Making Money in a Zero-Marginal Cost World

-- By StevenWu - 13 Nov 2009

I. Introduction

It is hard to generate revenues from the sale of zero-marginal cost goods.

Not necessarily. Sellers of pirated CDs and DVDs do very well, for example. That's why drug dealers get into the business: it is more profitable and less illegal.

Although regulatory protection has previously guaranteed profits, these protections are becoming easier and easier to circumvent. Companies are turning to alternative methods to generate revenues. There are four predominant methods of generating revenues based on zero-marginal cost goods. (1) Sell other goods and services bundled with zero-marginal cost goods. (2) Deliver zero-marginal cost goods in a more effective way. (3) Use zero-marginal cost goods to learn about the users of the goods. (4) Deliver zero-marginal cost goods with advertising. The first two focus on being able to generate monetary profits directly related to zero-marginal cost goods. The latter two attempt to generate capital other than monetary profits.

II. The Strategies

1. Selling Zero-Marginal Cost Goods Based on Bundling with Other Goods

Zero-marginal cost goods can be bundled with other tangible and intangible goods to generate a profit. Examples of tangible goods that can be sold include human labor for modification and servicing, hardware to consume the zero-marginal cost goods such as video game systems or computers, and freedom from legal harassment particularly for the music and movie industry.

At this point, it is simpler to say that the service business is enabled by free software, rather than saying the software is being sold along with the services. That's obviously true with respect to complementary hardware.

Examples of intangible goods that can be sold include charity from sponsoring a productive activity, community from Apple products, authenticity from bottled water, and emotional security from paying for antivirus software. The very act of paying for the product is intimately related to these feelings of charity, community, authenticity and emotional security.

Perhaps. But that's a really strained way of saying that the consumers bought the product because the product made them feel a certain way. To say that they were sold the feeling is simply an advertising metaphor, not a description of a transaction.

2. Selling Zero-Marginal Cost Goods Based on More Compelling Delivery

Revenues can be generated by delivering zero-marginal cost goods more compellingly. At times, the delivery can be based on convenience, speed and reliability. At other times, providers can attempt to compel users to purchase zero-marginal cost goods by destroying the value of the good once it is divorced from payment.

Convenience is particularly important for pornographers. Pornography is readily accessible for free on the internet, yet subscription sites are still profitable. Subscription sites allow individuals to have the convenience of downloading large amounts of high-quality pornography from one high-speed location. Such sites are usually easily navigable and provide a high degree of reliability. Users are willing to pay for this convenience even when pornography is available for free.

You undermined your argument. Whatever "high quality" means to you, it is evidently distinct from the convenience of delivery.

Forcing users to update their zero-marginal cost goods on a frequent basis is another way to compel users to pay for a subscription-based service for the goods. The reliance on updates is particularly important when users interact with one another. Even if the software of massively multi-player online role-playing games can be replicated, users are willing to pay for subscriptions because the games are routinely updated and updates are required to interact with other users.

Same thing. If the real point is that access to other players is controlled at the server, what is being sold is access to services.

3. Delivering Zero-Marginal Cost Goods while Collecting Data

Providers of zero-marginal cost goods can also generate profits through data aggregation. Examples of this include Google's search engine, Facebook and G-mail. Data aggregation is useful for three reasons. First, businesses can use this information to develop products to solve the user's problems. Second, businesses can use this information to design more effective advertising campaigns. Third, businesses can sell this information to other businesses that can use the two aforementioned strategies.

This taxonomy is a false simplification. Simpler to say that some bitstreams are used to barter with users for resaleable personal information.

4. Delivering Zero-Marginal Cost Goods with Advertising

Zero-marginal cost goods can also be delivered with advertising attached. Delivering zero-marginal cost goods with advertising does not directly increase the flow of funds from users to producers. When software providers are paid, they are paid by businesses looking for advertising channels. Users are not expected to provide monetary capital. Rather, they are expected to provide their attention, which will be converted into capital at a later date through an increase in brand value. Advertising is particularly effective when combined with data aggregation.

Once again, you get these sentences by distorting a simpler underlying account. Advertisers pay to have their messages attached to other messages or digital services consumers want.

III. Combining Strategies

There is often a struggle between users and providers who utilize the latter two strategies. Users can block advertisements or impede data aggregation. Users are especially reluctant to suffer advertising and data aggregation if they know of other products that are equally effective without similarly annoying features. Once users are familiar with alternative products, providers must pursue the former two strategies. However, if the latter two strategies are performed in a highly competent way, they become the former two strategies.

The conflict between users and providers of information exists because data aggregation or advertising is a hindrance to the user rather than an asset. However, data aggregation or advertising need not be a hindrance. Users are often willing to incur costs so that their data can be aggregated or so that they can be exposed to advertising. If data aggregation and advertising can be seen as features rather than as defects, then they become one of the bundled goods or one of the more effective forms of delivery. Data aggregation and advertising can be seen to serve the user's ends.

