ingredients; a recipe book needs ingredients. They would go then to the merchants, and they
will say, "You're about to have a flood of people coming in here asking for this new
product, Jell-O, and you should stock it. And here in the back of our truck we have
lots of boxes of Jell-O." So what they did is they created demand by giving away a product
that was useless by itself and then satisfied that demand by selling it to the merchants
which required no license. And there--and that was the beginning--King Gilette did the
same thing with razors and blades, although it's a complete urban myth, by the way, that
King Gillette ever gave away razors. He didn't. What he did is he sold razors as a discount
to banks and then the banks gave them away as part of a save-and-shave campaign; very
clever. Once again, the razor is useless without the blade and so, ultimately, you know, you
got one thing for free but you bought another. Now, this is... This is the model and today
we have--you get your cell phone for free, especially if you work at Google, and you
pay for the minutes. This is form of free is not a new economic model. This form of
free is a trick. It is called a cross subsidy and the reason it's a trick is that it's not
really free, you're paying. You're paying sooner or later. You're not paying now; you're
paying over time; you create it by giving away one thing for free; you created an annuity
and a way monetize someone over time. We in the--you know, we see this in many places.
"Buy one get one free" is not free, "Free gift inside" is not free, you know, even loss
laid in stores are pretty quickly paid back. So that's 20th century free. 20th century
free is not really free because the underline cost of the products are not on zero and so
you need to pay them back pretty quickly or else you go bankrupt. That is... That defined
free in the 20th century. Now, what we've seen in the 21st century is a different economy.
This is the economy not of Adams or razors but of this, the virtual swords. The difference
between economy of Adams and the economy of bits is something that, you know, again, you've
internalized. But it was formalized by the likes of George Gilder, Michael Carlson, by
Kevin Kelly, and "New Rules to a New Economy", Nicholas Negroponte in "Being Digital, and,
in a sense, Stewart Brand in his original phrase, "Information wants to be free." All
of them understood that there was something different about information economies and
bits economies. And the basic difference is this, Adams economies are inflationary; they're
based on scarce resources, be they raw materials, land, labor, et cetera; they tend to get more
expensive over time. Free can only be a trick in atoms economies because the marginal cost
production and distribution are nonzero. Bits economies are deflationary; they get cheaper
over time. We knew this from--going back to Moore's Law, but what happened with the Internet
is we took Moore's Law's deflationary force, which is 50 percent every 18 months, and we
added to it the deflationary forces of storage, which is 50 percent every 14 months, and bandwidth,
which is 50 percent every 12 months. And this triple play of deflationary forces, processing,
storage, and bandwidth, created, you know, an economy where the underlying--the marginal
cost of reproduction and distribution are falling by about 50 percent a year. So, whatever
it cost you guys to stream a video on YouTube today it will cost half as much as that a
year from now and so on. This is... Now we've had moments in history where industrial economies
had deflationary episodes. When we went from muscle power to steam power, we had a deflationary...
It was cheaper to do something; steam was cheaper than muscle. But then again, you've
got inflationary again when we went from steam to electricity. Suddenly, deflationary--you
know, step function and then it got inflationary again. Bits have been going 50 years and they
appear that they're going to be going for many more years. These are based on, you know,
you understand the underlying physics of why this is. And what's interesting about these
three forces is that each one is based on different physical properties; in the semiconductor;
quantum properties for the processing; plutonic process is for bandwidth; and mechanical processes
of magnetic density for storage. But each--but in all cases, we've got a long way still to
run. So it looks like this is the first deflationary economy that's going to run decade after decade,
and that is unique. And what that means is that zero becomes an inevitability. Hall was
the first person to sort of, you know, put this in economic context for me, and he described
it at the time as a sort of a battle of two French economists, *** and Bertrand, and
now I'm going to do violence to the subtleties on this one. But, basically, in the mid 1800s,
at the beginning of economics, we were wrestling with some very basic things; and one of those
things is, "Where does price come from? What sets price?" And, you know--I mean, Adam Smith
wrestled for years on the concept of, "Is price based on some intrinsic quality or character
of the products?" And eventually, of course, we came up with prices what the market will
bear, prices what people will pay. But there was a lot wrestling about these basics. And
one of the problems--one of the things we were trying to figure out was, "What about
competition? What does competition do with the price?" Now, you would not think that
competition was a new concept, but it was. And the reason was, is that we were just starting
to have similar goods. Before the industrial age, all goods were unique and you didn't
have head-to-head competition. With the beginning of the Industrial Age, you saw this a lot
in England with things like silverware and plates in China and cutlery and things like
that; we started to have similar products. Not only are the products mass-produced so
they were all the same within the same factory, but the different factories would have products
of similar quality. Now, again, before the, you know, even in those days when you were
starting to see similar products, you still didn't have marketplaces where the two were
head-to-head. But they could imagine that someday you will have a world where you would
have true competition. The question is what would happen to price? *** argued that
