Free Lunches

by on June 19, 2006

The Wall Street Journal has a write up of Craigslist, the online classified site that is steadily taking over the world. The author seems bewildered by the Craigslist phenomenon, seeming to think there must be some kind of trick or hidden agenda at work:

“The Internet at large, and free classifieds in particular–and even beyond that, Craigslist free classifieds in particular–certainly pose challenges to the newspaper industry as far as being able to raise their profitability over time.” Many in newspaper publishing would consider that an understatement. But Mr. Buckmaster is sanguine: “The demise of the newspaper has been overstated.” Phew. I expel a nervous chuckle of relief. In Mr. Buckmaster’s view, newspapers would be better off being a little more Craigslist-like: Go private, eschew Wall Street’s demands for continually “goosing profitability” and give your readers what they want. Much trouble in the world comes, in Mr. Buckmaster’s view, from losing sight of that essential goal.

After we’ve retired back to the living room for coffee, Mr. Buckmaster allows that the world is perhaps not quite that simple. When asked whether there’s a Craigslist model that other companies could emulate, the unflappable Mr. Buckmaster, his eyes once more fixed firmly on the horizon out the window, waxes lyrical for a moment: “It’s unrealistic to say, but–imagine our entire U.S. workforce deployed in units of 20. Each unit of 20 is running a business that tens of millions of people are getting enormous amounts of value out of each month. What kind of world would that be?”

Before I have time to object, Mr. Buckmaster comes back to our world. “Now, there’s something wrong in the reasoning there,” he admits. “You can’t run a steel company in the same way that you run an Internet company”–more points for understatement. “But still, it’s a nice kind of fantasy that there are more and more businesses where huge amounts of value can flow to the user for free. I like the idea, just as an end-user, of there being as many businesses like that as possible.” As an end-user, I suppose I do, too. But there are no free lunches, even if Craigslist–and the meal Mr. Buckmaster and Ms. Best provided for me–sometimes seem to come close.

The oft-repeated (especially by libertarians) view that there’s no such thing as a free lunch is actually nonsense. Civilization abounds in free lunches. Social cooperation produces immense surpluses that have allowed us to become as wealthy as we are. Craigslist is just an extreme example of this phenomenon, because it allows social cooperation on a much greater scale at radically reduced cost. Craigslist creates an enormous amount of surplus value (that is, the benefits to users vastly exceed the infrastructure costs of providing the service). For whatever reason, Craigslist itself has chosen to appropriate only a small portion of that value, leaving the vast majority to its users.

One way to look at this is to simply regard it as naivet© on the part of their management. But I don’t think that’s quite right. Consider this graph from Alexa:

That shows the relative traffic of Craigslist and the New York Times over the last 4 years. As you can see, in 2002, the New York Times had between five and ten times the traffic that Craigslist did (it’s hard to see exactly what CL’s number was). Today, they have about the same traffic. And there’s every reason to think Craigslist will continue to grow faster than the Times, as they’re nowhere near saturated in smaller markets.

If Alexa’s data went further back, we’d see equally impressive growth in the years between 1999 and 2002. What’s going on here, I think, is that the revenue forgone by Craigslist doesn’t simply disappear into the ether. The lack of ads and fees makes Craigslist a more pleasant website to use, which makes it possible for them to attract and retain users more effectively. In effect, they’re taking that surplus and investing it in user satisfaction rather than taking it as financial gains for themselves. That, in turn has a snowball effect: happier users tell their friends about you, and they, in turn, try the site and they too are happy.

This strategy is actually more common than the Wall Street Journal seems to think. Wikipedia is another example of a site that runs this way. (I’d show a Britannica vs. Wikipedia chart, but you can barely even see Britannica’s line in that chart) Another is LiveJournal, a site that until a couple of years ago was run primarily by volunteers and still makes 90 percent of its functionality available to users who never see an ad and don’t pay a dime. And of course, Google’s first advertisement didn’t appear until nearly 4 years after the site went public.

The strategy has another advantage too: charging people money for things is expensive. A significant fraction of the cost of a classified ad is the labor required to sell the ads. Even if you could automate that process, it’s still relatively expensive to process a credit card transaction. The same is true of ads. Which means that not only is Craigslist letting its users keep more of the surplus, but its surplus is actually bigger, too!

In the long run, then, I think sites that pursue a Craigslist-like strategy will come to dominate their categories, because they simply undercut their competition. That sucks if you’re the competitor, but it’s great for the rest of us!

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