Nerd Culture is Toxic to Effective Pricing

Depending on exactly when you think the Internet started, it’s possible to make the case that for most of its existence, the Internet has not just been non-profit, but has been in some sense anti-profit. Early Internet startup founders had serious conversations about whether or not selling stuff on the web constituted misuse of the Internet.

That strain of thought is mostly dead; Wikipedia exists as a sort of public utility, but few people argue that the rest of the Internet should be more like Wikipedia. (In fact, any look at a serious Wikipedia edit war shows how bad it would be if the rest of the Internet worked just like Wikipedia.)

But there’s another strain of thought that’s nearly as harmful: the thought that it’s not acceptable to charge a huge markup for something with a low marginal cost. Music sharing used to be the front line of this debate: on one side, the music industry argued that music was property just like anything else, and that misappropriating it was just a clever kind of stealing; on the other side, programmers argued that when the marginal cost of copying a song is zero, the right price for it is zero, too. Like a lot of debates, this one got solved by technology rather than discussion—music companies found something they could charge for (distribution, selection, and an interface), and the infrastructure behind free music couldn’t support itself without ungainly and deceptive ads, even disregarding the cost of defending against legal threats.

Nerds have an instintive sense that business works in a pretty simple way: you buy some raw materials, you transform them into a product, and you mark up your costs by some fair percentage, where “fair” is enough money that you could potentially be worth as much as Steve Jobs, but not as much as Bill Gates. The web economy gives them plenty to be outraged by:

• Virtual goods and downloadable content: these pixels work exactly like the free pixels; they just cost money.
• “Enterprise” pricing that offers 5% more features for a 500% markup.
• Online storage companies that basically resell cloud hosting to consumers at a massive markup.

The cloud hosting market is particularly interesting because it includes one company that does support nerd-friendly pricing. Tarsnap quotes rates in “Picodollars,” has no free version, and doesn’t have a graphical user interface. Dropbox is a similar product, with human-friendly pricing. Guess which startup’s founder ranked in the top 100 in North America’s most challenging undergraduate math exam, while still in 10th grade. And guess which startup last raised money at a $4bn valuation.

Price discrimination is a fundamental part of the Internet, not because it’s important to charge people lots of money, but because it’s so hard to charge everyone. The same people who argue endlessly about how Netflix is a ripoff compared to Bittorrent only have a venue to argue because other people are paying, usually by viewing ads.

A more accurate model of Internet businesses is that user acquisition is the big underlying cost, and that everything an online company does is an attempt to, on average, recoup this cost and then some. Zynga can raise money because they have a formula: invest $X in a game and $Y in promoting it, and get a predictable number of customers, some small fraction of whom will spend enough money to pay for the whole enterprise.

The right model might be casinos. Their product is pure profit (or at least purely predictable profit). They lose money on plenty of customers, and can’t do anything about it. But those customers only get the experience they get, at the price they pay, thanks to the subsidies of lots of regular customers and a few whales.

That’s uncomfortable. Startup founders want to be Larry and Sergei, not Steve Wynn or Sheldon Adelson. But it’s better for the web if people who produce good products learn how to charge for them. Otherwise, the whole show will be run by people who come up with brutally effective pricing schemes, and then back their way into a product that justifies them. The enterprise software industry is a monument to what results.