the manufacturers would conspire. They would conspire to keep capacity off the marketplace
to prep price up. You know, if the demand for teacups is 10,000 a week, you don't want
to make 20,000 a week 'cause that will press the price down. So what would happen is that
they were--there would be some sort of signaling between the manufacturers to keep capacity
off the market and they would have a cartel, a behavior. Bertrand, a few years later, looked
to that and argued just the opposite. He started that rather than compete on capacity, they
would compete on price. And what would happen is that they would not take the broader good
of the marketplace into consideration. They would instead use their own good, the good
of their own company, and it would be preeminent, and they would undercut their competitors
until--to gain market share, until they hit the marginal cost of production. So that if
it cost $10 to make a plate that they would compete their way down 'til the price was
$10.10, or whatever. And it broadly that--in a competitive market price would fall to the
marginal cost. And this was considered a completely theoretical debate for about a hundred years
until we created two things. Well, on the Internet, we created, first, the most competitive
market the world has ever seen, the barriers to entry are zero; the ability to replicate
a new product is infinite; and we also created the marketplace where the marginal cost of
production and distribution is close to zero. And so what these totally theoretical economic
speculations from late 1800s did is essentially define the law of gravity online. And what
that says is that zero becomes an inevitability of--you know, because zero--the marginal cost
of production is close to zero, then the price will go close to zero. And as a matter of
fact, people will tend to round down to zero itself because the psychological benefits
of zero as opposed to any other price are so great. And if you don't make your product
free, someone else will. Now, the products aren't exactly identical but they're often
close enough that free tends to win. And so, what this created was a situation where free
becomes not so much a choice-- not so much an option but inevitability in the marketplace.
You know, the products--your product--for any given class of products, free will be
out there. It is one of the prices. You either make it your price and compete on something
else, making money out of something else, or you find a way to compete with free by
selling something that adds additional value. And the reality is we do both. The first pass
of the Internet was to apply the 20th century form of near-zero marginal cost free which
was the media business. Radio is free to air; televisions are free to air; the marginal
cost of reaching the nth viewer was close to zero. And so what we did is we max--we
used the sort of, you know, the new economy at that time which was the amazing ability
of broadcast to reach additional people with no additional cost and use that to create
mass audiences. Then we monetized those mass audiences by selling attention, audience attention,
to advertisers, and economists call that a two-sided market. One side is free, producer
to consumer, and the other side is paid, advertiser to producer. And that is--in the first wave
of the Internet, that's what we did. We used the marginal cost economics of the Internet
to create mass audiences and we slapped ads against them, ads against them, those very
same display ads that we were using in print and we created a two-sided market. Then the
second way of the Internet was Google and you did the same thing, but you created a
new form of advertising that was [INDISTINCT] matched to the granular nature of the Internet
itself. It didn't require mass audiences, it works as well for mass, for the generalist,
for the specific, for the mass and the niche. What is also great about it is that, of course,
the Internet was agnostic as to the nature of the biz moving over it, unlike broadcast
which is really one to many and designed to entertaining once it [INDISTINCT], the Internet
is scale-agnostic and so it could work for services, for custom things. You know, on
the Internet, every television channel is unique to you. In broadcast, that can't be.
And so what we've--and so what we did is we'd extended that media business model beyond
media to cover services and software and everything else. And then, over the past five years or
so, mostly after the dot com bust, we invented the first new business model, I would argue,
and that is Freemum, which--the free plus premium equation which I'll get to. My slide
is slightly out of order, but I want to give one more story from the history of digital
economics. This is a story taken from Kevin Kelley's "New Rules." But it was ... In 1963
the transistor had just been invented and commercialized by Fairchild, and they needed
to gain market share. And at the time they were competing-they want to compete for the
UHF tuner market and--which is dominated by RCA with the tube at the cost $1.05-it cost
over $100 to make everyone of the Fairchild's 1211 transistors. And yet they wanted--and
which is functionally identical, actually functionally slightly superior, but basically
did the same job as the tube. So what they did is they realized they needed to match
the tube for price. Now, they assumed--there was enough of the kind of understanding of
quantum effects and scale effects of semiconductors to know that the price would come down. But
they had to make a bet. They had to make the bet that the price would come down by 99 percent.
So what they did is they priced the 1211 at $1.05, matching the tube even though it cost
them $100. The effect was they gained more than 90 percent of the market overnight. And
two years later, with all that volume, the price not only had come $1.05 but even lower
to 50 cents and they could make money. Now, one of the cool things about digital-free
is that it sort of--it sort of makes a mockery of all of the lessons that we've been told,
you know, that "There's no such as a free lunch," et cetera. But the biggest mockery
is that is that old joke that says that, you know, "I lose on every product but I'm making
up--make it up in volume," it turns out to be exactly the way some semiconductors work.
