Friday, June 24, 2005

Free lunches - if you choose carefully from the menu!

The BBC News website recently had a very interesting piece about the entrepreneur Niklas Zennstrom, the man behind both the file-sharing program Kazaa and Skype, which lets users make very cheap or even free phone calls via the Internet based on the Voice over Internet Protocol, VoIP.

Zennstrom discusses the use of a business model where "some users are paying for services, but not everyone". Skype services are free so long as the caller and the person being called are both Skype users. Skype makes its money out of users who buy additonal services and who use Skype to make or receive calls from conventional telephone networks.

But, as Zennstrom comments, it is not unusual to provide services free to some customers while others have to pay. For example web based e-mail services like Yahoo!, or web-site hosting through Lycos are provided free, so long as you don't exceed the (now quite generous) storage limits. You can also view some of the online stories at the New York Times and Economist web sites for no charge, but you will have to pay (either through a subscription or for an individual download) to access other material.

What is the economic logic behind this? Didn't Milton Friedman famously tell us that "There's No Such Thing As a Free Lunch"?

One way of looking at it is that what you are getting is a free taster. Try out a little of it for free, and if you decide that you like it, maybe you will be happy to pay for more of it. Sometimes products are offered free (to everyone) at the beginning when they are being launched, in an effort to build up the customer base (see my earlier post on the importance of network externalities). But that's not what I am talking about here. For example in the case of Yahoo! mail so long as you stick to the "lite" version of the product you can continue to get it for free (although you will be exposed to advertising messages which will earn revenue for Yahoo!). You don't have to pay anything directly unless you want to move to one of the business "versions" of the product. "Versioning", as described by Shapiro and Varian in their book "Information Rules", is a technique for applying price discrimination. Customers select the version of the product that is in line with their willingness to pay. As we see this might be the free version.

Of course this doesn't mean that Friedman was wrong. There still isn't such a thing as a free lunch - somebody has to pay. But if you select carefully from the menu you can get what you want for free while those who are willing to pay for the full version, or to pay to advertise, provide the funds to keep the service available to you for nothing.


Post a Comment

<< Home