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Chris Anderson. “Free: The Future of a Radical Price” (Hyperion; $26.99);

(This blog is based in part on Malcolm Gladwell’s recent article in The New Yorker).

In the 1990’s a group of University of Illinois professors invented a web browser they called Mosaic, before anyone knew what web browsers were — then built a company called Netscape that gave it away for free. Millions downloaded Netscape. Netscape made its money by leveraging its widely-known brand name to sell server software. Its IPO in 1996 was a watershed — Wall St. noticed how Netscape’s share price soared by 10 times days after its launch, and decided this was the ideal way to make money. ( The result was the dot.com bubble that exploded in March 2000.)

Now the editor of WIRED magazine Chris Anderson has written a fine book that makes an exceedingly powerful yet simple point.

In the digital age, many products are bits and bytes. Digital products have zero marginal cost to reproduce. According to economic theory, in a competitive industry (and all digital industries are competitive), if marginal cost is zero, then the optimal price is zero too. Hence prices will gravitate quickly to zero — and they do.

Anderson’s previous 2006 book The Long Tail was equally insightful and spoke about how tiny niche markets can become huge businesses by leveraging the Internet.

Anderson writes: “In the digital realm you can try to keep Free at bay with laws and locks, but eventually the force of economic gravity will win.”

That law of gravity is the inexorable downward pressure on prices, driven by competition and zero marginal costs.
A great many industries have simply ignored this law and have reached the edge of bankruptcy, or even stepped beyond it. The music industry for one. Newspapers for another. 

In this blog we often observed how the global depression creates opportunities, through major shifts in business paradigms. The “free” paradigm is a good example. Is your product one that has low or zero marginal costs? If so, can you find ways to provide it for free, while still building a powerful organization with strong top-line and bottom-line performance?

* Can you offer some ‘lead’ products for free, while charging for others?
* Can you leverage what Anderson calls “Fre-mium” strategies: 90% of customers get the product or service for free, as a standard commodity, while 10% of customers whose needs are more special pay for ‘premium’, and generate all the revenue. 
* Can you introduce your product for free, then find a way to begin charging for it (realize, this is highly difficult, people hate to pay for what they once got for free)?
* Can you price “virtually” for free? (i.e. charge for maintenance contracts, etc., that generate the revenue)? Rolls Royce sells jet engines at low prices, but makes all its profit on high-margin service contracts.

Incidentally, there is a mathematical proof that a zero price is optimal.

Total Profit is Revenue (Price times Quantity) Minus Total Cost (TC).

Take the derivative of total profit with respect to quantity (Q), and equate to zero, in order to find the maximum. 
Result: d(PQ)/dQ – dTC/dQ = 0
Or: Price = Marginal Cost

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Blog entries written by Prof. Shlomo Maital

Shlomo Maital
July 2009
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