Priced and Unpriced Online Markets

Article: Priced and Unpriced Online Markets. Benjamin Edelman. Journal of Economic Perspectives—Volume 23, Number 3—Summer 2009—Pages 21–36

URL = http://people.hbs.edu/bedelman/papers/priced-and-unpriced-online-markets-jep2009.pdf

Abstract

"ome online resources are free and others are not—but it can be hard to predict which resources are in which category. Do users pay for web-based e-mail? Sometimes they do, as in the case of lifetime e-mail service from Pobox, but often they do not, as in the case of Hotmail from Microsoft or Gmail from Google. Do users pay for wireless Internet access at “hotspots”? Historically such access carries a fee, as it does at the T-Mobile HotSpots at many airports and hotels, but now a number of retail outlets are providing such access without a fee, such as Panera Bread, Whole Foods, and recently Starbucks. Do users pay for software? Many users do pay for a wide variety of commercial software, yet other software like the Linux operating system and the FireFox web browser can be downloaded without charge.

Zero prices offer important benefits, even relative to small positive prices. For one, fee-free access reduces transaction costs—eliminating the need for billing systems as well as, in many cases, account setup, user names, and the like. Furthermore, zero prices seem to create an environment of experimentation and progress for products and consumers (Lessig, 2002; von Hippel, 2001). Finally, consumers overwhelmingly favor zero-price products, even beyond what might be predicted by their ordinary efforts to maximize consumer surplus (Shampanier, Mazar, and Ariely, 2007).

Yet experience in other contexts offers cause for concern. Although marginal costs may be near zero for many levels of use of online resources, costs generally eventually increase as usage nears a capacity constraint given by technological capability or system design. More generally, experience in other contexts repeatedly reveals overconsumption, scarcity, and even hoarding when resources are provided without charge. For examples, see Parry (2002) on highway congestion, Starkie (1998) on airport landing slots, and Baumol and Oates (1988) on pollution.

With competing forces both supporting and opposing zero prices, typical Internet-related activities—like surfing the web, web searches, and e-mail, along with behind-the-scenes practices like domain names and the allocation of IP (Internet Protocol) addresses—present a natural context to reevaluate our sense of the tradeoffs that arise between free and a positive price.'

Author

Benjamin Edelman is Assistant Professor of Business Administration, Harvard Business School, Boston, Massachusetts. His e-mail address is bedelman@hbs.edu.