Thesis project

As Chris Anderson notes in Free! it is true that you can’t compete with free in the economy of bits in the long run. If your marginal cost is close enough to zero, either you or your competitor will stop charging for the service. With the cost of storage, bandwidth and processing power halving each year, this day will inevitably come.

So, how do you compete with a good enough service such as YouTube that offers high functional quality, rich features and solves the users problem (a demand for video clips) for free? One thing is certain, price is taken out of the equation. In order to charge your users for a similar service, you would have to offer a hefty amount of extra value and somehow make sure that YouTube just don’t copy your model and offer it for free.

What you need to do is look at each part of the process that adds value to the end product for the users and firstly decide on if you could do it cheaper than your competitor (e.g. if you could stream high quality videos cheaper than YouTube) or, if in fact the customer is adding this value himself. If you can find a value-adding task that is in fact executed by the user in your competitors business, it might prove to be a deal changer. If you are able to carry out this task for the customer instead, that might be just the extra value you add to your service that beats the competition (note that this is without competing on price).

The most classic example of the opposite of this thinking is what IKEA has done to reconfigure the value constellation. By letting the buyers perform a value adding task (assembling the furniture), IKEA is able to sell it cheaper. The genius of this is that IKEA figured out that the customers value their money more than the time it takes to assemble the furniture, therefore customers take on part of the value creation while still feeling that they have done a bargain. This reconfiguration enables IKEA to keep a lower price than the competition.

But, think about what would happen if furniture was free. Would you choose to buy furniture from IKEA where you have to do some of the value adding yourself or would you prefer to get ready assembled furniture? Suddenly, what was a competitive advantage has turned into a major disadvantage.

So, how are users part of the value creation on YouTube? The most obvious example would be in their quest to find relevant and interesting material. Much of the value a user gets from using YouTube actually comes from his/her own ability to find relevant stuff. What if a competitor came up with a recommendation engine that took care of this value adding and served relevant stuff without the user having to participate in the process?

Suddenly we have a situation where the user pays for neither service, but gets more value (as in output of value minus participation in the value creating process) from the new service. That might be enough for a major shift in the competitive landscape.

Micropayments doesn’t work because they aren’t easy enough. Even if the amount requested is only a couple of cents, the transaction cost of just clicking through all the steps with your payment provider (in some cases providing all your VISA details and in other logging in with your e-mail and password) is often to high. For me at least, its rare to find information on the web that I figure would be worth this trouble without having the possibility to consume it beforehand.

This has however been a major reason to believe in the future of micropayments, they would work if they were one-click or even automatic. The evidence of this model would be the iPhone App Store, where buying stuff is so easy (only insert your account password) that the transaction cost of the payment itself becomes close to zero. I’ve bought tons of stuff in the App Store without even reflecting on if the application is worths it’s price (most applications are priced at a low 7 SEK).

However, something is missing in my transaction cost calcuation: the transaction cost of having to make a decision. Interestingly, this is the sole focus of transaction costs in Chris Anderson’s book Free! when he tries to explain the difference between price and zero price.

Chris Andreson refers to the George Washington University economist Nick Szabo’s concept of “mental transaction costs” (more on mental accounting). Basically the mental transaction cost is the value we put on not having to think about a buying decision, the mental part of our different feelings towards price and zero price.

These two transaction costs (the effort of the body in filling in VISA details and the effort of the mind to make a conscious decision) together with the price itself sum up to the total transaction cost of a buying decision.

What still bothers me is the App Store situation, how come my perceived mental transaction cost is so low in that particular setting? Could the App Store hold the key to the future of other micropayment systems?

While reading through Chris Anderson’s widely hyped book “Free: the future of a radical price“, I can’t help myself to think that the focus of the book is somewhat misleading.

As Chris notes, free is nothing new, it’s just a way of disconnecting the cost of the product and the customer’s direct expenses. What is new is that where the customer someway or the other always had to pay in the end, when the cost of digital goods approaches zero, there is nothing to pay. The cost of the product is zero and therefore the price can approach zero too.

This is an extremely interesting shift, but it is not driven by price but by cost. Its the cost structures that are changing and that is what has the power to affect an entire industry. Price is something entirely different and even though the end customer pays zero, the costs have to be covered.

New ways of re-configuring the value chain (such as analysing the users behaviour and presenting information accordingly instead of hiring an editor) and lowering costs (such as replacing humans with algorithms) are the real game changers here.

Still, Free is a really interesting book and I’m sure to get lots of inspiration from reading it!