Wednesday, January 14, 2009

An economy based on free junk

Loss leaders are hardly a new concept, but they seem to be growing in importance. The idea behind a loss leader is that a company gives one product or service at a loss, or minuscule profit margin, in the hope that it'll attract customers who will then also buy more lucrative products. For instance, the price of a ticket at a movie theater barely covers the theater's expense of showing you the movie. Their profit only comes in when you buy concessions.

There are times when a loss leader is appropriate, but in many cases, the consumer ends up losing. Moviegoers have to deal with the sounds of popcorn being crunched and candy wrappers being rustled during quiet parts of a movie.

Part of the reason that loss leaders are gaining in momentum is that the Internet has come with a culture of free things. Try to think of how many sites' services you pay for on the web — I'll bet you could count them on one hand, and probably on one fist. Or, think of how many times you heard music, legally or not, without paying.

But someone still has to get their money, and the mechanism for them to do so sometimes hurts the product. Consider music. I've already complained that music numbs our brains, but now that artists are finding it harder to sell tracks, they're starting to use them as marketing tools. Snoop Dogg's Landy in my Egg Nogg was commissioned by Landy's maker to promote the drink, for instance. A platform already skilled in numbing our minds is being tuned towards manipulating them.

Newspapers have had a loss-leader model for years: they made almost nothing from selling newspapers, and instead got most of their revenue from advertisements and classified ads. That created conflict (or at least the potential for it) between the papers' editorial and sales departments. It also meant that newspapers were vulnerable when classifieds moved to craigslist, which is one of the biggest reasons that newspapers are struggling even as our thirst for news is at an all-time high.

Sometimes the loss-leader model makes sense. Cell phone service providers heavily subsidize phones and make their money through your phone bills. That works because you're essentially taking a loan for an expensive piece of hardware and paying it off as you pay for the service.

Generally, the loss-leader model makes the most sense when the loss leader and the profitable product are closely related — when they're both used for the same common end-goal. This is the case in cell phones, printers (where the money is earned in selling you ink) and Shai Agassi's plan for electric cars, in which the cars themselves are free but the electricity costs you. The end goals there are communicating, printing and driving, respectively.

But even in these cases, there's a potential for the system to hurt consumers. Apple's iTunes store is a loss leader for the iPod (Apple still profits from iTunes sales, but not nearly as much as it does from the iPod). For years, this made Apple consenting if not complacent to record companies' insistence that the music come with anti-piracy encryption — which also, as it happened, meant it was only possible to play that music on iTunes or an iPod. Apple was happy, record labels were happy, and consumers had less freedom.

Of course, the proliferation of loss-leader models isn't just companies' fault. We the consumers buy into it, sometimes insistently. We'll go to a movie theater and pay $10 for a ticket and $7 for a popcorn and soda, but we'd refuse to buy $15 tickets and $2 snacks. That's maybe the saddest part about this system: we're losing out not because some CEO is trying to bilk us, but because we wouldn't have it any other way.

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