Making Money When Its All Free

-- By AlexeySokolin - 17 Oct 2011

Transitional Stages Matter

On the horizon is a world where cultural goods are distributed freely and quickly to everyone who wants them. Such a world fundamentally challenges the conception of private property in ideas and the businesses built on that foundation.

Now is a time of transition. Transitional stages are important because define how power is distributed and the principles that will drive cultural norms. It matters how we move from intellectual property regimes of today and how we restructure our industry. This paper explores various economic models which have emerged to address the needs of tomorrow.

Economic Axioms for Digital Goods

Digital goods such as software, music, video and text have a Marginal Cost of zero. It costs nothing to duplicate and transfer an mp3 or ebook file.

They are also called pubic goods and are nonrival, non-excludable, and subject to free ridership. While some may indeed be emergent (e.g., music, literature), many require significant capital investment. In other words, they have a non-zero Fixed Cost. Western economic theory suggests that because public goods are free to consume, they do not get produced at adequate quantity or quality without substantial subsidy. Free software may suggest otherwise.

Examples of digital with high fixed costs goods are blockbuster movies (Harry Potter), high-end video games (Starcraft), and professional software (Adobe Photoshop). These goods cost nothing to share, but large sums of money to create, requiring employees, office buildings and financing.

One of these is not like the others. As you were just pointing out, we can make free software without those inputs. Your category of "professional software" includes an image processing program, but not operating systems, databases, and office suites? Even about Photoshop you are talking through your hat. Evidently you have never encountered the GIMP.

Photoshop, Starcraft and Harry Potter are all digital goods with high fixed costs. I do not think they are different in kind. Sure, you're right--each has a free software equivalent. For Photoshop or Illustrator, there is the GIMP or Inkscape (I've been designing websites since 2000 and have made a choice based on basic usability to stick with Adobe). Free to play games in 2012, like Path of Exile, ape games made by commercial studios with a large budget in the 1990s. Lots of Harry Potter fanfic and fan-made Fallout movies are out there for those that want it. Perhaps there is something here about innovation (corporate structure needed?) versus polish or idea extension.

Do you draw any lines between using a pirated version of Photoshop vs. using the free software equivalent which copies the interface and functionality (Photoshop first launched in 1990, the Gimp first launched in 1996). If not, then why develop free software alternatives at all? Is there a difference between MegaVideo? and user generated video? The idea that anarchist networks can better generate software doesn't, for me, explain why content not generated by anarchist networks is also free (aside from redistribution motives that are provided as tautology). I have definitely benefited from the economy of sharing of commercial content (from Napster to Kazaa to BitTorrent? ), but I don't know how the Gimp provides any ethical justifications for sharing content made otherwise. Thus my interest in an alternative that makes sense for my set of values.

This also includes the cost of financing which is a function of the risk of the venture. Higher-risk ventures require a higher rate of return as part of the fixed cost—start-ups and movies are expensive to finance.

That depends. All this really turns out to mean is that expensive things are expensive, and that money is sometimes expensive too. But, for example, extraordinary films are made all the time on budgets that are infinitesimal by Hollywood (or even Bollywood) standards. Expensive celebrity "actors," expensive promotion and expensive distribution (financed of course by purchases of expensive money multiplied by risk premium) are irrelevant to the production of compelling, informative, elegant and intelligent culture. So all this supposed economic sophistication is, to put it mildly, actually beside the point, as it is when the pharmaceutical industry talks about the cost of drugs.

My cost of living is the cost of living in New York city, and I don't have a choice of whether the money I use is expensive or not (aside from moving out of here, which I am not inclined to do, given that I moved here in the first place!). If we want to consume expensive things, like Harry Potter, and not the much less expensive but next best thing, then they remains expensive. Cost is only irrelevant if you don't consume it. Which brings me back to--if the extremely cheap or free version is totally out there, then why are we so compelled to BitTorrent? the expensive one? What does that preference signal? That we prefer "actors"? That we like celebrities? That seems to make them pretty relevant (and explains their compensation).

