“Free customers are more valuable”

“Free customers are more valuable”
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First Published: Mon, Apr 23 2007. 03 27 AM IST
Updated: Mon, Apr 23 2007. 03 27 AM IST
Sunil Gupta, the Edward W. Carter Professor of Business Administration at Harvard Business School, is one of the leading experts on marketing strategy, pricing and customer management. He has made some startling revelations in his research paper on the profitability of a free customer in a networked setting, a two-sided market such as Monster.com that needs to attract both content generators (sellers) and content consumers (buyers). Gupta says the value of a buyer (a non-paying customer) is slightly higher than the value of a seller (paying customer) even though there are far more buyers than sellers in the online marketplace. In an interview with Rajeshwari Sharma, Gupta says that while the model applies only to simple two-sided markets, non-paying customers are also important to other businesses in the physical marketplace. Excerpts:
What is your latest research all about?
Many firms deal with two sets of customers. For example, auction houses and real-estate firms have buyers and sellers; employment services have job-seekers and employers; dating services have men and women. In such situations, commonly called two-sided markets, a firm may not charge any money from one set of customers. For example, eBay generates almost all its profits from sellers through commissions and listing fees. Buyers do not provide any direct profit to the firm. However, without buyers, the firm would have no sellers and vice-versa. Our research shows how a firm can assess the value of these “free” customers, who do not provide any direct profit to the firm.
Do free customers have the power to impact a firm’s profitability?
Yes, free customers have a significant impact on the profit of a firm in the two-sided market. Without these “free” buyers, sellers won’t be attracted to the firm. In order to create a meaningful market, a firm such as eBay has to have enough buyers. The more buyers it has, the more sellers it is likely to attract, which will lead to higher firm profitability.
Does your research on free customers find application in the physical market, too? And how?
Although our research is based on the data for an online auction house, the results are also relevant for physical markets such as real estate.
How does your free customer model help in valuing the free customer Sunil Guptawhose real worth is not apparent?
In our application, buyers are “free” and sellers provide revenue to the firm. As the number of buyers increases, more sellers find it attractive to join the firm. This is called indirect the network effect. We have built a mathematical model to capture these indirect network effects. Our model allows us to find the impact of additional buyers on the number of new sellers, which in turn influences the overall revenues and profits of a firm. Our biggest surprise was that buyers were even more valuable than sellers though buyers were free and there were almost five buyers for each seller.
How important are free customers, who are more often than not ignored by firms, to a business’ growth and marketing policy?
In two-sided markets, free customers are critical. Without buyers, a firm has no sellers and, hence, no business. This is especially true in the early stages of a firm’s growth when it is still building a critical mass of buyers and sellers. While this intuition is straightforward, our model provides a way to put a dollar number on the value of “free” buyers. This provides guidance to a firm on the maximum amount of money it should spend to attract or acquire these free customers.
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First Published: Mon, Apr 23 2007. 03 27 AM IST
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