More on why usage-billing makes more sense than freemium.

A fairly undeniable fact regarding Kamikaze pilots is that they didn’t only remove themselves from the gene pool, they also took out a lot of people who were simply playing by the ‘normal’ rules of war. A similar fate awaits not only those companies hell-bent on distributing their wares for free, but also for many of their more conventional competitors who will get caught by the shrapnel.

Like all good sects, the free web has its own illustrious leader, Chris Anderson, author of the The Long Tail and Free. Anderson has refined his notion of free over time, so that it now no longer focuses primarily on the ad-funded model, preferring instead the trendier freemium concept. His philosophy can be summed up by his phrase “give away the head and charge for the tail”.

The core of the free argument is based on the notion of the distribution cost of digital content being close enough to zero to round down. Hence it doesn’t cost much to give away your product to anyone who wants it, and in doing so you create an opportunity to offer a premium version to your grateful users.

In a review of Anderson’s new book, New Yorker writer Malcom Gladwell points out that even if the distribution cost is very, very small, when you multiply it by a number that is very, very large, for example the number of videos streamed by YouTube, you still get a figure with lots of digits before the decimal point. In other words, if your free offering is really popular, the zero-distribution-cost part of the freemium equation stops being true.

Taking this idea one step further, let’s look at an industry that really does have zero (rather than negligible) distribution costs, and was already doing free when the internet was just a twinkle in TBL’s eye.

Nothing New Under the Sun
In eighties England there were only four TV channels. It is an uncomfortable fact that just about any Englishman in his forties can tell you what triple salco or puissance mean. There were two ad-funded networks, ITV and Channel 4 – the other two channels were provided by the ad-free BBC.

Things must have been pretty sweet for the two ad-funded networks, and even the arrival of two fledgling satellite broadcasters (BSB and Sky) towards the end of the decade did little to upset the status-quo. Most commentators argued that people were very unlikely to pay for a service that could be had for free – and they were almost right. The cost of buying rights to premium content combined with the expenditure required to operate their respective services pushed the two struggling entrants into a shotgun marriage, and British Sky Broadcasting (now known simply as ‘Sky’) was formed.

But then a strange and important thing happened. It appeared the Great British Public was not universally happy with its free programming. It transpired that many people were actually willing to pay for content. Some wanted to see live sporting events, others wanted to see films before they were available to rent, and others just liked the idea of surfing dozens and dozens of channels. Whatever the underlying reasons, the UK rapidly transformed itself into a nation of satellite viewers – as evinced by receiving dishes now nestling like mushrooms on every other house in the UK.

In a move that must surely give the freesters food for thought, an entire nation went from free to paid – and moreover in a industry with a distribution model that represents the best case scenario for free.

Nothing is Identical Under the Sun, Either
Okay, TV in eighties England is not the same as the internet now. Viewers had practically no choice, and the arrival of the satellite operators actually reduced the quality of the free offering, because the satellite operators bought-up the rights to the content people most wanted to watch. Barriers to entry are also very different: it costs a lot less to create a website than a TV network. This last point is important, because when there are only a handful of national operators, there is no real need to do any marketing – everybody knows who you are. One of the key aims of the freemium model is to get your service noticed by letting your free offering do the marketing for you.

Nevertheless the principle still holds: we have seen that under certain circumstances people are willing to pay for content - even in the face of a free alternative. And more to the point: people are willing to pay for the head (the most popular content), even if the (admittedly short) tail can be had for free. This is the exact antithesis of Anderson’s argument.

Any physicist or mathematician can tell you that while you can’t prove a theory with a single example, you can certainly disprove one. So does this imply the free web, and freemium in particular, is based on the incorrect premise that the easier content can be distributed, the less likely people will pay for it? Unfortunately not. Business is not science, and what holds in one market doesn’t necessary hold in another. But we have shown that the pro-free arguments, which at first glance can seem so alluring and self-validating, are in fact nothing of the sort.

That said, the disturbing reality is that, based on current alternatives, the free web – at least in the guise of the freemium model – makes a lot of sense. Or, more succinctly, in the land of blind web revenue models, one-eyed freemium is king.

The real problem, therefore, is not so much with freemium (chronically flawed as it is) - but with the lack of any viable alternatives.

The Paid Web
There are two basic ways of billing for stuff on the web: subscriptions and micro-payments. We have already argued strongly against subscriptions on this blog, and will therefore proffer only a brief summary here: subscriptions, whether on the web or anywhere else, are a form of lock-in. Users know this and so view them with suspicion. People don’t take out subscriptions to restaurants or shops, for example, because they don’t want to limit their future choices. Most importantly, they resent paying for something they either no longer use, or use less than expected.