A Survey of Business Models

Pay for Product. In the most conventional business model, people pay directly for the product or service they consume. The product has value, and the buyer is willing to pay up to their personal assessment of that value. The parties split that value assessment such that the buyer is better off and the seller is better off, subject to bargaining power (e.g., monopoly). Ethical concerns arise when the seller uses coercive political force to appropriate most of the value to itself, as in the case of Telecoms overcharging consumers to use free-to-produce text messages. Prior to the digital economy, large firm organizational structures were needed to build distribution infrastructure and spread out costs through economies of scale. Pricing power followed. In the digital economy, goods are free to distribute and the asymmetric capture of rents by oligopolies becomes difficult to justify. Even more controversial is the distributive result: those unable to pay rents are deprived of access to public resources.

Sharing. The free economy shifts the balance of power to consumers, providing on demand access to any digital good. For some, however, sharing raises ethical questions about misappropriation from other consumers. A classic free riding problem can occur, such that one group of people benefit from the contribution of another group of people (producers, sellers, or the buyers which pay and subsidize fixed costs) without their consent.

No. You're not describing the sharing economy, you're repeating bilge washed into your brain by the "content" oligopoly. In the sharing economy, producers and distributors have consented to the terms of sharing. They make production and distribution possible that otherwise would not occur, they give everyone value, and everyone has agreed to share. All the supposed problems, including the "ethical" problem you arrogantly claim we have, are therefore non-existent. I explained all this more than a decade ago in Anarchism Triumphant. Creative Commons, Free Software, the Wikipedia, and many other pillars of the sharing economy have arisen since, as I said they would. You're welcome to disagree about how all this plays out, but you're not welcome to distort the argument by assuming falsehoods.

This was imprecise. There is nothing ethically difficult for me about Free Software, Creative Commons, Wikipedia, Kickstarter, Anonymous, etc. They are all awesome. I have no reason whatsoever to invent business models for things that are free by design. What I feel squishy about is the idea of sharing media and software that are designed as "expensive" without paying for them. I, for one, think there is value in the higher price of good design (I know you disagree, but let's call it aesthetics). Yes, it's all bits and the square of 767354 looks like copyrighted MSFT code. But, just because a chair is made of molecules and I'm made of molecules doesn't mean that we are the same. So I do think that there is a distinction between things made in the free economy and things not made in the free economy. And I think taking not-free to free requires some justification other than "we could do it just as well" and "people really like free things." Is there a solution where both sides are happy?

For institutions structured to produce costly digital goods, this interferes with generating market compensation and leads to antagonism with a powerful and otherwise beneficial distribution channel. More people see the content but less profit is made.

Not necessarily. And at any rate that tradeoff is radically reductive. Is your view of the overall significance of the total replacement of the world's proprietary encyclopedias by Wikipedia, for example, captured in the proposition that "more people see the content but less profit is made"? Should we include in the cost-benefit analysis that we all have instantaneous access everywhere to information in a fashion that has changed everyone's life for the better? That we have democratized the production of knowledge in ways that will continue to transform the nature of human thought? That we have provided an experience of intense beneficial collaboration to hundreds of thousands of people around the world? Less profit? Even if that is true, who gives a shit? Economic rent is tolerable because necessary. Since when has it become an end in itself?

I agree on Wikipedia, and other examples of culture that come from the coil-internet as you spin the planet. I have no idea whether most of our production will be as such. I'd love it if Free was the dominant economy. My language referred to file sharing, not goods produced in the way you describe. As for your rhetorical question of when has profit become an end to itself--I would say that question defines how a market economy works (a descriptive statement, I hope). Good or bad, that seems to me to be beyond the scope of what you taught in class.

Freemium. Services can be tiered: one group of people uses a free product, while another pays for additional functionality. Examples include Flickr, and Dropbox. Usually the free product is targeted for personal use and the premium product is for professional use. This model is ethically attractive: all groups understand how revenue is being generated and opt-in to the system. The difficulty is reaching appropriate scale and getting enough free users to convert to premium such that the entire venture is funded.

No, the difficulty is that the need to cripple the technology in order to support the service-restriction model distorts the technology. Flickr is not better than federated photo sharing through this thing we invented about 7,000 days ago called the World Wide Web. Dropbox is a ridiculous form of stupidity-reinforced privacy-destroying cloud storage than which all Columbia students already have better alternatives available for free that no one tells them about. There's no ethical attraction in making technology deliberately worse so that you can also sell people something they don't need at prices they shouldn't have to pay. Your analysis is only attractive if you're prepared to ignore everything that someone who disagrees with you might say about it.

