Let That Other Guy Pay! Saving Money in Two-Sided Markets

Continuing with our theme of Spreading The New Frugality, this article explains how you can save money on food and other consumer items by taking advantage of one of the idiosyncrasies of our modern economy: the two-sided market.

PS: For those of you who missed last week's post, the phrase "The New Frugality" is just a catchy-sounding name for plain old regular frugality.

There's an intriguing section in Chris Anderson's otherwise mediocre new book Free discussing two-sided markets. These are markets where products are free or heavily subsidized for the end consumer, thanks to a third party who pays the bills.

The most obvious example of a two-sided market is broadcast media. Over-the-air television and radio are free to consumers because advertisers are willing to pay for access to a large audience.

But let's think about this arrangement a little more deeply. Who really pays in this kind of arrangement? In reality, the advertisers don't really pay. The people who buy advertised products end up paying. They pay in the form of higher prices.

If you see a national marketing campaign for Pepsi and at some point decide to buy a can of the stuff, you should be well aware that in making that purchase, you indirectly pay for that advertising--as well as for several other embedded costs. Furthermore, you pay for incremental profit margins on top of all these costs because Pepsi, understandably, wants to make a profit selling bubbly brownish liquid.

Quite frankly, this model works exceptionally well. Forgive the finance-speak for a moment while I give a quick example of exactly how well: in the most recent quarter, Pepsi printed operating margins of 20.7%. During the worst recession in recent memory.

[Some of you might reasonably ask, "wait--are 20.7% operating margins good?" And I'm here to tell you that, yes, they are. Really good. Very few companies can maintain this kind of profitability long-term. Seriously, if I had a nickel for every money-losing technology company I met during my prior life on Wall Street that claimed it would earn 20% operating margins, I'd.... well, I'd have a very tall stack of nickels.]

Let's look at a few more examples of two-sided markets:

1) Free credit cards: Consumers who carry credit card balances and who do the most buying subsidize your access to free revolving credit.

2) Online pay sites: Online sites tend to obey a 5% rule, where 5% of users paying for a premium service generate enough revenue to subsidize a large pool of free users (e.g., Flickr or Yahoo Games).

3) Grocery stores: Grocers make the bulk of their profits on prepared and processed foods (what we call second-order foods here at Casual Kitchen). Therefore, shoppers who buy Hungry Man frozen dinners essentially subsidize shoppers who purchase simple grains and inexpensive in-season produce.

Okay, this is all very fascinating, but what is my point? Well, as we'll soon find out, this two-sided market model--where some pay and others get a free ride--works well not only for companies. This model works exceptionally well for consumers too.

For the consumers who put their money back into their pockets.

Nobody says you have to pay extra for heavily advertised or overpriced foods, products or services. Let others purchase them, and let those purchases subsidize you, while you buy less-processed and less-marketed items without these embedded costs.

This thinking goes far beyond the grocery store. In fact, you can apply it to practically every area of consumer spending. The big home renovation firm that advertises all over town will likely charge you an arm and a leg for a job, while the small-time contractor who quietly built a good reputation by word of mouth may do better work for much less. Instead of patronizing heavily advertised national chains, you might find better value (and much better food) at a local owner-operated restaurant. The eye doctor or dentist in a prominent, high-rent office in your community will likely charge high prices, but she may not necessarily give the best care. And so on.

However, don't misread this post and conclude that you should never do business with any company that advertises, pays a lot in rent or earns 20.7% operating margins. Nor does embracing The New Frugality forbid you from buying widely advertised second-order foods like Pepsi, Doritos, M&Ms or any of a long list of foods I myself occasionally indulge in.

The point of this post is to get you to think about what you are actually paying for when you buy products or services that are particularly expensive, heavily processed or heavily marketed. Ask yourself whether that incremental cost is worth it to you. If it's not, then choose to not buy.

This is the easiest way I know of to save a lot of money, not just in the grocery store, but in all areas of consumer life. It's never been easier to be frugal, and there have never been more reasons to embrace The New Frugality. Spread the word, and help those around you embrace it too.

Photo credit: Meanest Indian

Related Posts:
Spending to Save: Frugality and Expensive Food
Defeat the Diderot Effect in Your Kitchen and Home
Six Good Things About the Awful Economy
41 Ways You Can Help the Environment From Your Kitchen

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J.N. Urbanski said...

BRAVO! I couldn't have put it better myself. I have this debate with one of my clients (in production/ entertainment) who says that "Free" content is the future. However, it cannot not exist everywhere; in the "Free" scenario someone always has to be pay. And if it's advertisers (which it always is for my client), then it's us.
I've been saying for years that it behooves us to pay for our content, at least in part, or we will pay dearly elsewhere. Free news puts too much of a burden on the producer. And most important of all, if we rely on advertisers to pay for our content, then these sponsors will have the power to dictate our content just like they do on television. Sooner or later, ratings will influence our tastes and styles as they do on television.

Daniel said...

Thanks JNU, appreciate the feedback. I hadn't really gone into how the media companies become tastemakers for us and how advertisers are dictating play more and more on what we see in the media, but those are valid issues worth pursuing. Thanks for your comment!


J.N. Urbanski said...

You're welcome! I think it's a really important subject. I'm keeping a close eye on proceedings. This book "Free" basically conceded at the end that there's no such thing as free anyway, so it was only a catchy title.