Subscriptions can work when people are willing to exchange a degree of product choice for some sort of benefit (most often a discount). This can occur with magazines or newspapers, when the customer realizes they would have probably bought the publication anyway. But in the fast-moving world of the web, where people don’t know what’s coming next and so don’t want to limit their choices, and where there’s so much free stuff available anyway, subscriptions (even in the context of freemium conversion) don’t work.

As to micro-payments - the practice of charging a tiny sum for each incremental bit of service or content - Clay Shirky killed that idea long ago. He quite rightly pointed out that regardless of the size for the requested payment, the ‘mental transaction costs’ associated with an endless stream of tiny decisions rapidly add up to one big and annoying cost in terms of time (our most valuable resource) and inconvenience. Micro-payments are even worse than subscriptions.

A Thought Experiment
Einstein loved thought experiments (and look where they got him) – so let’s try one here. In a way it’s ironic that we’ve just held up newspapers and magazines as an example of how subscriptions can work in the real world, when these very same two categories are getting absolutely hammered on the web. So let’s balance the books and use newspapers as the basis for our though experiment.

Let us imagine a magical world in which a copy of a newspaper can be printed and distributed for free to every household in the world. Let us also imagine that each issue has a special microchip embedded inside. Many people will pick up their free paper every morning and throw it straight in the trash. Others may skim the front and back pages over breakfast and then throw it in the trash. But a certain percentage (dependent mainly on how good the newspaper is) will actually open it up and read inside. This is were the microchip comes in – it’s clever enough to tell when the newspaper is being read properly.

After an acceptable period of product engagement, it beeps and says, “Good morning, I can see you’re really getting into the paper today. How about we charge you ¢20 every time you read more than half a dozen articles?”. The reader has a little think and asks, “What if one day I don’t read the paper, or only read four articles?”. “Then we won’t charge you”, chirps the microchip. Our reader likes what he’s hearing, but he thinks a bit longer and then adds “Clay Shirky says I’ll rapidly get fed up deciding every morning whether I want to be charged for reading the paper”. The microchip was expecting this one: “Clay’s right. We only ask you this once whether you are willing to pay for reading the paper thoroughly. If you agree, you’ll just get a monthly bill, based on how much you’ve read”. “What if I find a better newspaper and stop reading this one?” asks the reader. “Then you’ll never hear from us again” says the chip.

Our reader puts the paper down and begins to reason: what’s my downside? I can’t buy a good newspaper for ¢20, and if I don’t read it, I don’t pay. No annoying interruptions. No sections I don’t have access to. I only pay for what I consume, and if I stop reading it altogether, it just disappears. Finally he exclaims, “Microchip dude, you gotcha self a deal!”.

Fantasy, eh? Not entirely. What a lot of people don’t seem to grasp, or at least leverage, is the fact that the web is bi-directional. This model can’t work for TV or satellite because they are broadcast mediums - the information only flows one way. But it can and will work on the net.

Not Quite Cloud Billing
We call this model micro-billing. One decision, one bill, very small payments.

In many ways it’s similar to the way billing works in the cloud, in that you only pay for what you use. But there are key differences. In the cloud, billing generally starts the moment you begin using the service, but micro billing uses a usage threshold, below which you don’t pay. It’s very important that people are able to try products without paying – this is the best part of the freemium model. It makes sense for content owners to leverage the web’s negligible distribution costs to get their products in front of consumers. The product functions as its own marketing device.

Micro-billing also has a maximum usage fee. In our thought experiment the threshold payment and the maximum payment were the same (¢20), but in some situations it makes sense for them to be different. The key point is that a potential customer should always be able to work out the most the service will cost. People hate getting into open-ended commitments.

Finally, a word on price. How can a quality newspaper only cost ¢20? Well, for the same reason you can find electronic gadgets in cereal packets: volume. With over one billion people connected to the web, companies with content that can be digitized have to learn to offset the loss of their semi-monopolistic status in the physical world, with access to this much larger, albeit more competitive, online market. In a key difference with the freemium model, all active users pay. Some may pay more than others – but they all pay. When you have a very large customer base and such low variable costs, you can charge much less for your product and still maintain a decent return on capital.

In the freemium model, on average 97% of people use a service without paying for it. This means the price for the paying users is much higher than it could/should be because 3% of the user base is effectively subsidizing the remainder. Micro-billing significantly lowers the cost of a service, increasing the likelihood people will regard it as good value, and hence sign-up for being billed

Sayonara Baby
Free to use (as opposed to try) is a dangerous trend, not least because it also punishes those current and potential competitors who can see it doesn’t make sense. Tim Cohn put it best when he asked “is free the new barrier to entry”.

Fortunately, the example of the TV market in England shows that all is not lost – it is possible to introduce a paid model into a market which was previously all free. But the model has to be right. Currently, there is no compelling paid model for the web, and so freemium wins by default.

We believe usage-based micro-billing is the paid model the web has been waiting for.