If Flickr and Dropbox are so useless and terrible, then why are they happily used by millions of people? Dropbox is extremely convenient, and it is free up to 2GB of data. The limitation that turns that service into a pay service (more space) is identical to my limit on email from Columbia (more space). Does Columbia University distort the technology because they don't want to host my attachments over 1GB? And I already pay them! Dropbox doesn't owe me anything--how is their service restriction an affront? As for free alternatives, I am all ears to suggestions that don't require me to run a server or my friends to FTP into it.

As an aside, a "suggestions" page would be a welcome addition to this Twiki--a table with alternatives for stupidity-reinforced privacy-destroying websites that all of us duped Millennials have come to love. Something like this but for apps rather than desktop programs.

Advertising and Data. Instead of making money from a product directly, businesses can generate large user-bases and sell their audience. For example, 96% of Google’s revenues are from advertising. Attention is scarce and valuable to companies that sell products for which people pay directly. An alternate spin on this is to sell the underlying behavioral data of the user-base. The data provides insight on what happens next and how to best market to this population. While ingenious, these two approaches can erode the user experience, as well as their secrecy, anonymity and autonomy.

Differentiated Marketing. Another way to escape zero pricing is to market a product so that it is not a commodity, and commands a premium. Technology commentators advocate connecting with fans and generating a reason to buy with value separate from that of the free product, such as a superior experience or emotional connection. While functionalists tend to dismiss branding as brainwashing, some believe that well-marketed products create legitimate emotional benefits. The pricing can be done either by tiering, or using auctions. In the auction set-up, people self-discriminate and bid up to their willingness to pay. For some this is zero, for others it is a positive value. Successful examples are Radiohead’s “In Rainbows” (1.2 million downloads), Nine Inch Nails ($1.6 million in one week), and Kickstarter ($75 million raised). Inherent in the auction model is a utility so positive that people pay as expression of gratitude. The creator must be particularly good at signaling the differentiation of the good from a commodity such that price does not equal marginal cost.

Adjacent Product Bundling. A version of freemium and marketing, some businesses give away their core product using the distribution mechanism of sharing and make money but selling related services. A popular musician can bundle t-shirts with their music, an artist can sign limited edition prints of their digital drawings, an expert blogger can do speaking engagements on top of her regular content.

How Do We Decide

Structuring the digital economy raises a host of ethical considerations. Are we achieving the right distributive result? Are we coercing one set of people to benefit another without consent? Are our core privacy principles being undermined? Business models adapt to the philosophies we choose. We must do so carefully in this transition.

This conclusion doesn't mean anything.

We're a little better off than we were in the last draft, but some significant problems remain. Your supposed ethical objections to sharing depend on outrageous factual falsehoods uncritically repeated. Your analysis of the "profit economics" of culture contains both some factual inaccuracies and some serious theoretical blind spots. The theme of the essay now sometimes seems to be that the future should be postponed if possible, for reasons that aren't very clear except that profit in the hands of a few is inherently good and the betterment of humanity is not enough of a reason to reduce it. The primary argument on the other side—that knowledge has always been strictly rationed in human society, unjustly, but necessarily, for reasons we can now avoid, thus allowing billions of existing human beings to escape ignorance—is not even acknowledged, let alone answered.

I am not sure where to go with this based on your feedback. To me there are two parts of your course: the descriptive and the normative. As a technophile, I find the descriptive stuff fascinating. The normative stuff--that which you justify with "from each according to ability, to each according to her needs," and proclaim what is the Greater Good of the Many is harder to swallow. That's not a technological argument, but a philosophical one. I don't even disagree--I certainly want knowledge to be infinitely available. I like Free Software solutions, how they expand the pie for humanity, and am humbled by the movement's accomplishments. But when your argument comes into contact with non-anarchist production, I would like a stronger philosophical footing. My attempts to find one based on personal alignment got shot down. So I tried in this draft to take out any strong normative statements, and be descriptive of what I've seen in the for-profit startup ecosystem.

As a for-profit startup founder, I am more interested in building an innovative company than in participating in emergent culture generation. From my perspective: I can work 70 hours a week at a job and contribute to projects I love on my time off, or I can work 70 hours a week on something I care about. It's not a hypothetical. And I have to work because money is expensive. So it is not particularly practical to me that today "profit economics" is on the outs and I should instead be giving away my product for free.

If there's a useful direction I could take this, glad to hear it.

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