You can lose money on each one but you make it up in volume, which is to say that the--that
scaling of products up reduces its cost, you know, so fast that you can sell ahead of your
price. You can sell it not at what it cost today, but what it will cost you tomorrow
because the--because, you know, Say's law, "Supply creates its own demand," that the
lower price will create so much more demand and we'll find so many ways to waste these
transistors that the volume will bring your manufacturing efficiencies down even faster
than you had expected. And so, this is what low price can do. And, as you know, transistor
is now free, essentially, and we waste them--and we waste them by using for things that no
one have ever intended before because they cost so little that we don't have to--don't
have to consider its underlying expense. I'm going to talk about Freemum a bit, but first
I wanted to address one of these things you hear all the time that "You can't compete
with free" argument. The music industry has been saying this a long time, how unfair it
is that music is free because you can't compete with that. Well, that's rubbish. You can compete
with free. And a company you're familiar with this had perhaps the longest history of this.
These are the sort of the five--the four decades of Microsoft's competing with free. 1970s,
the computer industry was a hardware business. It was one dominated by IBM and its microcomputers
and mainframes, and software was something you got for free. You got the tapes for free;
it came along with the hardware. And Microsoft as a software company, a heretofore unknown
creature said, "Look, if you want software companies like us to exist, if you want--if
you want it to be a commercial business of creating software, you're going to have to
pay for software." And so, this famous letter, open letter of the hobbyist, Bill Gates, wrote,
explained the underlying and central structure and tried to get people to pay for what they
used to get for free. And that worked pretty well. So, many people did and the notion for
paying for software became accepted. Then in the 1980s they had to compete with free
in a different way. Now they're moving to the desktop and their competitors, WordPerfect
and others, were bundling free applications software with the computers. Now, again, the
marginal cost of production of--you know, marginal cost of putting a software on our
computer is zero. There are some opportunity cost, which is perhaps that's the sale not
made, but the expectation would be that if you got WordPerfect free in you computer,
you'd use WordPerfect to save your files and WordPerfect if you'd learn the key commands,
you've all remembered that, and that when it came time to upgrade you would pay for
your next version of WordPerfect. So Microsoft had to--who was selling Word and Excel had
to compete with the bumbled-free software. So what did they do? They created Microsoft
Works which was a way to match the competitors on price, it was fee, and lock them into Microsoft
file standards. And they--and WordPerfect is essentially no more, you know, no longer
a force in the marketplace because Microsoft used free to compete with free. In 1990s,
they dealt with piracy in China first. Piracy is the marketplace imposed when the price
is zero on you. If you don't do it, you know, the animal forces of digital economics will.
The pirates can make the price--can duplicate the CDs and DVDs for, you know, for no marginal
cost and they--and as a result, although the pirates sell it a low price, it's cheap in
the marketplace, as far as the manufacturers are concerned, the revenues are zero. So what
Microsoft did actually is, not what you may think, which is, you know, send NATO in. Instead,
they complained a little bit, but secretly they weren't that upset in their rare moment
of candor. Like I said, China is a developing economy. If they're going pirate a software,
we'd rather that they pirate our software because someday they will have developed.
They will be able to pay for software and then they'll be hooked on ours. I'm paraphrasing.
"Hooked" may not have been this word. And that, in fact, works. China did develop. As
a matter of fact, China developed faster because Microsoft did not--was not incredibly, you
know, brutal in it's crackdowns on piracy because they--because free stuff lowered the
cost of entering computing, lowered the cost of computer, over all, it accelerated China's
adoption of computers, accelerated China's development, and essentially ensured that
China would be ready to pay for software faster. So that is--so keep that in mind because we're
going to come back to it. But at the same time, it was fighting free on another front,
which is the browser. And Netscape was giving away the browser for free and to sell the
server. Microsoft may have once entertained ideas of selling browsers, it did have some
proprietary web technologies at that time, but they clearly had to match the price. So,
they not only gave away the browser for free but they bundled it with every computer, something
that Netscape could not do, and that created some Antitrust issues, which we would also
come back to. So now we had, you know, this decade and Microsoft's competing with the
open source; Linux, Apache, MySQL et cetera. It turns out that you can compete with open
source. You know, open source have been going long enough that we'd now understood pretty
much how the market plays out. You have two markets. You have the very price-sensitive
market, and then you have a risk-sensitive market. What you--you know, today, Microsoft
competes very well with open source. Enterprises tend to buy Microsoft, and big, big companies
would tend to buy Microsoft products, not always but some––but many do, banks and
such, and others would tend to buy--tend to use open source. What Microsoft turns out
to be selling at this point is not software. What they're selling is a contract, a service
level agreement. What they're selling is a phone number that you can call when things
go wrong. So what Microsoft is selling is piece of mind. They're selling risk reduction.