As I was writing this paper, Pandora Radio introduced me to Coldplay's Viva La Vida. It fit my musical tastes perfectly. It then tried to play Britney Spears's Blackout. No thanks. Do I seem like a Britney Spears fan? I guess a computer program wouldn't know better. Google tells me what to read, Amazon tells me what to buy, eHarmony tells me whom to fuck, JDate tells whom to marry, CareerBuilder? tells me what where to work and Facebook tells me whom to be befriend and what to do with my new friends. In the past, these functions were performed by family and friends. These companies are not my friends and they are obviously not my family. They play at my fears. They toy with my subconscious. They do it in subtle ways. Lady Gaga's Beautiful, Dirty, Rich is on. I love that song.

Steve,

I've added a comment box to make it easier for others to comment on your paper, since you have invited us to do so. I have also commented by reference on your paper in my own, available here.

-- DanaDelger - 18 Nov 2009

I edited based on your paper. Thanks for the thoughtful paper. It was fun to read. Also, thanks for the comment box.

-- StevenWu - 19 Nov 2009

I thought the analysis was good, Steven. You might wish to consider adding some hyperlinked text for some additional factual support. For example, you could add statistics on MMORPGs demonstrating your claim that subscription-based games are preferred over free games. Or link to reports on AdBlock? for section III. I feel confident you already know this, but the earth/chain icon in the edit screen creates the external link formatting just in case.

One other thought I had was that a fifth strategy is giving goods for free with donation encouragements. Or maybe this ties in with your discussion in section II.1.

It was a smooth read. I would welcome your thoughts on my essay if you are so-inclined.

-- BrianS - 19 Nov 2009

The first category that you identify may be defined too broadly. The term “bundling,” suggests the tying of non-zero marginal cost goods to zero-marginal cost goods either literally or technologically. For example, creating videogames coded to play only on a proprietary platform. This kind of activity is different in kind from simply laboring to produce something that people will feel motivated to pay for due to feelings of “charity, community, authenticity, and emotional security.”

The second category that you establish seems to suffer because it does not distinguish between creating a compelling distribution system and compelling people to use your distribution system. Updates that create strategic incompatibilities coerce the customer in a way that a simple offer to distribute content efficiently at a price does not.

The third and fourth category that you identify could probably be collapsed into one category. Every content provider that is in the advertising business has a strong incentive to mine data in order to increase the value of its advertisements. This fact begs the question of who really provides content with ads without collecting any user data.

Finally, I agree with your general point that data mining can create a desirable kind distributional efficiency if it is used by content distributors to reduce consumer search costs. I do, however, recoil in fear at the thought of Facebook being able to correctly suggest who I should “friend” and where I should go to meet my new friend for lunch in order to have a meal that we will both enjoy. Are you really willing to embrace such a future?

-- StephenClarke - 19 Nov 2009

I agree with your first criticism that my first category might be too broadly defined. I just don't know if I see a meaningful distinction between those two categories other than that one is tangible and the other is intangible.

I think that the third and forth category is often related, but not necessarily related and consequently should be kept separate. The reason why I would keep them separate even if they are often related in reality is because this establishes a cleaner theoretical framework. I think that all four are often related. Most people do not use any one of the strategies in isolation.

I am not ready to embrace such a future. I just see it as highly likely. People really like Facebook and Pandora. Pandora isn't even seen as a danger. I use Pandora. Do you use Pandora? Do you feel like allowing your musical tastes to be so heavily influenced by Pandora is a good idea? I would actually really like it if Google recommended books to me.

I finished Winston Churchill's first book on the Second World War recently. It was fantastic. Seriously. It was one of the best books I've read in a while. Then I read Superfreakonomics, which was well-reviewed. I really didn't like Superfreakonomics though. Then I read Jared Diamond's Collapse, which I thought had its ups but was entirely too long-winded. If I could read these books on a Kindle with Google recommending books that I would love, then I would almost assuredly be complicit in my own destruction.

Wouldn't you? Do you like Pandora? If Facebook could introduce you to people whose company you immensely enjoyed and recommend activities you would enjoy, would you not want Facebook to do that for you? I waste a lot of time doing a lot of random crappy things with random boring people. I would love a device that told me who I would want to associate with. Of course, my personality, if it remained anything similar to what it is now, compels me to hang out with pro-abortion people, anti-abortion people, religionists, atheists, Satanists, the poly community, the LGBT community, White Separatists and any other fringe group that I can't think of at the moment. Facebook, if it tried to appeal to me, would introduce me to a diverse range of interesting and random individuals who were all random in the particular Steve-Wu way. I would love a device that told me what exercises to do and what foods to eat to have the physique of so many Hollywood idols.

