How Can I give you something for Free?

This sounds like a crazy question, after all, is there anything simpler than giving things away for free? In fact, there is another question hidden behind: Why do I want to give things away for free? Why giving things away for free will determine how one should give away things for free.

Then why would a business want to give away things for free?

The answer is that the future demand for a particular good depends on whether the consumer is using this good in the current period. There are several reasons why current usage will determine future usage. The most common reason is "experience goods" that is, before trying this good, the consumer has no idea how good and how useful this good is. The rational motivates giving away samples for new products.

The second reason is network effect. For example, LinkedIn is only useful if there are many professional on this platform. However, if one charges a price to every professional, many professional will simply refuse to get on the Platform. By offering free basic services to all professionals, LinkedIn is able to increase its base dramatically. ¹

The third reason is addiction. I will delay the discussion in the specific example later.

With so many reasons to give things away for free, why would anyone not give things away for free? Duh, because blindly giving things away for free actually decreases consumers' willingness to pay, which is the opposite of our goal. Even a temporary free giving-away might anchor consumers' expectation. This has two consequence. It lead to stronger resistance when the firm transitions to paid services; It incentivize consumers to delay purchase and wait for free offers (eg. sales and discounts). In other words, it could self-canabalizing. I for example, whenever purchasing on Amazon, would look at its price trajectory, and figure out that I can expect that Amazon will discount it to price x with 90% confidence. I will set up an automatic alert when the price on Amazon does fall to or below x.

My favorite example of giving things for free is Dropbox. Let us start with the basic. It is a freemium business, except it is different. Users are given some free space account when they sign up. The amount of free space is fixed, only nominally.  The capacity of the first disk drive, the IBM 350 disk storage unit, is only 3.75MB. The typical hard disk we use today, is probably around 1TB.² This is a a quarter million to one change, and mirrors the inflation of file size we experienced. I still remember those days in middle school when I would use a 3.5-inch floppy disk, which has accomodates about 1.5MB. Today, even if it is still compatible with my computer, I would find a floppy disk completely useless, because the real 1.5MB has been "inflated away". It is fair to say, in real terms, Dropbox is chipping away the size of free space every year. By inflating the free space away, it avoids the thorny problems of generating resistance or at least annoying consumers.

There is also wisdom in continuously and slowly inflating size away. When the size of free space is reduced in one stroke, one will have more incentive to find alternative storage services; however, when the consumer find himself just slightly above the limit every month or so, that incentive is greatly reduced, similar to the "boiling frog" story.  In addition, the asynchrony of hitting the limits among users poses a challenge to coordinate migrating to alternative platform.

What really brings my attention to Dropbox is actually an email from them, informing me due to a technical problem that have affected me (I was not even aware of it), they are giving me one year of Dropbox Pro for FREE, that is 1TB for free for one year:

We apologize for any inconvenience this may have caused. To thank you for bearing with us, we're giving you Dropbox Pro for free for one year starting today, October 10, 2014. If you have any questions, please reply to this message or email us at selectivesync@dropbox.com. We’re here to help.

This is excellent, maybe for me, but definitely for them. For one thing, they made it clear this is just a compensation, so it avoids anchoring consumers' expectation in any way---it is just my lucky day. More importantly, it could potentially convert me from a free riders to a paid customer. Here is why. First, the technical problem was Selective Sync. It is reasonable to expect that whoever uses that function derives more value from an average user and probably deal with larger data files. Good targeting. Second, addiction to a service is present here. There is a Chinese saying "It is easy to transition from a poor life to a rich one, but the reverse is much harder". There is some psychological cost to transition from knowing no limits to living under stringent limits. This cost, is often unanticipated by consumers.

Beyond the psychological aspect, there is a more rational or orthodox source of addiction.  It might seem weird to talk about addiction to an IT service/product, but it is very relevant in this area. Let me take the least consumer-facing product--VMware's ESX, a hypervisor technology. Swapping out ESX for alternatives are exactly hard, but many companies use the management tool designed for ESX, and they build their operations around that. These are the real switching costs.³ Dropbox is no different. When one is granted free access, the natural response is to use the heck out of it, after all, he reasons:"I probably will never get as lucky". He figures out all the bells and whistles of using Dropbox, what a fun! Dropbox is after all an extremely useful service, and everyone can find so many uses of it. From my perspective, I might want to use it to collaborate with other people on research. Imagine one year later, my pro service is over.  I still have a couple of collaboration in progress. No, I cannot leave Dropbox. How could I propose to my collaborator that we find an alternative despite its great performance and just because I am a cheapo? The bottom line is it is very hard to switch collaboration platforms. There is a psychological aspect to it: people tends to overly discount the future cost (of moving their files away and switching to another sync service when their account expire) vis-a-vis the utility they gain from using Dropbox in the current period (a phenomenon known as time inconsistency). In other words, I would think to myself that I will simply move all my files back to hard disk when my pro service expires, but when the time comes, I will instead choose to pay for continued pro service. This problem is exacerbated by the fact that people on average tend to underestimate the cost of making the transition back (planning fallacy).