What they're selling is an insurance that this would do the job that you required. Now,
what's important about that is that if you are a CIO of a big company, you don't care
as much about money as you care about not getting fired, not having the whole system
fall down, et cetera. So, this service-level contract is actually quite enticing, and when
you look at the companies that monetize the open source, Red Hats and IBM, et cetera,
once again, they're selling the service; they're selling the phone number; they're selling
the support they're selling the risk reduction. So, what Microsoft ended up doing was again
using the software--it's essentially sort of saying, "We're not in the software business
anymore. We're in the risk reduction business, and whether this is sort of appropriate for
your needs or just that we have a contract obligation to serve your needs, that's what
you're paying for." Now, what is interesting is what they're doing now. Microsoft has just
decided to make their older enterprise software free to startups. There's something called
Biz Park (ph). If you're less than three years old and less than a million dollars of revenues,
you can get all of Microsoft's enterprise software for free. And what's interesting
about this is that's exactly the Chinese piracy model. What they're saying is, "You're young,
you're developing. If you're going to use free software, we'd like you to use our free
software. Someday this low cost of entry will help you develop faster. Once you've developed
faster and you're ready to pay for software, we'd like you to pay for ours." So once you
passed a million dollars or three years, you have to pay and then a hope would be that
you're hooked on Microsoft's software and you'll buy theirs. So what's interesting is
that the Chinese piracy market was foreseen, you know, widely as its parable thing turned
out to be the exact right business model for the emerging web business market where the
pirates are now matched--are now replaced by startups and entrepreneurs and other young
companies who are largely influencing the marketplace of tomorrow. So, I wanted to end
with a couple of tactical things about Freemum which really the most interesting. I think
Freemum is the first 21st century business model. Freemum is free plus premium, and it's
the inversion of the old free sample. So you go into a department store, you got sprit
of perfume and, you know, 1 percent will get the free perfume and 99 will pay. You know,
Starbucks has a slice of a muffin, 1 percent will get a taste of free muffin, everyone
else will pay. The marginal cost of that is none, zero, and so you need to--you've got
to be limited in what you give out. Freemum is just the opposite. You give away 90 percent,
you give away 95 percent for free, what you do with that free, free becomes a form of
marketing. [INDISTINCT] have explained to me the Google strategy is the max strategy.
Use free to maximize your reach; maximize your sampling; maximize the consumer awareness
of the product. Then the consumers try the product and self-identify as different consumer
classes. Now, some of them will say, "Hey, free is good enough for me." But some of them
may say, "I want more." And the question is, "What more do they want?" And those people
who want more become the premium. They're the flicker pros to the flicker. They are
the, you know--in the software [INDISTINCT] they're the ones who say, "I want features,
or I want more capacity or storage or et cetera." And what we find, broadly, is that every product
is different and every market is different, and trying to find [INDISTINCT] your products
into the frees and the premiums requires understanding exactly where are people are willing to pay
more. Once they use the product and they love the products, they become pricing sensitive.
And what we find is that people who convert... There's two ways to buy software online. One
is the source say, "Hey, subscribe, or you can't use it." What you get there is you get
obviously 100 percent of the users are paid, but the trim rates are very high. And a lot
of them feel cheated. They didn't know what they were getting. In the Freemum model where
people try it first and then are up sold or convert to the paid thing only when their
usage patterns are established. They find the trim rates are much, much lower and they
become price-insensitive. They are your best customers because their making a switch for
the right reason which is that they've tried the products, they understand it, they get
to realize it's valuable to them, and price becomes less important than the utility of
the product itself. The "Wall Street Journal" is an interesting example in Freemum. A lot
of people are portraying the newspaper wars as being free versus paid. But it's not. It's
free versus Freemum. And Murdock is very clever about this. And Alan Murray who runs washintonjounal.com
gives the five rules of web--of newspaper content. And the first is that you need both,
free and paid. So that--OK. Many people don't understand that it's as propulsive at it is.
The second is quite counterintuitive. You would have thought an exclusive is exactly
what you can charge for, right, its unique content. You know that--you know, you can
only charge for scarcity and exclusives are, by definition, scarcity. Why do they give
away their exclusives? Because if they don't, people will report on their exclusives. You
know, as "TMZ" exclusively reported yesterday, Michael Jackson has died. You know, the people
were exclusively reporting, in a free context, get all the traffic... I mean, it only takes
only person buy subscription to tmz.com and then reports on it elsewhere and... So that's
their concern. Now, the reason--eventually what they end up doing is they... And then
we go to three, "Don't charge the most popular content on your site." What they're doing
is they're saying--to refer back to my last book, "The Long Tail", you've got the head
of the curve which is the really popular stuff. That's the high-traffic figures; monetize
that with advertising. Then you got the tail of the curve. Its niche is specific. At that
point, people--the traffic levels are too low to advertising but the engagement levels
are much higher. This is metals trading news. At this point, people know why they're there,
it's relatively unique because there's less competition in the marketplace for that kind
of news, and is often responding to people's professional interest, which is they are price-insensitive.
