Making Money in a Zero-Marginal Cost World

-- By StevenWu - 13 Nov 2009

I. Introduction

It is hard to generate revenues from the sale of zero-marginal cost goods. Although regulatory protection has previously guaranteed profits, these protections are becoming easier and easier to circumvent. Companies are turning to alternative methods to generate revenues. There are four predominant methods of generating revenues based on zero-marginal cost goods. (1) Sell other goods and services bundled with zero-marginal cost goods. (2) Deliver zero-marginal cost goods in a more effective way. (3) Use zero-marginal cost goods to learn about the users of the goods. (4) Deliver zero-marginal cost goods with advertising. The first two focus on being able to generate monetary profits directly related to zero-marginal cost goods. The latter two attempt to generate capital other than monetary profits.

II. The Strategies

1. Selling Zero-Marginal Cost Goods Based on Bundling with Other Goods

Zero-marginal cost goods can be bundled with other tangible and intangible goods to generate a profit. Examples of tangible goods that can be sold include human labor for modification and servicing, hardware to consume the zero-marginal cost goods such as video game systems or computers, and freedom from legal harassment particularly for the music and movie industry. Examples of intangible goods that can be sold include charity from sponsoring a productive activity, community from Apple products, authenticity from bottled water, and emotional security from paying for antivirus software. The very act of paying for the product is intimately related to these feelings of charity, community, authenticity and emotional security.

2. Selling Zero-Marginal Cost Goods Based on More Compelling Delivery

Delivering zero-marginal cost goods more compellingly can also generate revenues. Convenience is particularly important for pornographers. Pornography is readily accessible for free on the internet, yet subscription sites are still profitable. Subscription sites allow individuals to have the convenience of downloading large amounts of high-quality pornography from one high-speed location. Such sites are usually easily navigable and provide a high degree of reliability. Users are willing to pay for this convenience even when pornography is available for free. Forcing users to update their zero-marginal cost goods on a frequent basis is another way to compel users to pay for a subscription-based service for the goods. The reliance on updates is particularly important when users interact with one another. Although the software of massively multi-player online role-playing games can be replicated, users are willing to pay for subscriptions because the games are routinely updated and updates are required to interact with other users.

3. Delivering Zero-Marginal Cost Goods while Collecting Data

Providers of zero-marginal cost goods can also generate profits through data aggregation. Examples of this include Google's search engine, Facebook and G-mail. Data aggregation is useful for three reasons. First, businesses can use this information to develop products to solve the user's problems. Second, businesses can use this information to design more effective advertising campaigns. Third, businesses can sell this information to other businesses that can use the two aforementioned strategies.

4. Delivering Zero-Marginal Cost Goods with Advertising

Zero-marginal cost goods can also be delivered with advertising attached. Delivering zero-marginal cost goods with advertising does not directly increase the flow of funds from users to producers. When software providers are paid, they are paid by businesses looking for advertising channels. Users are not expected to provide monetary capital. Rather, they are expected to provide their attention, which will be converted into capital at a later date through an increase in brand value. Advertising is particularly effective when combined with data aggregation.

III. Combining Strategies

There is often a struggle between users and providers who utilize the latter two strategies. Users can block advertisements or impede data aggregation. Users are especially reluctant to suffer advertising and data aggregation if they know of other products that are equally effective without similarly annoying features. Once users are familiar with alternative products, providers must pursue the former two strategies. However, if the latter two strategies are performed in a highly competent way, they become the former two strategies.

The conflict between users and providers of information exists because data aggregation or advertising is a hindrance to the user rather than an asset. However, data aggregation or advertising need not be a hindrance. Users are often willing to incur costs so that their data can be aggregated or so that they can be exposed to advertising. If data aggregation and advertising can be seen as features rather than as defects, then they become one of the bundled goods or one of the more effective forms of delivery. Data aggregation and advertising can be seen to serve the user's ends.

As I was writing this paper, Pandora Radio introduced me to Coldplay's Viva La Vida. It fit my musical tastes perfectly. It then tried to play Britney Spears's Blackout. No thanks. Do I seem like a Britney Spears fan? I guess a computer program wouldn't know better. One day, Google may tell me what to read, Amazon will tell me what to buy and Facebook will tell me whom to be friends with. They will offer me better recommendations if I let them aggregate my data. They will play at my fears. They will toy with my subconscious. They will do it in subtle ways so that I do not quit using their products. Lady Gaga's Beautiful, Dirty, Rich is on. I love that song.

Steve,

I've added a comment box to make it easier for others to comment on your paper, since you have invited us to do so. I have also commented by reference on your paper in my own, available here.

-- DanaDelger - 18 Nov 2009

I edited based on your paper. Thanks for the thoughtful paper. It was fun to read. Also, thanks for the comment box.

-- StevenWu - 19 Nov 2009

I thought the analysis was good, Steven. You might wish to consider adding some hyperlinked text for some additional factual support. For example, you could add statistics on MMORPGs demonstrating your claim that subscription-based games are preferred over free games. Or link to reports on AdBlock? for section III. I feel confident you already know this, but the earth/chain icon in the edit screen creates the external link formatting just in case.

One other thought I had was that a fifth strategy is giving goods for free with donation encouragements. Or maybe this ties in with your discussion in section II.1.

It was a smooth read. I would welcome your thoughts on my essay if you are so-inclined.

-- BrianS - 19 Nov 2009

The first category that you identify may be defined too broadly. The term “bundling,” suggests the tying of non-zero marginal cost goods to zero-marginal cost goods either literally or technologically. For example, creating videogames coded to play only on a proprietary platform. This kind of activity is different in kind from simply laboring to produce something that people will feel motivated to pay for due to feelings of “charity, community, authenticity, and emotional security.”

The second category that you establish seems to suffer because it does not distinguish between creating a compelling distribution system and compelling people to use your distribution system. Updates that create strategic incompatibilities coerce the customer in a way that a simple offer to distribute content efficiently at a price does not.

The third and fourth category that you identify could probably be collapsed into one category. Every content provider that is in the advertising business has a strong incentive to mine data in order to increase the value of its advertisements. This fact begs the question of who really provides content with ads without collecting any user data.

Finally, I agree with your general point that data mining can create a desirable kind distributional efficiency if it is used by content distributors to reduce consumer search costs. I do, however, recoil in fear at the thought of Facebook being able to correctly suggest who I should “friend” and where I should go to meet my new friend for lunch in order to have a meal that we will both enjoy. Are you really willing to embrace such a future?

-- StephenClarke - 19 Nov 2009