I had to say, it is a most brilliant move. I am very impressed. The only sad ending to the story is that: knowing my time-inconsistency problem, I am not taking advantage of the free offering. I am only using 0.6% of the 1TB.⁴

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1 In this example, free basic services is a permanent feature for LinkedIn, but one can imagine a platform only provides free service during mobilization stage. For example, google search offered ad-free search in the beginning and then incorporated ads when it became dominant. In some sense, google started to charge us in terms of "attention fee".^↩

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3 http://en.wikipedia.org/wiki/History_of_hard_disk_drives^↩

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3 Yoffie, David, Andrei Hagiu and Michael Slind, “VMware, Inc., 2008,” HBS No. 9-709-435 (Boston: Harvard Business School Publishing, 2010), p.15^↩

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4 If this surprises you, here is a even more surprising story. In sophomore year, I was lucky to get a dingle---a double dorm room occupied only by me. What I did? I limited myself and belongs to only half of the room (using bookcase and bed to block my use of the other half), so that I 1)will not accumulate too many belongs that I have to get ride of later 2)will not get used to having a huge room and face the difficult transition of being confined to a much smaller room the next year.^↩

A Funny Encounter, or sad?

So I ran into someone on the street.
He asked me if I am from China. I said yes. Then he said he has a friend who went to China. Without my asking how was it, he said "She told me in China, no one can practice any religion, except for tai chi".
I was stunned for a second. and said "what?, tai chi?"
"Yes" he continued, "she also told me the emperor does not like christianity, or what is that person called again, not emperor, you know china is a communist country, so do you guys call him dictator?"
"President, actually", I replied, at a loss how to explain to him what my perspective is"
"yeah, president", he continued, but probablly not so convinced that we also use such a term. He went on to tell me things that made me wonder if I ever lived in China.
Don't get me wrong. I like this fellow. He is a superb man from other parts of our conversation, not on china.
But it strikes me as horrifying that in US, some people still cling to such an outdated view of China. That impression is probably true 40 years ago when China was in the cultural revolution.
What can I say? When we move to a place that is foreign, and when we have language barriers, and when we move there with prejudices, our perception of that place will be quite wrong. Maybe we enclose ourselves too much to protect ourselves and we never even ventured to see the true place.
We trust anecdotes too much. It is more personal than hard facts. After all, a trusted friend told me so. Just as we need to take a grain of a salt with what eye witness say in court due to many cognitive bias, personal perceptions could easily go way off when the subject is complicated and hard to comprehend.
Maybe I should not think of this too much. This is after all, an encounter, and will be an anecdote, isn't it?

Life, not for sale, but for purchase

One thing that makes people uncomfortable about universal health insurance is so called death panel, where health care has to be rationed among people.
It is sad, but it is not outrageous.
Some people argued that you cannot put a price on life.
Well, not for sale, but for purchase.
What do I mean? There is a maximum price one is willing to pay for his life! This is quite obvious, since people are putting a price on their life all the time. When opting out of insurance, when not seeing the doctor when not feeling well, or when choosing to take indirect flight to save money. At least, they are putting a price on a partial life---in a probablistic sense.

So how much are you selling your life? You may ask?

There isn't a price! Hence my title, life, not for sale but for purchase.

This seems most bizzare and irrational. Not really, when it is for sale, I possess my life, and at this point I value it infinitely. When it is for purchase, I do not possess my life, and there is only finite amount I am willing to pay for it. The fundamental effect is income effect, as economists call it.

If you really insist, then let me explain it in a trivial example. Suppose life gives you certain utility $U_0$, and money gives you some utility $U(c)$ where c is money. Of course it is concave. Suppose you total utility is the sum of these two. The optimization problem is
\[
U(c)+U_0\; or \; U(c+p)
\]
for selling life, and
\[
U(c-p)+U_0\;or \; U(c)
\]
for buying life.
One can easily show that as long as $U(\cdot)$ is bounded above, given a high initial c, there is no price for life for sale. In that situation, there will always be a price for buying life.

So which concept is more relevant? In the medical context, buying life is more more relevant.

time inconsistency and the evolution of policies

Just something random came to my mind.
Imagine there is a National Park that is open to public. Every year some visitors ran into accidents. The public begins to demand a rescue team to help out. Sure, no problem. The government set up a rescue team. To cover the cost, every one must pay an insurance fee before entering the National Park.

"That is not fair!" some protested, "We don't need that stupid rescue team! We are never like those stupid duechbags, we stay in line and we know our stuff!" Yeah yeah, why should those cautious hikers subsidize those reckless fools?

