Why the Web Always Be (Mostly) Free

It's surprising how many executives don't understand the economics of their own businesses. Earlier this year, the publisher of a large, successful magazine told me he can't wait to "charge for information the way God intended" now that giving away content in exchange for advertising dollars has failed.

There are so many reasons why publishers who think this are wrong. First, most forms of media are already given away quite successfully. Second, the economics of Web publishing determine that there's more money to be made by giving away content than by selling it. And finally, research shows that disruptive technologies require us to rethink our own cost structures, not our customers'.

Note that virtually all radio and television content is free for consumers. In a recent Slate column, editor Michael Kinsley demonstrated how newspapers are already being sold at the cost of the newsprint. The costs of researching, writing, editing, and printing the news, (plus the 20 percent or so profit margin) are borne by advertisers.

For magazines like this one, giving away free subscriptions to qualified readers results in higher revenues than paid subscription models. This is because they can charge advertisers more for access to the magazine's targeted audience. Even magazines that charge for subscriptions often sell them at a loss with respect to marketing and printing costs. In fact, publishers have set up elaborate auditing mechanisms to keep their competitors from simply shipping magazines to people who might be interested in their title.

Digital Economics

Although it used to be called a new economy business, online publishing has a lot in common with the traditional steel business. The fixed costs (servers, writers, editors, producers) are high, while the variable costs (sending out one more page) are low. In businesses with high fixed costs and low variable costs -- like content sites where it costs no more to publish another page--expenses rapidly converge on zero. The more you sell, the lower your cost per unit. This is what happened in the newspaper business at the turn of the last century. Publishers like William Randolph Hearst cut the price of papers to a penny per issue to drive competitors out of business and increase advertising revenue.

Knowing this, it's strange to imagine charging for content. What happens when you charge for access to your site? Your production expenses stay about the same and your readership plummets. In essence, the cost of serving each reader goes up dramatically.

The best business book I read in the last five years is Clayton Christensen's The Innovator's Dilemma. The author explains that when a disruptive technology emerges in an industry, traditional players fail to understand the economics of it. The margins seem impossibly low and the products are uneconomical to their traditional customers. (Does this remind you of online advertising?).

Look back at the failures of the last couple of years, and you'll begin to see the outlines of our problem. Every new site required millions to be spent on branding, just as a new, traditional company might. Expensive offices were acquired in desirable locations. Traditional journalists were paid budget-busting salaries to join online startups. Instead of minimizing fixed costs, we outspent our traditional competitors. William Randolph Hearst wouldn't have made such mistakes.

What Next?

Online advertising is suffering right now, but advertisers are still spending. In the first half of 2001, the supposedly discredited online ad spending was down only 8 percent. Between 5 and 10 billion dollars will still be spent for online ads this year.

Of course, existing advertising methods and prices may not survive. Just because the Internet has changed publishing, doesn't mean that it comes with a ready-made business model any more than print does. Those who are quick to condemn Salon for not making money on advertising should remember that The New Yorker, Harper's, and The Atlantic Monthly aren't big money makers either.

We must understand that building a media business is an expensive, long-term investment. We can see examples of this patience in the way Hearst built his newspaper empire, Henry Luce created Sports Illustrated, Al Neuharth started USA Today, or Ted Turner created CNN. These businesses took millions of dollars, many years, and an executive (usually the owner) with vision and ability.

Truly successful online publications will be privately held or strongly controlled by a visionary CEO. They'll either be large enough to be able to minimize their fixed-costs per page view, or they'll be small and focused, and will charge a lot for advertising. Mid-size sites without a focused market will continue to fail. And the most important quality of the winners will be their ability to persevere in the face of withering criticism. When they ultimately succeed, what they did will seem obvious to us in hindsight.