It's so meaningful to them that they'll pay almost any price. In this gets back to Stewart
Brand's original comment, you know, that "Information wants to be free," which is exactly half of
the statement. The statement was, "Some information wants to be free because digital economics
allowed it to be so. And some information wants to be incredibly expensive because its
value to you is so great." And so, what we end up is we get abundant commodity... Generic
information wants to be free where specific customized relevant information can be very
expensive. So what you'll see with "The Wall Street Journal" and others is that the deeper
you go into the, you know, into the details of the sections and their subject, the more
likely they are to charge. When you go into their archives, the more likely they are to
charge. The narrow is--the tail is paid and the head is free. And so, what we find is
we're giving away the head, selling the tail ... We are monetizing the head with the media
model and monetizing the tail with the Freemum model of direct revenues. Both of the models
are free but you don't use the same on across the boards. And the analogy here is, I think,
video games. I would encourage you... As you're looking at the kind of evolution of Freemum,
the two markets I would encourage you to look most closely at are the video game market
and the iPhone Apps market. Video games are fascinating. This is the--this is the third
silver disc business to drop the silver disc. Obviously, we know what happened with music;
the silver disc is gone, music became free. The industry prospered, except for the labels.
Every other aspect of the industry used free successfully to create celebrity; create recognitions;
to create sampling; and then they sold towards merchandize licensing; Apples or a lot of
iPods;, all of that was based on free. Only the labels suffered. Then software did the
same thing. Software moved online to software as a service, and that used the Freemum model.
And now, the video game industry, starting first in China and Korea, and now the United
States is moving from a packaged consumer goods model where you're selling a box for
$50, the silver disc online, and free to play becomes the default mode. And what you see
in these games--and you know them as Club Penguin, Neopets, Webkinz, Maple Story has
a picture there, but most of these things is that--what's fascinating is where do they
charge? It's free to play, but at what point do you invoke the price tag? And every game
is different and they try not to make it punitive. You try not to create a two-tier society where
paying users have, you know, like superpowers and [INDISTINCT]. Instead there's two ways
to get power. You can earn this with your time and labor, or you can buy it. So this
is the classic time-money calculus. With Maple story, just to give you an example, when you
die in the game, as a free user, you respond in a span point and you trudge back to where
you were. If, however, you buy a reincarnation stone, you're reincarnated right where you
were. If you want to go to another world, you have to wait for the bus which is actually
just a server, it's a server mirror that at a certain point they kind of cue up everybody
who's going to switch from one server to the other and move them all in their batch. Or
you can buy a teleportation stone, and not like the reincarnation stone, but the teleportation
stone which allows you to move--and move from server to server at will. Now, what's interesting
is that, the first ones completely arbitrary. Whether you reincarnate here or there is arbitrary.
The teleportation stone actually has some computational cost associates and you're doing
an inefficient server. But the point is that you're saving time. And time-money calculus
is the one universally. Young people have more time than money so they'll build their
virtual equity overtime. They'll go with the force and kill the squirrels or whatever it
is to--it takes to get your gold. Older people have more money than time and they'll pay
for convenience and labor-saving. People pay the lower risks on Second Life which is (our)
quite a game but has similar dynamics. If you want to put down routes and build a house,
you have to rent some land. That means that you've got--you've got persistence; you've
got continuity; that your laborers will remain. And so, that's another thing that people will
pay for. Status is a classic. If any of you have children who are playing Club Penguin,
you know, very quickly, down the line they're going to come to you asking for a credit card.
Why? They want a pet for their penguin. They want cooler hair, they want a better shirt,
they want a carpet, you know, for their igloo, they want to go to a cooler land, et cetera.
These are all status things. They want it, they're engaged, they get the game, they want
more, and they'll pay for that. And as you realize, you're seeing this across the board.
