The dismal economics of paywalls

November 4, 2010

Mark Thoma sends me a very clear explanation of the economics of paywalls from Kellogg’s Shane Greenstein:

Two fundamentally different models have competed in information markets.

In one model, an information provider formats the presentation of information, selling advertising space to another party. These sites want search engines to find them. This model involves little gatekeeping of the user. Much of the open commercial Web operates this way.

In the other model, an information provider sells passwords to users…

Vendors can charge serious subscription fees for password when the information is unique enough that users are not tempted to go to the free advertising-supported alternatives…

The Wall Street Journal has had a bit of success providing unique coverage of financial matters… Similarly, many sports teams have started gatekeeping for deep coverage of team matters…

In most other news markets, in contrast, gatekeeping had a hard time surviving because it was not valuable. This outcome should be blamed on competition between many news outlets with similar material. If one vendor tried to restrict access with gatekeeping activity, another vendor could offer the same information for free, thereby attracting another eyeball for their advertisers. Users tended to go to the latter, undercutting the former.

This outcome arose because the cost of sending files to one more reader is nearly zero, which makes it tempting for competitors to charge nothing and sell advertising. If that attracts large numbers of users from the gatekeeping site, it renders any gatekeeping strategy unprofitable.

There’s a couple of important things to add to this analysis, I think. Firstly, there isn’t some lumpen mass of “users” who are in search of information and go to where they find the most value. Every major newspaper in the world has vastly more readers today than when the only way of reading it was to pick up a physical copy. And the daily readership of an inside-the-beltway publication like Politico dwarfs the print circulation of the largest newspapers in the world — Bild, or The Sun, or USA Today.

When online publications go free, they’re not just competing for users; they’re creating new readers in a way that pay sites have enormous difficulty doing. That’s one of my big problems with paywalls: even if they’re the most effective way of monetizing existing readers, there’s an enormous opportunity cost of implementing them, in terms of the new readers who will in future never read the site because they’re put off by the paywall.

Sites with paywalls understand this, of course, which is why they make selected content free, or allow readers some quota of free articles before they reach the wall. But there is always a downside: such approaches require registration, which many people find too burdensome; and they also mean that the site develops a reputation as somewhere to be avoided unless there’s an article you really want to read. Certainly it becomes very difficult to search such sites for specific information.

More generally, Greenstein sees the economics of content as a competition between providers, where the lowest-cost providers win. But he misses something, I think. It’s not just that readers don’t see the value in paying for content when something “similar” can be found elsewhere. It’s also that there is positive extra value in reading free content, since it becomes much easier to share that content via email or blogs or Facebook or Twitter, you don’t need to worry about following links or running into paywalls, and in general you know that the site will play well with others on the open web.

The point here is that giving away content for free doesn’t have to be a regrettable necessity; it can actually be an exciting way of maximizing the value of your content.

And meanwhile, the richness of the web does not mean that news sites, say, are competing mainly with each other. If Newsday puts up a paywall and it fails, is that because readers can find content similar to Newsday’s elsewhere for free? Yes, in part. But it’s also because the people who would otherwise visit have lots of other things they also like to do. They like to spend time in Farmville, or they want to watch a video of a dog skateboarding, or they want to see their house on Google Earth, or they want to go walk their dog. These aren’t people who need certain information and are going to seek it out at the lowest cost; they’re just people who would visit Newsday’s website if it was free, but won’t if it isn’t.

That’s why gateways and paywalls are such problematic things, online: they’re a bit like that crappy VIP room in the back of the nightclub which is much less pleasant than the big main space. You might wander in there from time to time if it’s free, but if you need to buy an expensive bottle of Champagne to do so, forget it. There’s lots of other stuff to do, both online and off. And so the walled-off areas of the internet simply get ignored.

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