If I could have my future employers offer me a device that I could carry so that I could maximize my value to them, I would carry it. Perhaps some kind of machine that would issue orders from HQ so that at every waking moment I could be a productive capitalist cog. Hell. It would offer me the ability to go home once in a while. I could sleep when it would interfere with work as little as possible.

After hearing some of the arguments, my feelings are that in the future we will be forced to live in a world of complete nakedness. I think in class we incorrectly assume that people do not want advertising or data aggregation. This is just not empirically true.

Do these clarifications and the edits above address your comments?

-- StevenWu - 19 Nov 2009

"I think in class we incorrectly assume that people do not want advertising or data aggregation. This is just not empirically true."

I think this is true and false. Part of the argument against data aggregation is that even if we think we want it, we don't because of what it has the potential to do. It has the potential to raise prices based on knowing a given person in particular will pay more than others for a product. (I recently was looking at a CD on Amazon, about two months ago, and it was 8.99. I signed in and turned on Amazon Prime and it was suddenly 9.99. I sent Amazon a note asking them about it. They never replied. I saved the screenshot, though at the time I figured it was a glitch. Maybe not.). It has the potential to be turned against us in the event of a data breach. It offers the government new ways to know who people are and what they think about all sorts of things. It offers to reveal secrets about all users in ways the users wouldn't guess. Now maybe you have no secrets, maybe the government will only learn that you are a super-citizen and want to send you a Valentine's Day card once it knows all about you, and maybe your data won't be hacked. Today. As we talked about in class, memory is now eternal. The price of Facebook Recommendations today might be zero, as you suggest. Or, it might just be one of those no payments for 90 days things. If the bill comes due, there's no refund on privacy. What is said is said eternal, etched in silicon.

Now, that said, the part that I think is true is that you are clearly not alone in being willing to trade privacy for the benefits you discuss. I am not yet, in this regard, taking all my own soapbox advice. So I certainly do understand where you are coming from.

-- BrianS - 20 Nov 2009

"If I could have my future employers offer me a device that I could carry so that I could maximize my value to them, I would carry it. Perhaps some kind of machine that would issue orders from HQ so that at every waking moment I could be a productive capitalist cog." Steve, it's called a "Blackberry."

-- DanaDelger - 20 Nov 2009

Dana, that was the joke. It was a kind of depressing joke. Brian, I was not being facetious when I called it "slavery."

-- StevenWu - 21 Nov 2009

Isn't there a fifth category -- extorting money from people who take the zero-marginal-cost goods that you happen to have a statutory monopoly on by threatening them with litigation?

-- GavinSnyder - 30 Nov 2009

I tried to include that in my first category when I wrote, "freedom from legal harassment particularly for the music and movie industry."

-- StevenWu - 30 Nov 2009

How about teaching people how to use zero-marginal cost goods? Like the example that Professor Moglen gave in class, of the father who wanted to pay the teachers to teach his son how to use the free software that his son could use to paint?

-- AllanOng - 30 Nov 2009

To me this has a little bit the feeling of "making things simple enough for business school students to understand." It's like a report on the Venice Biennale written by a seller of art supplies, or, worse yet, an investor in art supply companies. Everything you say seems to me to be accurate, though much of it can be said way more simply, usually by the straightforward method of treating the commons as a commons, and observing that the commons enables surrounding economic activity in certain relatively predictable ways.

The main question is, so what? We do not attend the art show in order to figure out which art supply companies made money off it: we go to look at and be affected by the art. You have evolved a taxonomy of what the people who do not understand what's going on think about instead. That's not useless, by any means, although I think its utility to any individual businessman is slight. What can it do for those of us who are trying to see more deeply than the superficial level at which the moneymaker swims?

My purpose was two-fold:

First, I think that by thinking of the business from this angle, one might come up with new businesses that threaten freedom. After considering the issue from this perspective, I have come up with a few such ideas that are probably fairly profitable that haven't hit the market place yet.

Second, I think that the profit-motive drives tremendous productive and destructive behavior. By offering a different perspective on where the moneymaker swims, we have a better understanding of destructive threats.

For example, as far as I can recall, all of the threats that you discussed in class involved consumers who were being spied on and shouted at against their will. I would like to know what to do about consumers who want to be spied on. Every day, I see businesses moving towards allowing consumers the option of opting out of being spied on or shouted at. Instead, they are persuading the consumer that being spied on or shouted at is in his best interest. Pandora offers a very compelling service that cannot be delivered without tracking their consumer's preferences. As far as I can see, compulsory nakedness is the only solution.

-- StevenWu - 27 Jan 2010