There is no free (free) lunch

Airlines often use marginal pricing to sell empty seats. But for airline seats the marginal cost does not tend to zero dollars and hence the seats are never free.

Sep 1st, 2009
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Airlines often use marginal pricing to sell empty seats. But for airline seats the marginal cost does not tend to zero dollars and hence the seats are never free. There is no free lunch.

By Jeff Bairstow

I have just finished reading the much ballyhooed book Free: The Future of a Radical Price, by Chris Anderson (New York, Hyperion Books, 2009). The actual reading of the content did not take very long—the book has fewer than 250 pages of text in a small format with relatively large type. As might be expected from a former writer for The Economist who is now the editor of Wired magazine, the book reads like a series of quite stylish but somewhat once-over-lightly magazine feature articles.

Foolishly, I bought my copy—from Amazon, list price $26.99, sale price $16.99, Kindle price $9.99. I could have bought a “free” version as an audiobook (somewhat abridged) directly from the book publisher’s website. You will note that none of these editions is truly free. Neither the author, nor the publisher, is in the business of giving away free copies of “Free.” There is no free lunch.

So here’s what the author gives as an example of a “free” product. Back in 1961 a single transistor cost $10. Today, Intel manufactures incredibly complex microprocessor chips containing more than two billion transistors that sell for around $300. You could say that’s a price of 0.000015 cents per transistor. But, of course, you can’t actually buy a single transistor at that price. You just try it. So, no free lunch, here.

This is hardly a startling revelation despite the author’s hyping of “this radical idea for the new global economy.” Almost 20 years ago, Andy Rappaport, a market researcher with the Boston-based Technology Research Group suggested that transistors would essentially become free as the costs of integrated circuits continued to fall. And Bob Lucky, then director of AT&T Bell Laboratories, was fond of suggesting that, by using optical fiber, the unit cost of transmitting a single bit on a long-haul link must tend to zero.

I noted these long-term market developments in the very first column I wrote for Laser Focus World in January 1992. Economists have long been familiar with this phenomenon—they usually call it “marginal cost pricing.” Airlines often use marginal pricing to sell empty seats faster as the date of the flight approaches. But for airline seats and many other high-cost commodities the marginal cost does not tend to zero dollars and hence the seats are never free. There is no free lunch.

Another “free” market model is the magazine whose printed pages you are now reading or viewing the electronic version on the Internet. If you are a “qualified” subscriber, you will receive the magazine every month without having to make a payment. So Laser Focus World appears to be free to you. But, wait a minute! Who pays for the writers, the editors, the paper, the printing, the postage, and so on? The advertisers do, naturally. And when readers buy advertised products, they also pay some fraction of the advertisers marketing costs. So there is no free lunch here, either.

Naturally, if you are a monopoly supplier, all bets are off anyway. Take Microsoft, which has incredible profit margins for the Windows operating systems. No doubt Microsoft could sell its retail version of Windows for a few dollars and still make a handsome profit. You can be absolutely sure that Bill Gates will never let that happen. No free lunch on Bill, anyway.

Anderson’s first book, The Long Tail (Hyperion Books, New York, 2006), also struggled with the reasons for the explosion of Internet retailers. In this new book, the author advances a number of “free” theories, none of which appears to work consistently.

Not willing to concede defeat, even on the weakest of his theses, Andersen closes the book with a list of some 50 business models built on his concept of “free.” These range from the old tried and true giveaways, such as banks giving away “free” toasters to new account holders, to the more unreal models such as giving away virtual property (on Second Life). In my view, there are no free edible lunches here, either.

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Jeffrey Bairstow
Contributing Editor
inmyview@yahoo.com

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