Why Giving Things Away for Free Actually Works

Hal Varian, Google’s Chief Economist, once pointed out that in today’s internet economy, the one truly scarce resource is attention. This single idea unlocks the strategy behind some of the world's most successful companies and holds powerful lessons for anyone looking to build a business.

Imagine you’re running a company with incredible technology. You can provide instant access to the content of millions of books, organize and store photos, translate dozens of languages, and offer sophisticated document creation tools. You even let people see their own house from space. What do you charge for this suite of services that’s collectively worth thousands of dollars?

If you’re Google, the price is zero. For the average user, all of that power is completely free. This isn't because the founders are nostalgic for communism or believe all information should be free. It’s a calculated business decision. A visit to Google’s headquarters in Mountain View reveals this philosophy in miniature. Employees get free gourmet meals, massages, yoga classes, and even laundry service. The company provides these perks because it encourages talented people to stay longer and work more productively, which ultimately boosts the company's revenue. The lesson here is that a great often starts by creating immense value.

Paying with Attention

That same principle applies on a global scale to Google’s users. The more value Google gives away, the more it gets back in the form of loyalty and attention. That loyal audience is an incredibly valuable asset, which Google then sells to its set of customers: advertisers. This two-sided model is so effective that in 2008, a year when established companies like General Electric and Berkshire Hathaway struggled, Google’s earnings remained steady, generating billions in free cash flow while roughly 99% of its users never paid a cent.

But plenty of other companies have tried and failed with advertising models. What makes Google different is the tangible value it offers advertisers. It’s not just about reaching a massive audience of 500 million people. It’s about reaching a massive collection of individuals with distinct, known preferences at the exact moment they’re interested. People don't idly search for topics they don't care about. When someone types in a search query, they are signaling intent. For an advertiser, this is gold. They pay only when an interested person clicks their link, with the price for keywords set by an auction system. It’s a highly efficient model for any to learn from.

The Growing Power of Free

This “free” strategy is booming far beyond tech. At its core, it often relies on what economists call a two-sided market, where you need two different customer groups to have a business. The classic example is a bar’s “Ladies’ Night,” where women drink for free to attract paying male customers. Today, this is driven by a few key factors.

First, the cost of digital information has plummeted. Thanks to advances in computing and storage, distributing content to millions costs nearly the same as distributing it to thousands. As Hal Varian explains, competition in a world of cheap digital media naturally pushes prices toward zero. Second, crowd-sourcing has lowered the cost of content creation. YouTube, for example, became the world’s largest video library without producing its own videos; users did it for them. Wikipedia, written by volunteers, has made traditional encyclopedias like Britannica largely obsolete, offering a more comprehensive product for free. Similarly, popular websites like The Huffington Post run on a lean staff supplemented by thousands of unpaid contributors—a model that anyone looking to should study.

Finally, there's the peculiar psychology of zero. Researchers at MIT found that people have an irrational preference for free things. In one experiment, when a low-quality Hershey's Kiss was offered for 1¢ and a higher-quality Ferrero chocolate for 26¢, customers were split. But when the price of the Kiss dropped to zero and the Ferrero to 25¢, 90% of people chose the free Kiss. “Free” isn’t just another low price; it’s a powerful emotional trigger that can dramatically boost demand.

Competing in a World of Free

For established businesses, this shift is a serious threat. The music industry has watched sales collapse, and software giants like Microsoft have been forced to offer free, web-based versions of their products to compete with Google’s office suite. An analyst once remarked that if Microsoft were starting today, it wouldn’t even consider charging consumers for software. This is a critical insight for anyone launching a in the digital age.

Fighting free with nearly free doesn’t work. As the MIT experiment showed, there’s a world of difference between a penny and zero. For most companies, matching a zero price is impossible because their cost structures are too different. Just look at the newspaper industry. As readers moved to free online news, advertisers followed, forcing papers to cut costs, which lowered quality and drove more readers away. Their attempt to offer free online versions of their papers has been a financial disaster, with one estimate suggesting they gain only 1.7 cents in online ad revenue for every dollar of print advertising lost.

So what’s the alternative? Instead of competing on price, you have to compete on value. Think of the retail landscape: department stores struggled, but discount giants like Wal-Mart and luxury boutiques like Tiffany’s thrived. They catered to different ends of the market. Similarly, the way to fight a free product isn't with a cheap one, but with a premium one. A newspaper can't win with a $50 annual subscription against free, but a financial data service can with a $1,700-a-month Bloomberg terminal contract because it provides indispensable value. This principle applies to many ; focus on delivering unique, high-quality information that people with a laser focus on a subject are willing to pay for.

News organizations could create exclusive communities, like GlobalPost’s Passport service, which offers members special access to reporters for an annual fee. For those running an , this might mean leveraging a personal brand—a popular columnist could start a paid book club or offer exclusive analysis via a newsletter.

Ultimately, there’s no such thing as a free lunch. “Free” can be a powerful strategy, but somewhere along the line, someone has to pay the bill to keep the business alive. Whether it’s advertisers footing the bill or a customer paying later for a premium service, a path to profit must exist. As Peter Drucker said, profit is the price of survival.