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Internet Economics Essay

Cross-subsidies are the essence of the phrase “there’s no such thing as a free lunch. ” That means that one way or another the food must be paid for, if not by you directly then by someone else in whose interest it is to give you free food. Sometimes people are paying indirectly for products. That free newspaper you’re reading is supported by advertising, which is part of a retailer’s marketing budget, which is built into its profit margin, which you (or someone around you) will ultimately pay for in the form of more expensive goods.

You’re also paying with a bit of your time and, by Ewing seen reading that newspaper, your reputation. The free parking in the supermarket is paid for by the markup on the produce, and the free samples are subsidized by those who shell out for the paid versions. Phone companies sell calls; electronics companies sell gadgets. But cable giant Compact is in both those businesses and a lot more besides. This gives it flexibility to cross-subsidize products, making one thing free in order to sell another.

To that end, Compact has given about 9 million subscribers free set-top digital video recorders. How can it make that

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money back? Compact earns back the cost of its DVD in 18 months. Add hidden fees. Compact charges a $20 installation fee to every new DVD customer. Charge a monthly subscription. Compact customers pay $14 a month to use the DVD box. Even if Compact paid $250 for its DVD’s?a very high estimate? the boxes would pay for themselves within 18 months. Upsets other services.

Compact hopes to win over customers with free DVD’s, then interest them in services like high-speed Internet ($43 a month for 8 MBps) and digital telephony ($40 a month). That doesn’t count pay-per-view movies, which can cost $5 each. In the gift economy, the cross-subsidies are more subtle. Blobs are free and usually don’t have ads, but that doesn’t mean that value isn’t being exchanged every time you visit. In return for the free content, the attention you give a flogger, whether in a visit or a link, enhances her reputation.

She can use reputation to get a better job, enhance her network, or find more customers. Sometimes those reputation credits can turn into cash, but we can rarely predict the exact path?it’s different each time. Cross-subsidies can work in several different ways: Paid products subsidizing free products. Loss leaders are a staple of business, room the popcorn that subsidizes the loss-making movie to the expensive wine Internet Economics By Cabinetmaking being not Just sold at a fraction of its cost but given away entirely. This can be as gimmicky as a “free gift inside” or as common as free samples.

This form of free is ancient, familiar, and relatively straightforward as an economic model, so we won’t focus on it much here. Paying later subsidizing free now. The free cell phone with a two-year-subscription contract is a classic example of the subsidy over time. It’s Just shifting phone service from a point-of-sale revenue stream to an ongoing unity. In this case, your future self is subsidizing your present self. The hope of the carrier is that you won’t think about what you’ll be paying each year for the phone service but instead will be dazzled by the free phone you get today.

Paying people subsidizing free people. From the men who pay to get into nightclubs where the women get in free, to “kids get in free,” to progressive taxation where the wealthy pay more so the less wealthy pay less (and sometimes nothing), the tactic of segmenting a market into groups based on their willingness or ability to pay is a conventional part of pricing theory. Ere takes that to the extreme, extending the concept to a class of consumers who will get the product or service for nothing.

The hope is that the free consumers will attract (in the case of the women) or bring with them (in the case of the kids) paying consumers or that some fraction of the free consumers will convert to paying consumers. When you walk through the striking interiors of Lass Vegas attractions, you get the view for free; in exchange the owners are expecting some people to stop and gamble or shop (or, ideally, both). Within the broad world of cross-subsidies, free models tend to fall into four main categories:

FREE 1: DIRECT CROSS-SUBSIDIES WHAT’S FREE: Any product That Entices you to pay for something Else. FREE TO WHOM: Everyone Willing to Pay Eventually, One Way or Another. When Wall-Mart offers a buy-one-get-one-free deal on DVD’s, it’s a loss leader. The company is offering the DVD below cost to lure you into the store, where it hopes to sell you a washing machine or a shopping basket filled with other goods at a profit. In any package of products and services, from banking to mobile calling plans, the price of each individual component is often determined by psychology, not cost.

Your cell hone company may not make money on your monthly minutes?it keeps that fee low because it knows that’s the first thing you look at when picking a carrier?but your monthly voice mail fee is pure profit. Companies look at a portfolio of products and price some at zero (or close to it) to make the other products, on which they make healthy profits, more attractive. Free 1 . Direct Cross-subsidies Technology is giving companies greater flexibility in how broadly they can define their markets, allowing them more freedom to give away some of their products or services to promote others.

Ryan, for instance, has disrupted its industry by defining itself more as a full-service travel agency than a seller of airline seats. Your credit card is free because the bank makes its money from the service charge it imposes on the retailers you buy from. They, in turn, pass that charge back to you. (Of course, if you don’t pay your bill off in full at the end of the month, the bank makes even more money from your interest. ) : Content, Services, Software, and More. FREE TO WHOM: Everyone. The most common of the economies built around free is the three-party system.

