How to survive in the age of the free-lunch economy

Type: Think Pieces Written by Dr Madsen Pirie | Thursday 31 August 2006

By looking at various industries, Dr Madsen Pirie explores how through time certain products become cheaper and cheaper. He underlines how the the companies react to changes in their products price. For instance, how the music industry reacted as downloading tracks became free. As this keeps happening with more and more industries, how are they going to be able to support themselves?

The libertarian science-fiction writer Robert Heinlein famously observed that “there ain’t no such thing as a free lunch," but today’s producers and retailers are increasingly faced by a public which expects one. Our economy has a habit of turning what was once an item of value into a throwaway freebie, and the economics of this are making people rethink their ideas.

When George Orwell was Down and Out in Paris and London, he observed that homeless people, then called “tramps," would pick cigarettes from the gutter and sometimes roll their own from the residual tobacco (there were few filter tips in his day). The problem was matches; these were a valuable commodity among the destitute community, for few would spend the few coppers a box cost, even if they had the money. Now, of course, free matches are widely available, and not as many people buy them. They use free boxes which carry advertising, or they use cheap disposable lighters at a tiny fraction of what a lighter used to cost.

The obvious question is “What happened to the match companies?" Given that not nearly as many matches are sold, how do they make their money? Some of them went out of business, some diversified, and some survived by making the boxes and books of matches which are given away, making money from the companies which offer them, rather than from the public direct.

The public expects its matches free, providing an early example of a trend which has encompassed more and more products. Record companies made money by selling at several pounds each pieces of plastic which cost pennies to produce. The value lay in the intellectual property. The physical object that changed hands in the form of a vinyl disc, a tape, or a CD, was the way value was exchanged. The rise of the personal tape recorder caused some concern, because teenagers didn’t regard it as stealing to copy a friend’s music. Record companies began insisting that DJs talk over the opening of the records they played so that listeners could not record a “clean" copy.

The rise of the internet and of file sharing caused a major change in the dynamics of that market. Purchasers, many of them young people anxious to stretch their pounds, found they could share files with each other, and that advancing technology gave them top-quality copies. Music sales went into decline, and there were fears for the industry itself. The solution has been paid-for downloads such as those bought through Apple’s iTunes. Purchasers have been found to be ready to pay a small sum to download legally, with increased numbers of them making up the lower price they pay. The music industry is breathing more easily, but no one doubts that it was the free product which forced the change.

A similar problem has been faced by the movie industry, given the high quality of internet downloads. The spread of broadband has led to the availability of illegal, but free, downloaded movies. It remains to be seen whether the iTunes formula can be replicated, with extremely low prices being paid in return for convenience, choice, and legality. One thing is certainly true: the people who made Hollywood movies a few years back never expected that their work would be given away free with copies of daily or Sunday newspapers, or that this would constitute rational and sensible economics. The point is that the promotion is worth it to the newspapers and their advertisers.

Newspapers and magazines themselves have had to adjust to the fact that people expect their on-line product to be free. Some charge subscription for access to their content but the publications which granted free access have usually roared ahead in on-line readership and potential value to advertisers. And they are the ones more likely to be cited and quoted, along with their writers, than the subscription ones.

People expect their on-line papers and magazines to be free, and the problem for proprietors is that some undoubtedly choose to read the free on-line copy instead of buying a printed one. The economics of the business include having to react rapidly, just like those of the movie, music and match industries. If people expect it for free, you have to work out other ways of making your profit.

Shed a tear for the phone companies that invested billions in converting landlines to fibre optic, only to see an explosion in mobile telephones which by-pass them. Then shed a tear for the mobile companies that invested billions in G3 licences only to watch the rise of voice over internet protocol (VOIP) services. When Skype offers phone calls free of charge, as they do for millions, for how much longer can the others charge money? People are beginning to expect free calls, just as they expected free matches. They are free in the sense that they cost nothing on top of what people are already paying for.

Other products and services are bound to follow. Food is not usually free, at least not yet, but it costs a fraction of what it did. The student standby of baked beans bought at 7p or 9p a can still costs money, but only just, and probably costs less to produce than some other goods already supplied free. It is quite conceivable that baked beans and other foods could be supplied free to customers, with the profits being generated elsewhere in the economic chain.

This is the point. The old model in which producers and middlemen took their profits from cash paid over by customers is looking dated. For many goods and services the money is made from advertisers, from people who will pay for customer lists, or from people who want to add value to their existing package of services. In an increasing number of cases their contribution to the economic chain is enough to allow the product to be offered free at the end of that chain. And if people obtain it free from one source, they are unlikely to continue to pay for it from another.

In the Star Trek series nobody pays for their food or appliances because these are generated by replicators, and come free, barring a small energy cost. We are by no means at that stage, but in the plethora of free goods and services, and in the increasing demand for free products by the public, we can begin to determine the shape of a very different type of economy.

This article originally appeared in The Business.