WPenner's Blog

It’s been 15 years since Chris Anderson’s article, “Free! Why $0.00 Is the Future of Business”¹ took the world by storm, causing the likes of Malcolm Gladwell and Seth Godin not to see eye-to-eye. Today, despite the obvious widespread benefits of capitalism and the fact that many things consumers used to pay for are now for free or very low cost, it is a system that is fighting for its legitimacy, with even the largest companies in the world struggling. How did we get here, and where might we be heading?

There is a large group of people for whom capitalism is illegitimate, yet continue to take part in the capital system by being customers and actively trying to change companies through activism. This has led some companies to question their own legitimacy. There are many suggested approaches to deal with this loss of legitimacy that go by different names: shared value capitalism (Michael Porter), inclusive capitalism (Lynn de Rothschild), conscious capitalism (John Mackay), compassionate capitalism (Mark Benioff), or JUST capitalism (Paul Tudor Jones). ²

Per Bylund, at the Mises institute, names an enterprise offering free (or below production cost) goods and services as a social good “social entrepreneurship” and distinguishes between social and market entrepreneurship. ³ His overall point is that “social” is less legitimate than “market” entrepreneurship. To get there, he makes some emotional points that will resonate differently with different people, but two are more theoretical and worth examining. He suggests that 1. For the price charged to consumers to be so low, the people paying for the company’s offerings must differ from the people receiving them. 1. This encourages entrepreneurs to set the cost of acquisition (i.e. customer facing costs) below the cost of production. This third party payor obscures the market value of the product or service and hides important “you’re going broke!” signals from the entrepreneur.

These arguments miss important market dynamics. In a B2C business, it seems uncommon for the person paying to differ from the person using a product, yet it happens all the time. Parents, for example, pay for things their children consume daily. In the world of B2B, this practice goes from common to standard — the purchasing department never uses all of those pencils or drinks all that coffee. So, that a third-party payor somehow breaks capitalism and radically obscures the value creation/capture mechanism seems incorrect.

Perhaps Bylund is really arguing a bigger point: that charging nothing is not a valid business model. Which brings us back to capitalism as a legitimate enterprise in the 21st century and to Chris Anderson’s contention that free is the new price of doing business.

Anderson details several business models that support some people receiving value for free, including: 1. advertising — content paid for by advertisers; 1. cross-subsidy — costs paid by consumers purchasing related consumables; 1. labour exchange — costs paid by service providers for work; and 1. freemium — costs for free users paid by premium users; 1. zero marginal cost — the cost of delivering the first item pays (or almost pays) for the cost of subsequent purchases

These all shift the payor away from the consumer, the very practice that Bylund finds illegitimate and yet are legitimate business practices taught in every business school. It’s important to notice that there is still no free lunch, just a matter of who is paying and when.

Towards the end of his article, Anderson has a brief discussion on “externalities”. While economists think of business in terms of money, the idea of externalities is that there are many other human values that in any transaction may be more important than money. Third part payors probably expect benefits of these kinds when paying money for particular results.

Any foundation or billionaire providing funding for social change fits into this class. These groups value keeping their money less than funding startups that have a close to 100% chance of going bankrupt. The big pay-off on the surface is achieving their social goal.

Bylund may even be subconsciously referencing this phenomenon when discussing the subjective nature of consumer valuation of products. He says consumers always trade something of less value (i.e. money) for something of more value (i.e. a good that solves a problem).

What needs to be addressed is the overall market inequities that develop because of shifting the payor away from the consumer. While Bylund argues that “free” obscures the value of a company’s offering to the entrepreneur, it also becomes opaque to the overall market. The consumer who believes their lunch was free one time becomes resistant to paying the actual cost the next time. The artificial devaluation of the value for that product or service ripples throughout the entire market and drives smaller players out because they cannot recover their costs of production.

This seems analogous to African countries receiving shipments of free clothes from well-meaning philanthropists. The unintended consequence was putting an entire industry of tailors, fashion designers, retail businesses, and so on out of work.

This problem is worth further consider, at some point: has the free business model unlocked theretofore unimagined amounts of wealth for creators and value for consumers? Or is it self-inflicted harm driving the economy to the brink of collapse where the only survivors are the astronomically rich who can afford to give everything away until their competition disappears and they achieve a monopoly?

Photo by Krists Luhaer on Unsplash.