Free: Accounting for the Costs of the Internet’s Most Popular Price
65 Pages Posted: 20 Mar 2013 Last revised: 17 Mar 2023
Date Written: February 28, 2014
This is the second in a two-part series of articles exploring consumer-oriented internet services through the lens of transaction cost economics. This work shows how personal information transactions—“free” exchanges—can be uneconomical: consumers cannot exit these arrangements; they create lock-in; and ultimately this is a deep moat against competition. Free transactions enable companies to bait consumers with what appears to be a good deal, but then substitute a switch—degrading privacy quality. This work has important antitrust law implications: the scaling and lock-in made possible by zero price inducements makes it next to impossible for competitors to swoop in with better products.
Offers of free services abound on the Internet. But the focus on the price rather than on the cost of free services has led consumers into a position of vulnerability. For example, even though internet users typically exchange personal information for the opportunity to use these purportedly free services, one court has found that users of free services are not consumers for purposes of California consumer protection law. This holding reflects the common misconception that the costs of free online transactions are negligible — when in fact true costs may be quite significant. To elucidate the true costs of these allegedly free services, we apply a transaction cost economics (TCE) approach. Unlike orthodox economic theory, TCE provides a framework for analyzing exchanges in which the price of the product seems to be zero. Under a TCE analysis, we argue that information-intensive companies misuse the term “free” to promote products and services that involve numerous nonpecuniary costs. In so doing, firms generate contractual hazards for consumers, ignore consumer preferences for privacy, and mislead consumers by creating the impression that a given transaction will be free.
While psychological research and behavioral economics may support an outright ban of free offers because of their biasing effects, TCE suggests reforming governance structures to place the business risks associated with free transactions more firmly in the hands of businesses. We suggest alterations to governance structures — such as the Federal Trade Commission’s Guide Concerning Use of the Word “Free” (FTC Guide) — to curb the incentives of firms to raise transaction costs for consumers. The FTC Guide provides support for two of the consumer protection measures we propose: first, a requirement that free service providers clearly disclose that such providers seek users’ personal information in exchange for those services, and, second, the establishment of a regular price before providers can market a service as free. We further argue that the recognition of users of free services as consumers for purposes of consumer protection law would better align incentives and ensure users access to legal redress against some of the most popular services on the Internet. Lastly, we suggest the adoption of alternative governance structures designed to reduce the cost of transacting by curbing the collection of personal information from consumers of free services and by enhancing the rights of consumers to govern the dispersal of personal information from free online services to third parties.
Keywords: platform competition, zero prices and antitrust, transaction cost economics, TCE, free, free offers, privacy, social network services, right to delete, portability, right to be forgotten, Williamson, New Institutional Economics, Federal Trade Commission, FTC free guide, Chris Anderson, attention
JEL Classification: A13, B25, D18, D23, D82, D18, K20
Suggested Citation: Suggested Citation