Hoofnagle & Whittington Paper on Free Offers

The prolific Chris Jay Hoofnagle of Berkeley and Jan Whittington of the Department of Urban Design and Planning, University of Washington have written The Price of 'Free': Accounting for the Cost of the Internet's Most Popular Price, forthcoming in 61 UCLA Law Review (2014). Here's the abstract:

Offers of “free” services abound on the internet. These offers cause a conundrum for consumer protection. Courts are apt to discount users’ claims against such services; one recently held that users are not “consumers” for purposes of California consumer protection law. Industry leaders push to monitor users ubiquitously, an imperative driven by the desire to fund “free” content. Policymakers struggle with this imperative and weigh it against vague consumer preferences for privacy, which users seem to happily abrogate to get the next new free service. These problems, we argue, flow from attention to the price of free offers instead of their costs.

To elucidate these costs, we apply a transaction cost economic (TCE) approach to “free” transactions with personal information. TCE provides a framework for analyzing these exchanges even where the price of the product seems to be zero. “Freemium” offers employ a form of cross-subsidy, a technique widely accepted in infrastructure industries, and a basic tool used to support the equitable delivery of products and services with the understanding that some have more willingness and ability to pay than others. However, we argue that information intensive companies misuse “free” to promote products and services that are packed with non-pecuniary costs.

Current governance structures allow firms to collect valuable information ex ante and monetize it ex post, despite consumer preferences for privacy and the impression, given to the consumer, that the transaction would be “free.” Some firms obligate consumers to divulge personal information in order to try a “free” sample of their online product. Other firms, such as social networking services, would not have a product if not for the personal information consumers create and upload. In both business models, what may begin as ex ante misalignment between the interests of the firm and consumer can become ex post maladaptation when the firm realizes the financial gains possible from monetizing the consumer’s personal information. Targeted advertising, switching costs, the cost to consumers to try to monitor the actions of the firm, viral patterns of distribution of consumers personal information amongst firms, and disincentives that lead firms to underinvest in information security, are among the contractual hazards that raise transaction costs for consumers.

We then turn to potential governance structures to curb the incentives of firms to raise transaction costs for consumers. One source for legal intervention is the Federal Trade Commission’s “Free Guidelines.” These guidelines will be reviewed in 2017, offering an opportunity to reconsider the fairness of free offers conditioned on provision of personal information. As currently written, they do not directly address exchanges for personal information. Still, two remedies flow from the FTC Guide: clearer disclosures that personal information forms the basis of the transaction, and the requirement to establish a regular price before marketing a service as free.

While behavioral economics may support an outright ban of free offers because of their biasing effects, TCE suggests other strategies for reform, focused upon placing business risk more firmly in the hands of businesses. These interventions go beyond the traditional transparency and accuracy requirements suggested by privacy law. They involve eliminating the avoidable costs that arise for consumers when compelled to provide personal information in order to try a “free” product, recognizing the role consumers play in the production and business of social networking services, and requiring each third party interested in access to a consumer’s personal information to obtain opt-in per consumer through full disclosure with terms of service and privacy policies.



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