You know, Facebook gifts and everywhere that people will pay for status once they're invested
in the reputation economy of that place. And then, finally, people will pay if you make
them. I mean, you can have this or, ding, time's up, you got to pay. Ping, is at the
end of the level, you know, you have to pay for the next out. They will do it if you make
them, but that's the worst of the possible options. Much better to find ways to sort
of, you know, to make them pay for things they immediately understand the value of;
they don't feel disrupted; they don't feel like there's a gun to their head; they don't
feel a nickel and a dime; they completely get the preposition. The other market place
that I'd pointed to is the iPhone Apps, Android Apps, et cetera, where the first wave was
you got $9.00 and you got free. And free maybe had add us but probably didn't. And then as
we get more clever, we ended--realized that what you typically have is two products. You
have the free form and then you have the paid form. Now, sometimes the free form will try
to up sell you, you know, take off the abs. Sometimes the free form will say, you know,
"There's more features so, there's more levels." And sometimes as we've introduced inter-app
payment processes, the form will be free and you'll just pay for more tracks for Tap Tap
Revolution, or you'll pay for more content on the fly, and that's the best ones because
it doesn't break the continuity of the flow. As you get to the point where you're wanting
more, you're really hungry for it, the price of this additional track or digital asset
becomes immaterial compared to the reward you're getting from the participation in that
it add up in its market place. So, I wanted to end on wanting credibly controversial note
which is Antitrust, and Google in particular. At this point, I'm just repeating something
that Alex is called--said in the speech, and we can continue this in the conversation offline.
But he made an observation which is that, when big companies, especially dominant companies
with quasi monopolies, use free. It may not--it may be policy and competition implications
that are not there when little companies do. And he drew the following analogy. Microsoft
is using its monopoly rent from Word and Office to subsidize its entry into Search. Google,
it using its--I'm not going to use the words "monopoly rent" here, but Google is using
its profits from Search to subsidize it's entry in to Office. When Microsoft does--uses
free, whether it's bundling software free with their operating system or distributing
its Internet Explorer, that is often considered anti-competitive. The trade analogy is that,
you know, in 1980's when the Japanese dumped memory chips in the U.S. market, selling under
cost to gain market share and drive out the competition, that was considered a trade violation.
And the question--and Microsoft, although the context has not been so much free as in
tying in market power and distribution efficiencies, there is the economic aspect to it which is
that, when companies that have a dominant position in one area use free, they're selling
under cost, right? They're selling under cost to gain market share. Now, it's perfectly
okay when 37 signals or some other startup uses free to gain market share. But what if
a company that has a dominant--that is deemed as being dominant and having a quasi monopoly
and one market uses free. Is it okay? Are there limits to where they can use free? Is
it analogous to the dumping argument of the 1980s, or is it entirely different? And I
think that this gets to questions of what is the market? What is dominance? You know,
what is fair, what is predatory, all these things or questions that will take a decade
to figure out. Christine Varney and FTC is going to start thinking about it now, maybe
someday these will get to the courts. I expect that over the next decade, we're going to
have to figure out whether free is an antitrust issue in this market place and I suspect that
the people in this room will probably part of that in one way or another. I hope you
guys--I think free should not be seen as predatory and unfair, but I would not be surprised if
others make the claim that it is. So, with that, I will end my Power Point and we can--we
best set up and turnover to questions. Thanks very much. By the way, the obvious first question
is, "Is the book free, and how can the book be free?" Putting aside, briefly, the hard
covers over there which are for sale, well, the digital forms of the book are free, all
of them, including Google books. I wished we had released yesterday, "Kindle", "iPhone
Apps", "Scribs", audio books, et cetera are free. The hard cover is premium. This is a
classic Freemum model, we believe in the book. We believe that the digital goods are an excellent
sampler, but we believe the physical book is superior form for enough people that small
a percentage of a large number will be a good market. All right now, we will find out this
week whether that's true or whether free books--free books satisfy demand or stimulate demand?
We'll see. >> Okay so, we have mikes on both sides of
the room. Please raise your hands so we're able to capture this for YouTube. What's your
first question? >> So, I wonder how this works out in telecom
where the marginal costs of a cell phone call is also zero but it doesn't seem to have paid
out in the same way. >> ANDERSON: So, the question was, in telecom
how does this work out? Well, I mean, actually telecom uses free all the time, right? SO,
long distance phone calls are free on cell phones, right? So, they demonetized the long
distance market to increase usage and adherence and attachment to that carrier. What digital
economics allow you to do, whatever the marginal costs of something to zero, it makes price
arbitrary. Price becomes, almost entirely psychological not economic. In the Adams economy,
prices pretty much are function of costs plus, right? In a digital economy, price is any
number you want. And it's not about economics, it's about what is the consumer going to value,
what are they going to respond to? If you can give away night time minutes to sell day
time minutes, if you can give away long distance to sell monthly subscriptions, again, it's
completely arbitrary. You're simply going on consumer psychology and that's how telecom
is using it. Skype, of course, decided to sell nothing, and because they could. And
so what they're doing is capturing consumer attention to bring out some way to monetize
that. Yes, sir? >> You are saying that the companies could
charge for premium content. Do you think that there is another obstacles that charging is
so difficult for the, you know, for the buyer to pay is that there are no convenient ways
to pay. People probably would pay for a premium article but, you know, spending 10 minutes
filling out the forms is no option. >> ANDERSON: Absolutely.