No problem, the coverage is voluntary. But one must make up his mind before entering the National Park. Either covered or not. One cannot get himself into deep sh*t and sign up for the insurance.

All is well for a while. Then some day, one guy got into big problem. Fell from a cliff and broke his leg. What is worse, he chose NOT to have the insurance. The rescue team did not help, and he died. The public was furious. How could this government agency stand by to watch a life disappear when it could deliver the help! When a life is at risk, the stupid government agency is still thinking about the stupid money! We need CHANGE!

Sure, you want change, and you are granted a change in a democratic government (though it is never guaranteed if it is for better or for worse). So the director of the rescue team was sacked and publicly humiliated. The new director was careful, and when this happened again, he sent his man.

Soon enough, fewer people want to pay the insurance fee. After all, they will still send out the men if I need help, won't they? As fewer people pay for it, to keep a balanced budget, the rescue team increased the price. Sure enough, even fewer people pay for it. After a couple of rounds, no one is paying for it. The rescue team is bankrupt.

So it is dissolved. The public was not happy, and sure enough the government bail it out. We gonna fund you.

And they live happily ever after. Except, many people never realize that now everyone is paying for the rescue team, whether you are a hiker or not. How so? It sounds condescending for me to even point out that the government money has to come somewhere. Yeah, the tax payers. No government generate its own money (though at least in China, many fail to understand this subtle point despite their high international rankings in math). Probably less well-off people in general do not go to that National Park that often. It is usually a vacation place for the more well-to-do. So we now have a more regressive tax.

Avoiding Fundamentals

I somehow feel in this age, we seem to avoid talking about fundamentals. When it comes to financial crisis, we talk about multiple equilibria and failure of coordination; when it comes to beauty, we point to artificial social construct; when it comes to poverty or poor performance, we emphasize discrimination and stereotypes.
I will not argue that all those other factors do not matter---most likely they do. But it does seem to me we go to great length to deny the role of fundamentals.
Part of the things is when we say the fundamental is problematic, we cannot avoid assigning blame or responsibility. Doesn't it feel great that our financial system is perfectly regulated, it is just an unfortunate mis-cordination that caused a big problem, that there is no intrinsic beautiful or ugly, it is just some stupid tastes imposed on us by the society, that we are all perfectly smart and diligent, but it is the society that is preventing us from achieving great things?
I personally consider science as a pure curiosity endeavor---one that involves asking and answering questions that interests us. Those answers should be prevented from having anything to do with our policy or judgement. The current frenzy to apply and extrapolate "scientific findings" probably lead to numerous restrictions imposed on our scientific endeavors.
Fundamental is never the full picture, but it is very often in the picture. Perhaps it is better if science remains a personal inquiry, rather than a public display.

International Trade---An Idiot's perspective

Some liberals adhere to Krugman as their intellectual backbone---after all, they feel their points are backed up by a Nobel-winning economist. However, it is recently reviewed that some of them completely ignore Krugman's insight that won him the Nobel Prize--why people trade. Krugman gave a clear answer to the benefit of intra-industry trade---it gives people more variety to enjoy.

Well, you know you can count on New York Times for idiotic protectionist argument. Man, it never disappoints me.

http://www.nytimes.com/2014/06/22/opinion/sunday/why-are-we-importing-our-own-fish.html?hp&rref=opinion&_r=0#permid=12084248

I once thought there is no point teaching intro Econ---these things are obvious, one does not need to learn it from a book. Now I still believe there is no point teaching intro Econ---it is beyond most people.

That is Crazy Excitement

In a previous post, People Are Over-Excited, I remarked that people are too excited about internet companies, and there is a bubble in this industry. I was talking about WhatsApp. Now I now discuss something else.

Imagine sending the following text message to your friend:

Yo

Yes, just these two letters.

Yo, now what? Guess how much funding this app got? 1.2 million USD.http://techcrunch.com/2014/06/18/yo-yo/

Some people are still skeptical of the existence of bubbles. They argued that apps like WhatsApp and Yo has built a huge customer base and that is important---A canonical app company's business model relied on harnessing network effects by operating at a sustained net loss and to build market share (or mind share). These companies offered their services or end product for free with the expectation that they could build enough brand awareness to charge profitable rates for their services later. The motto "get big fast" reflected this strategy.

Btw, I did not wrote the previous explanation. I copy pasted from Wikipedia's page on dot.com bubble. I only changed the dot.com to app. That reflects my attitude.

I am now very confident that there is a bubble. The problem is when it will burst and what will that bring about. The questions I am curious about is what is the differential effect on sound companies like Amazon and google versus those jokes. How will it impact the kind of innovation company takes? Obviously, innovation like Yo will stop, but will big companies be hurt to such an extent that they will need to suspend current promising research that might not promise immediate payoff. The impact on labor market is equally interesting. When companies shrink, where will excess programmers go? Will they shift to finance, especially into high frequency trading?