Here a third party pays to participate in a market created by a free exchange between the first two parties. Sound complicated? You encounter it every day. It’s the basis of virtually all media. In the traditional media model, a publisher provides a product free (or nearly free) to consumers, and advertisers pay to ride along. Again, radio is “free to air,” and so is much of television. Likewise, newspaper and magazine publishers don’t charge readers anything close to the actual cost of creating, printing, and distributing their products.

They’re not selling papers and magazines to readers, here selling readers to advertisers. It’s a three-way market. In a sense, the Web represents the extension of the media business model to industries of all sorts. This is not simply the notion that advertising will pay for everything. Media companies make money around free content in dozens of ways, from selling information about consumers to brand licensing, subscriptions, and direct e-commerce (see Chapter 9 and the back of the book for a more complete list). Now an entire ecosystem of Web companies is growing up around the same set of models.

Free 2. The Three-Party Market Economists call such models “two-sided markets,” because there are two distinct user groups who syntactically support each other: Advertisers pay for media to reach consumers, who in turn support advertisers. Consumers ultimately pay, but only indirectly through the higher prices on products due to their marketing costs. Means more spending at merchants and more fees for issuing banks), operating system tools given free to application software developers to attract more consumers to the platform, and so on.

In each case, the costs are distributed and/or hidden enough to make the primary goods feel free to consumers. FREE 3: FERMIUM WHAT’S FREE: Anything That’s Matched with a Premium Paid Version. FREE TO WHOM: Basic users. This term, coined by venture capitalist Fred Wilson, is one of the most common Web business models. Fermium can take different forms: varying tiers of content from free to expensive, or a premium “pre’ version of some site or software with more features than the free version (think Flicker and the $25-a-year Flicker Pro). Again, this sounds familiar.

Isn’t it Just the free sample model found everywhere from perfume counters to street corners? Yes, but with a pretty significant twist. The rotational free sample is the promotional candy bar handout or the diapers mailed to a new mother. Since these samples have real costs, the manufacturer gives away only a tiny quantity?hoping to hook consumers and stimulate demand for many more. Free 3. Fermium But for digital products, this ratio of free to paid is reversed. A typical online site follows the 5 Percent Rule?5 percent of users support all the rest.

In the Fermium model, that means for every user who pays for the premium version of the site, nineteen others get the basic free version. The reason this works is that the cost of Irving the nineteen is close enough to zero to call it nothing. FREE 4: MONETARY MARKETS WHAT’S FREE: Anything People Choose to Give Away with No Expectation of Payment. This can take several forms: Gift Economy From the twelve million articles on Wisped to the millions of free secondhand Altruism has always existed, but the Web gives it a platform where the actions of individuals can have global impact.

In a sense, zero-cost distribution has turned sharing into an industry. From the point of view of the monetary economy it all looks free?indeed, it looks like unfair competition?but that says more about our horologists ways of measuring value than it does about the worth of what’s created. The incentives to share can range from reputation and attention to less measurable factors such as expression, fun, good karma, satisfaction, and simply self-interest (giving things away via freelance or Scraggliest to save yourself the trouble of taking them to the dump).

Sometimes the giving is unintentional, or passive. You give information to Google when you have a public Web site, whether you intend to or not, and you give aluminum cans to the homeless guy who collects them from the recycling bin, even if that’s not what you meant to do. Labor Exchange You can get access to free porn if you solve a few Captains, those scrambled text boxes used to block spam bots. Ironically, what you’re actually doing is using your human pattern-matching skills to decipher text that originated on some other site, one of interest to spammed that uses such Captains to keep them out.

Once you solve it, the spammed can gain access to those sites, which are worth more to them than the bandwidth you’ll consume viewing titillating images. As far as they’re concerned, it’s a black box?they put scrambled Captains in and they get deciphered text out. But inside the box, it’s the unwitting free labor of thousands of people. Likewise for rating stories on Dig, voting on Yahoo Answers, or using Google’s 411 service. Every time you search on Google, you’re helping the company improve its ad- targeting algorithms.

In each case, the act of using the service creates something of value, either improving the service itself or creating information that can be useful somewhere else. Whether you know it or not, you’re paying with your labor for something free. Free 4. Monetary Markets Piracy This describes nothing so well as online music. Between digital reproduction and ere-to-peer distribution, the real cost of distributing music has truly hit bottom. This is a case where the product has become free because of sheer economic gravity, with or without a business model.

That force is so powerful that laws, copy protection, guilt trips, and every other barrier to piracy the labels could think of failed (and concerts, merchandise, licensing, and other paid fare. But others have simply accepted that, for them, music is not a moneymaking business. It’s something they do for other reasons, from fun to creative expression. Which, of course, has always been true for most musicians anyway.

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