Whenever they hear that something is free, some find it fashionable to remark that “there’s no free lunch” or “you’re paying in a different way”. In other words, these people insinuate that there’s always a “hidden cost” behind free products and services.
On the face of it, their counterpoint seems to be right. After all, how can a company survive if it gives things away for free, right?
However, if you scratch the surface, you’ll find that many things are truly free. In this post, I’ll give a few examples of such things and speculate about how their suppliers remain in business despite giving them away for free.
1. SOFTWARE
There are tons of free software e.g. ChatGPT, Hootsuite, WordPress. The two questions that arise about their vendors are:
- Do they make money?
- How do they make money?
Short Answer: Yes, they make money, via innovative revenue models.
Long Answer: Whenever a new revolutionary technology emerges, startups building products and services with and around them attract tons of venture capital. With that money, they can survive without making revenues, let alone profits.
Back in the day, the “survive without revenues” period lasted a few months, and “survive without profits” period lasted 3-4 years. However, in today’s world, companies manage to not just survive but flourish for more than a decade without making profits e.g. AirBnB, Flipkart, Uber.
The CFO of analytics company Snowflake recently said that tech companies start making profits only eight years after they IPO.
Years to profitability in Tech: 8 years after IPO.
“Many tech companies turn a profit about eight years after their IPO” ~ Snowflake CFO Mike Scarpelli via https://t.co/AMEa9bx34E— Ketharaman Swaminathan (@s_ketharaman) January 25, 2024
We saw this in blockchain 5-7 years ago.
We’re seeing it in AI now. The most egregious example of this trend that I’ve come across so far is the new AI agent startup /dev/agents aka CapitalG. Founded by the ex-CTO of STRIPE, CapitalG just raised a monster seed round of $55 million at $500M valuation. For the uninitiated, at the seed stage, a startup does not even have a product, let alone revenue or profit, and, not very long ago, seed rounds were typically $1-3M at $5-15M post-money valuation.
But these startups are the outliers. Most tech vendors do have revenues (though not profits) by the time they enter the public discourse. This is true of all the three software vendors mentioned above.
But it’s not like all of their users pay. Typically, most software vendors have FREEMIUM and PAID plans. With the revenues they generate from their paid subscribers, they’re able to serve their freemium users for free.
Any software vendor would love to convert as many freemium users to paid users as possible. While they can use the best practices we highlighted here and here in that pursuit, the fact remains that paid subscribers constitute less than 10% of user base for most software companies, so their product is truly free for a vast majority of their users.
2. FREE SHIPPING
When I mentioned that I got free shipping on a recent quick commerce order, somebody told me that it’s not really free. They claimed that I must have paid a higher base price to offset free shipping. That’s not necessarily true.
While the seller certainly incurs a cost for shipping, he might not be able to pass it on due to competitive pressures, so nobody pays for free shipping except the seller’s margins. Or he might be recouping the cost by inflating the prices of other items instead of the one I purchased, so some other consumer pays for my free shipping.
Either way, free shipping is free for me.
On a side note, according to GAAP, if an item doesn’t appear on the invoice or appears with a price of 0, it has No Commercial Value.
3. CREDIT CARD
Merchant incurs 2-3% Merchant Discount Rate cost for accepting credit card.
When all is said and done, there are only two reasons for a shopkeeper to accept credit card: (1) He will lose business if he does not (2) He will be able to make the customer overspend if he does. https://t.co/lEDrJ60Moj via @ValuePenguin
— GTM360 (@GTM360) August 24, 2018
Some merchants pass on the payments processing cost by surcharging credit card customers – but many don’t. Instead they either absorb the MDR cost as the cost of attracting lucrative credit card consumers or spread the MDR cost over all methods of payments including cash so that all consumers pay the same price, regardless of their method of payment.
In the former case, there’s no increase in the price of the basic product for anyone.
In the latter case, a cash consumer will pay a higher price than normal without getting anything extra in return; and a credit card consumer will get rewards and other benefits that would more than offset the bump in the price of the basic product.
On a side note, since credit card customers are generally more affluent than cash customers, this amounts to taking money from the poor and giving it to the rich, ergo this phenomenon is called “Reverse Robinhood Effect” in the industry.
“Hidden cost” is often a myth. Even if a free consumer incurs some additional cost that he’s not aware of, hidden cost is by definition hidden, so even a paying consumer could be incurring it without being aware.
Somebody surely pays but it doesn’t have to be the guy who gets it for free. Counterpoints like “there’s no free lunch”, “you’re paying in a different way”, and “hidden costs” don’t apply to him. He’s right in asserting that it’s free for him.
When I started my professional career, my boss told me, “Nothing free has any value”.
How times have changed!