>> And, in that being, what do you think about micro payments versus subscription?
>> ANDERSON: I'd actually deal with this quite a bit in the book, the failure of micro payments
today. There are two barriers, there are two explanations for the failure of micro payments.
The first is the one you just said, which is that the transaction itself is more troubled
than the revenue opportunity. The second... And I think overtime that's going to get easier,
the transaction systems are going to get better. The second one is psychological. The way to
think about is this, a price, just think of any price raises a flag in your head and that
flag is the sort... Is it worth, that flag? And you know, that flag is work. We have to
think, "Do I want this? How much do I want this? What's the right price for it?" You
know, "How should I pay? Do I have enough money? I might want something else?" These
all fall under the phrase of "mental transaction costs." Just processing that sort of, should
I pay, should I not, is work and we are nothing if not work avoidance machines. So, what Free
allows you to do is it allows you to thoughtlessly consume. You don't have to go to that thought
process. Now, this is what the venture capitalist Josh Kopelman calls the Penny gap. The difference
in one penny and zero cents is economically insignificant but psychologically black and
white, night and day. And the problem with Micropayments is that they all have the psychological
downsides of a price without any of the revenue upsides of a real price. So, what's happened
now? When you hear now—when people talk about Micropayments and you actually look
at what they're talking about, they're talking about 99 cents, $1.99. Micropayments used
to be fractional cents. And now they're a buck, 2 bucks, 3 bucks those are just transactions.
And at that point, when the transactions engines become so efficient, be it, you know, the
iPhone, iTune store or the emerging, you know, the emerging sort of transaction system within
Facebook, within iPod Apps, iPhone Apps, PayPal, what you guys are going to do with Android
as well. That side of the barrier at entry declines. Is that it's you don't have to pull
out your credit card, you don't have to type in your details, it's just a thoughtless click.
The question is, those psychological cost remain, how far can the price go? How far
down can that price go where it can still—-the revenue upside compensates for the psychology
downside of a real price? Is it 99 cents, is it 79 cents, is it 29 cents? You know,
we don't know. But it's now almost entirely or will be going forward almost entirely about
psychology, the consumer psychology of price, rather than that structural problem of the
transaction hassles itself. Yes? >> Yes. I wanted to ask you, what are your
thoughts on Radiohead's experimental awhile back "Within Rainbow's" where they asked consumers
to name their own price, most people ended up paying nothing for it. Would have they
been better off just saying, "Here's the free and we'll make our money off concerts and
off premium CDs and everything like that." >> ANDERSON: Yes, that's a great question.
So, what Radiohead did is a classic product segmentation strategy. So, in the old days
of music you pretty much had three prices. There was the album, the single, and the tour.
So, it was like, 15 bucks, 5 bucks, and $85, okay. So, what Radiohead did, is they basically
introduced not three skews or 15 skews, but something like 35 skews; different forms of
the album. So, there was--actually those were just the products. There were the individual
tracks; they were tracks of different bit rates; there was the vinyl; there was the
CD; there was the box set; there was the box; there was the book; there was the video; there
was the concert tour; there were the T-shirts. You know, it went on, I'm sure there were
the action figures—-I didn't see it, I wouldn't be surprised. So, what they did is rather
than having three prices they had, you know, they had at least 30 for the skews then you
can name your own price. So, they had an infinite continuum of prices ranging from zero all
the way to front row seats in Wembley Stadium that's, you know, at $500. What that allows
you to do is it allows you to maximize the economic value in the market place. By letting
people choose their own price, they were able to, you know, to get the people who-—not
only the people who want to pay less but also the people who are willing to pay more. By
having this difference--by saying, "Well, it's not that you get the album, the single
or the tour but also for our super fans, there's the $100 box set," they're able to tap that
side of the market as well. And by using Free, as one of the options, they're able to, not
only maximize the reach and let everyone sample the album, but they also got lot of attention
for the experiment in the first place. The result was, they had the most successful tour
in their history, they had the most box set sold-don't hold me on this number, I maybe
making it up-I think they sold a hundred thousand of the box sets at the very high price. It
was one of the, I think, one of the most successful albums, if not, the most successful album.
It was a total economic win along all lines and they did it by being clever about offering
lots of premiums to go with there free. They segmented their products into lots of different
price categories and lots of different audience categories ranging from not very engage—-I've
never heard Radiohead just want to sample one—-all the way to, "Oh my God. I love
Radiohead. I want everything they do and more." And that, I think, is what all of us have
to do, I think, we in the media industry, we need to figure out, we know... I'm a magazine
editor. We have Zero, that's our website, $5 that's our newsstand price and 80 cents.
That's $10 a year divided by 12 issues, 80ish. That's not enough. Where's our 29.95? Where's
our 39.95? Where's our 99.95? Where's our Radiohead? Where's our pet for our penguin?
