Why giveaways are changing the rules of business

Asimple lyric explains the dynamic driving so much innovation in today’s post-industrial marketplace: “The best things in life are free.”

Never in history has so much innovation been offered to so many for so little. The world’s most exciting businesses – technology, transport, media, medicine and finance – are increasingly defined by the word “free”. Whereas WalMart, the world’s largest retailer, promises “everyday low prices”, entrepreneurs and ultra-competitive incumbents develop business models predicated on providing more for free. It is a difficult proposition to beat.

Google charges users nothing to search the internet; neither does Yahoo nor Microsoft MSN. E-mail? Instant messaging? Blogging? Free. Skype, the Luxembourg-based company that is now a multibillion-dollar division of Ebay, offers free VOIP – Voice Over Internet Protocols – telephone calls worldwide. San Francisco-based Craigslist provides free online classified advertising around the world.

In America, the Progressive insurance group gives comparison-minded shoppers free vehicle insurance quotes from its competitors. Innumerable financial service companies offer clients free tax advice, online bill payments and investment research. Michael O’Leary, Ryanair’s colourful founder, predicts his discount carrier may soon offer free tickets to his cost-conscious euro-flyers.

Of course, Milton Friedman, the Nobel economist, is right: just as “there’s no such thing as a free lunch”, there is also no such thing as a “free innovation”. These “free” offerings are all creatures of creative subsidy. Free search engines have keyword-driven advertisers. Financial companies use cash flow from profitable core businesses to cost-effectively support alluringly “free” money management services. Ryanair counts on the lucrative introduction of in-flight gambling to make its “free tickets” scenario a commercial reality. Innovative companies increasingly recognise that innovative subsidy transforms the pace at which markets embrace innovation. “Free” inherently reduces customer risk in exploring the new or improved – and bestows competitive advantage. To the extent that business models can be defined as the artful mix of “what companies profitably charge for” versus “what they give away free”, successful innovators are branding and bundling ever-cleverer subsidies into their market offerings. The right “free” fuels growth and profit. Technology has successfully upgraded King Gillette’s classic “razor & blades” business model.

All this freedom poses provocative challenges for global regulators and economic development champions. One company’s clever cross-subsidy is another’s anti-competitive predatory pricing. Ingenious subsidies inevitably invite invasive scrutiny. Look at Airbus and Boeing. American and European trustbusters certainly frowned on Microsoft’s successful bid to bundle “free” internet browsers into its dominant Windows operating system. Yet bundling “free” e-mail and other “free” online services into Yahoo and Google search engines was deemed legitimate. In trade competition, not all “frees” are created equal. Europe’s proposed “Google-killer”, the Quaero search engine initiative, for example, is itself a créature de subvention. “Free” competition with Google, Microsoft and Yahoo could prove expensive. However, regulators might argue that the ever-growing suites of cross-subsidised “free” digital innovations proffered by these companies unfairly compete. That is, these search engineers could take cash from their most profitable keyword advertising and use it to offer “free” Quaero-like multimedia searches. Good for cost-conscious searchers, yes; not so great for state-supported competitors.

The simple reality is that technology will continue eroding entry barriers to provocative cross-subsidy. The more digital or virtual a process, product or service, the faster and easier crafting clever subsidies become. Scale matters, too. Global scale facilitates global subsidies. Just as advertisers subsidise free Google searches, marketers can easily download advertising-supported “free” songs, videos and games into iPods, Sony PSPs and Nokia phones. Internet-based telephone calls similarly lend themselves to sponsorship: “This free call from your brother in
New York is brought to you by Tesco . . . please press #1 to accept . . . ” While that prospect will not thrill traditional telecommunications companies, consumers might appreciate the “free” choice.

Opportunities to add “free” value that matters in a networked world are expanding exponentially. Why wouldn’t Ikea, the Swedish furniture giant with a reputation for horrible DIY documentation, want to post free instructional videos on its websites to make it less risky to buy its unassembled wares? By definition, successful companies are better positioned to subsidise such “free” innovation to deter potential rivals. Competing against “free” is hard. Consequently, complaints of unfair competition will multiply as innovative subsidy facilitates technical innovation.

The emerging “economics of free” thus creates policy quandaries for emerging economies. Do developing countries want to enjoy and exploit the economic benefits of “free” telecommunications and information for their citizenry and workforce? Or are “free” search and e-mail services merely post-industrial counterparts to the agricultural subsidies undermining a nation’s ability to grow its own digital entrepreneurs? Might China or a South American coalition complain to the World Trade Organisation that a Yahoo and Google were effectively dumping their services in ways that unfairly hurt indigenous industrial development?

Certainly, the “free” market paradigm is finding its way into the business plans of local Asian and Indian innovators in telecommunications, microfinance and other sectors. The work of C. K. Prahalad, the US-based management expert, on profitably bringing innovation to the bottom of the pyramid has inspired even established incumbents such as Unilever and Procter & Gamble to redefine “free” promotion in emerging markets.

The rise and intricate complexity of government subsidies in public life is increasingly provoking political controversy. Similarly, the private sector’s growing dependence on cross-subsidy as an innovation edge seems guaranteed to provoke a regulatory and litigatory backlash. Ironically, free markets create markets for “free” that conjure the spectre of unfair and anti-competitive subsidy. That conflict is inherently unavoidable. But while “free” has its costs, this century’s economic reality is that the surest sign of dynamic innovation is a sector where everyone – producer and consumer alike – eagerly awaits what is offered for “free”.

The writer, a lecturer and adviser on the economics of innovation, holds academic posts at both MIT and KTH, Sweden’s Royal Institute of Technology