Every marketer is familiar with the concept of price elasticity.
Sales = Price * Transactions
What is optimal price to maximize sales? It is well-proven that picking the right price is essential to the successful marketing of a product. Too high, and no one will buy it, and too low, there is no profit to sustain the business.
But is this antiquated 20th century economics, and a new game is quietly afoot? Let’s look at a few examples.
Skype provides a free Internet phone and was purchased by EBay four years ago for $2.6B with no business model. Its founders took the money and moved on and EBay is still trying to figure out what it paid for. There are rumours here in Silicon Valley of a spin-out. Everybody I know has a Skype account.
YouTube was purchased by Google two years ago for approximately $1.6B. No business model but a big audience. YouTube costs Google about half a billion dollars (not a typo!) a year to keep up with the volume of data that is relentlessly uploaded and downloaded. Everybody I know watches YouTube. Everyone I know uses Google.
Chris Anderson, editor of Wired magazine, is a leading proponent of free as the business model of the future. If cheap is good, then free is the best. In his 2008 book, Free: Why $0.00 is the Future of Business, he argues that technology is driving down the cost of things at such a rapid rate that the price will eventually hit zero.
At some point, the price is “closest enough to free” to round down. Therefore the winner will be the company who is fastest to free and devises a strategy to take advantage of a huge customer population that herds toward things that are free. To his credit, Anderson has put his money where his mouth is by putting an electronic copy of Free available online for free on his website.
Anderson however is not without his critics. Malcom Gladwell of The New Yorker magazine writes a scathing review of the concept, citing it to be overly simplistic and skirting the real issue of how do we fairly pay for things that cost real money to develop. In other words, are Skype and YouTube exceptions or the new rule? Are EBay and Google really smart, or suckers?
A little closer to home, I have to say that my own company IPextreme made a move in this direction last year with the opening of our Core Store for semiconductor intellectual property. We tested the price elasticity of our products by offering our customers a hard to resist offer: We’ll give you the product for a price that is an order of magnitude less than the “street price” if you purchase it on the web and sign our standard contract. Less cost for you, less cost for us. Everybody wins. The Core Store brought a nice little up tick in our business, but many customers still preferred the traditional sales model and were willing to pay for that. Six months later we pushed the envelope a little further and “rounded down” the price of the V1 ColdFire (for Altera FPGA devices) to “free”. The result was an explosion in the adoption of the ColdFire architecture in the Altera FPGA community. Not only were we shipping cores to companies in our normal high tech customer regions, but we added customers in 22 new countries. Free proved to be extremely effective in attracting new customers that would eventually move on to buying (other) things for real money.
However, even Anderson acknowledges that free is best suited for commodities that are digital and have little or no manufacturing or delivery cost. Perhaps Apple gives us some clue as to how free applies to hardware businesses.
Last month I finally relented and replaced my Samsung Windows Mobile smart phone with the new iPhone 3GS. The phone which is subsidized by the carrier (AT&T here in California) still cost me $199. Teardown reports note that the iPhone cost is around $150 and with the AT&T subsidy, Apple is rumoured to make about 50% margin on the hardware, considerably more than many of its suppliers I would imagine.
But the iPhone is more than a phone, it is platform for the free. Apple’s App Store has thousands of free software programs that can be downloaded for this platform, and each one of these companies had some kind of business, free or otherwise, that is built on this increasingly ubiquitous platform. And perhaps that’s where the future is leading us. Consumers want free, but are willing to pay for the platform which enables access to the free. They are not willing to pay for the application software, but are willing to pay for everything around it.
So perhaps as we climb out of this world economic crisis we are going to emerge with new business models for hardware and software that defy the traditional rules of the last centuries. Meanwhile, I’m taking bets on who pays billions for Twitter.
Warren Savage, President and CEO of I Pextreme, is a well-known and published authority in the field of semiconductor intellectual property.
He has a long history of pushing the envelope of design methodology from his work in fault tolerant computing at Tandem Computers in the 1980’s and driving reliable design methodologies into commercial practice at Synopsys for its DesignWare IP product in the 1990s. Much of his thinking became embodied in the seminal book on IP reuse, the Reuse Methodology Manual. Catch him on Twitter at warren_savage and ipextreme
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