When you visit your dentist, you often get a free sample of name-brand toothpaste. They are very handy for short business trips when light baggage is desirable. But if you decide to switch toothpaste brands, you must pay full price for your regular supply.
Thus free samples are a means to promote physical goods. Companies give away a little hoping to reap big gains from selling most of its products. After all, physical samples cost real money to produce and distribute.
With the advent of digital goods, the marginal cost for additional “samples” is close to zero. Most of them can be given away if enough payers are willing to pay for the fixed costs of providing them. In effect, zero marginal cost makes it both cheap to give digital goods away (freemium) and profitable to give most of them away. They are cheap because there is little consumption rivalry (one person’s consumption does not reduce other persons’ consumption). They are profitable because more exposure generates more revenues from the paying customers. These paying customers could be advertisers who are interested in reaching more potential customers of their non-digital products (e.g., search engines) or vendors of customized versions of the free versions (premium vs lite). In other words, the freemium version serves as a come-on to the premium version.
Thus, while physical goods with consumption rivalry and excludability must be provided as private goods at positive prices, digital goods with zero marginal cost could best be provided as free public goods with just enough partial excludability to ensure profitability. Partial excludability to otherwise public goods shows how digital market can creatively solve the historically incompatible goals of maximizing consumer surplus vs maximizing profit. Free access to resources with surplus capacity would maximize consumer surplus, and partial excludability would ensure enough profit to sustain the resources.
The consumer challenge is the embarrassment of free-good riches under time constraints. Retirees no longer need to waste their time playing bingo or playing golf any more. They can even go back to MOOC-school for free. In such a crowded space, one wonders how many of these digital startups that provide free public goods will become profitable. Many of them are funded by venture capital hoping for a big payout which may never come.
- WSJ. 1/31/2009. “The economics of giving it away.”