Zero-Price Goods and Cross-Subsidisation in Digital Markets

It turns out you can get some things for free in life.  Digital entertainment can be had, from various streaming platforms, for zero cost per month.  While the consumer must pay the up-front cost for the smart TV and some form of Internet connection, the entertainment streams for free.  Why does free streaming entertainment exist today?

Historical Analogies

Originally, most electronic entertainment was free to the masses in the form of radio and network television.  If you owned a radio or a television set, you could pick up broadcasts with no subscription charge!  The entertainment was paid for by advertisers, who paid the broadcaster for rights to air commercials at certain times.  Just like with influencers on social media today, the advertising could be done more or less covertly.  A show could be publicly sponsored by brand, with the brand and its slogans read at the start of every episode.  Or, for non-sponsors, commercials could run during the episode at various intervals.

The slow demise of free entertainment for most Westerners began with the rise of cable TV and convenient mediums of recording entertainment.  By the end of the 1980s, many preferred to watch cable TV or pop in VHS tapes, cassette tapes, or CDs to get their entertainment fix.  Free entertainment from radio and network TV still exists, but is often overlooked among the plethora of costly substitutes, including satellite radio and streaming TV and movie subscriptions.  Many consumers accepted paying for per-unit entertainment because it freed up their schedules: free entertainment ran on the station’s schedule, not the viewer’s.  A VHS tape or CD could be played whenever convenient for the customer.

Freemium Streaming Today

While most consumers pay for at least one streaming entertainment service, such as Netflix, Hulu, or HBO Max, free services do exist.  As one might expect, they are paid for through advertising, with companies paying the streaming service money to run traditional commercials or banner ads that scroll before, during, or after the episode.  Some freemium streaming services offer paid tiers, allowing consumers to forego the ads in exchange for paying for the entertainment directly.

Up to about 65 percent of all streamers utilize at least one free service, tolerating ads in exchange for no subscription cost, with younger demographics more likely to go freemium than older consumers with more income.  The most popular free streaming service overall appears to be Tubi, which hosts a large library of movies from many studios, followed by the Roku Channel.  A wide variety of freemium streaming services exists, often niche-focused and owned by the same oligopolist studios that are better-known for subscription platforms.

Economics of Zero-Price Digital Goods

Why do large companies that offer paid streaming subscription services also offer free services?  Some reasons are obvious, but others are less obvious and require long-term investment.  A look at the economics of zero-priced streaming, music, and video games:

Near-Zero Marginal Cost

Huge libraries of movies, TV shows, music, and video games exist.  This digital entertainment has already been created.  If the streaming service owns the rights to these creations, there is theoretically no future costs to incur on their behalf.  Royalties may be paid to the artists featured, but these are often figured after revenue has been incurred.  Thus, the streaming service owns petabytes of cost-free entertainment that it will profit from easily.  All that is needed is enough revenue to cover the cost of hosting all this data.

Ad Revenue is Readily Available

Fortunately, advertising online has been well-established.  Streaming services can set relatively low advertising rates, enough to cover the cost of its digital entertainment library servers, and create a new freemium service.  Advertisers may flock to freemium services because they know the demographic: budget-conscious consumers.  Large companies with value brands may focus those ads on freemium watchers, who may be searching for value brands more so than paying viewers.

Data Extraction as Implicit Payment

Streaming services may give viewers a “deal” on the digital entertainment in exchange for their viewing data.  The firm can see what viewers watch, when they watch it, how often they watch it, and how they react to new content.  Over time, this data allows the firm to create better features.  If data reveals that some types of content are rarely watched, the firm can save money by dropping this content from its servers.  Data from individual users can also be sold to advertisers to subject those users to targeted advertising, increasing the streaming firm’s revenue.

Captive Market to Target for Paid Upgrades

In addition to selling user data to other firms for advertising purposes, streaming firms themselves can regularly target freemium users with advertisements for upgrades to paid tiers.  The firm can selectively move the most desirable free content behind its paid tier paywalls, forcing consumers to upgrade if they want to continue watching it.  Therefore, zero-price streaming tiers can be valuable by attracting initial viewers and revealing which content is “premium” and people will pay for.  Although most viewers may resist the constant advertisements to upgrade, some will agree to become paying subscribers.

Testing Ground for New Digital Products

Will a new movie, TV show, song, or video game be a hit?  Streaming firms may drop a beta version on their freemium sites to analyze viewer reaction before ultimately releasing the new product on the paid tiers.  If the in-progress new offering is a hit, the finished product will go swiftly behind the paywall.  If the beta version is a bust, however, the project may be canceled or, after budget cuts, be placed on freemium.  Viewer reviews on the freemium site can help the company edit and re-tool the digital product to be “pay worthy”.

Long-Term Market Implications of Zero-Price Digital Goods

Due to the economic benefits to firms of luring captive audiences with zero-price digital products, the freemium market model will almost certainly continue in the long run.  Old content, no longer generating much interest from paid subscribers, can still draw customers who are targeted by paying advertisers.  Firms can also promote their freemium packages as generosity, claiming that they are opening up their “classic” libraries of content to give the public what it wants.  The data gained from zero-pay consumer browsing, viewing, and reactions to advertisements saves streaming firms the cost of running focus groups and doing market research - they have their own “research lab” of customers.