You know, how are we going to find ways? We use Free, we use Free successfully. Now, we
need to figure out how to use free to charge more. How to segment our audience into—-not
just hose who came in at those three prices, but those who, maybe if we could have packaged
what we do in different ways including the physical experience, we could charge a lot
more. If you followed recently the scandal over the Washington Post charging $25,000
to have lunch--dinner with the editors, that was their effort to find a pet for your penguin.
Yes. >> Do you think that Free has changed the
users' or the consumers' concept of quality? >> ANDERSON: Yes, that's a great question.
It is also addressed somewhat in the book. But there's—-you know, you get what you
pay for, right, there's this conception. Interestingly, there's another author named, Ellen Ruppel
Shell, who came out with a book at the same time called "Cheap: The High Price of Discount
Culture." But there's a general... So, it's all based on your starting position. I tell
the story of the "Village Voice" which is a weekly newspaper in New York that went free
and everyone said... You know, when they went free their quality declined. You know, that
you get what you paid for and that the free reflected the underlying values. Not actually
true, I would argue, but that's what people thought. But no one thinks that Google is
a worst search engine because it's free and that's because our expectation, our correlation
between price and quality was never set above zero, and it's all based on that. If a product
starts at zero, you don't use price as a test of quality. If a product starts at a price
and goes to zero, you might think that it was worth less. Now, there are exemptions
to the rule, Yahoomail, I told the story of Yahoomail versus Gmail in the book. Yahoomail
was 5 megabytes for free and anything more you have to pay for it—-I think it was 29.95
a year—-they--with the release of Gmail, they [INDISTINCT] that business. They basically
went to infinite storage for free, forever. Because Gmail had entered the market at, I
think, a gigabyte for free, people didn't think that Yahoomail had declined in quality
as a result. In other words, Gmail reset the consumer correlation between price and quality.
I think in the digital space, in the physical space, I think we have a very clean connection
between price and quality. And if it says, you know, if it says—-if something is free
and, you know, pair of socks is free, you probably should expect they're not the best
socks in the world. In the digital space, I don't think we make that same correlation
because we understand that the subsidies can be so defuse and the underline cost are so
low that we don't assume that only crap is free.
>> Okay, our last question. >> ANDERSON: We have another over here but
if we have... >> When you were talking about the newspaper
business, you were saying that, you know, you can have these articles that were sort
of the mass articles and you distribute them for free and then you have the niche articles
and you charged for them. Does that create an incentive for writers and for reporters
and what not to only seek the niche articles, right, especially if you have search engines
like Google driving a lot of the traffic? You know, you don't need the mainstream article
to drive traffic to your niche article because you have the search engine.
>> Fox: Right. >> Does that cause, you know, the mainstream
article to just vanish? >> ANDERSON: No. Maybe I should be little
more precise about that. My point is that, you monetize the mainstream articles with
advertising and the niche articles with direct revenues. So, they're both paid. They just--one
uses the medium model the other uses the Freemum model. Now, obviously, you know, the head
of the curve, the really popular ones, not only serve the virtue of being able to pay
for themselves on volume, but they're also great marketing tool. They create awareness
and they drive demand down the tail to the paid ones. So, I would argue that the usual
incentives of, you know, write about celebrities will remain, good or bad as that maybe.
>> I guess you have time, you're up. >> Is it time, we have one question over here.
>> ANDERSON: Yeah. >> I have the same question about the quality
associated with Free and as a follow up, isn't there a sort of skepticism that's associated
with Free also especially in the digital world? Say, like, "Oh, what's the catch?" I feel
like Google 10 years from now is going to say, "We charge $100,000 a year to use all
of our products, you know what I mean? So isn't there a type of skepticism that is also
associated? >> ANDERSON: Yeah, that's a—-it's great
question. And what we've learned overtime as we talk to more and more companies about
this is that very important that people understand your business model, up front. Because if
it's like free and there is no apparent business model, they're rightly suspicious that you
are going to sell their personal information or there's going to be some privacy to that
suddenly once you got hooked, it's going to be very expensive. If it's obvious of how
you're making money, it doesn't matter whether I'm paying as long as I can see that somebody
is paying then the logic of the whole thing makes sense and I don't feel that it's a set-up.
So, the fact that Google is using a third party to subsidies Search, reassures me that
you are not going to, you know, someday, you know, Window's going to pop up and say, "Like
Google? Start paying." Now, you may do that in the end, but the underlying logic of business
model is apparent enough. So, that again, invokes psychology. People use to expect that
were going to pay sooner or later, and it was just a question of what's the catch? Now,
they just want to insure that somebody is paying. It's probably not them, but as long
as somebody's paying, the whole logic of the whole thing kicks in and they can address
the product for what it is rather than watching for the catch. I think it's all we have time
for, thank you so much.