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Saturday, November 29, 2003
Digital Econ 101 and It's Problems
Here's a Slashdot post about my article that beautifully highlights the problems with orthodox technology strategy and economics:
"...The author tells us a story about the music market needing risk insurance, yet fails to consider the very notion of economic exchange in information goods. The problem with music is this. Consumers want music and indicate their preference for music by voting with their dollars. Yet, when the marginal cost of distributing the good is nil, and those that shouldn't be excluded from the market are being excluded, we have a problem. When you want to reward creators of music, and not exclude anyone from the market without specific reason, what is the right price you should sell your music?"
Ultimately, this poster argues that there's a market failure for all digital goods, and it has nothing to do with asymmetrical information - it's because digital goods are public goods. That is, they're like Central Park - you cant stop anybody from consuming them. Obviously, this isn't true - there's got to be some flaw in the argument, because there are plenty of functioning markets for information goods - porn, video games, and movies, to name just a few. But that's besides the point for now.
Furthermore, this guy is saying the following: it costs nothing to infinitely replicate an information good. Since price is based on marginal cost, which is zero, we shouldn't have to exclude anybody from the market. But some people are willing to pay a lot - and others only a little. So how the hell do we price our goods? Furthermore, since marginal cost is zero, how can we make any money? How can we avoid market failure?
This is the standard argument (and why econ breaks down for digital markets). It always leads to silly strategy, based on Deathstar DRM. Here's why, and here are the flaws in this argument:
1) Strategically, the cost of distributing information goods is not zero. The cost of replicating an information good is zero. Distribution is still a cost that's borne by the firm - at least in terms of the production externalities file-sharers impose on it. In fact, if you want to be strictly economical about it, the firm should charge the total fixed cost of an information good to the first buyer - since he can replicate it infinitely at zero marginal cost. Of course, strategically, this is an absurd proposition.
2) Consumers can't vote with their wallets - because they're forced to buy a risky contract under moral hazard. If they could, they might not - but they'd have to coordinate first. There's no coordination mechanism in this market, so what you've got is a massive coordination failure on the demand side - I may agree to vote with my wallet - but what about Joe and Mary? Unless I am sure that they will as well, I'm better off not doing so.
3) Economic orthodoxy is based around the notion of value through exclusion. This interpretation of value is highly questionable - any geek knows that value flows as much from inclusion as it does from exclusion. All the discontinuities in business models over the web are ways to create and extract value through inclusion. Think about eBay, or almost any other succesful business on the Net.
4) There is no 'right price'. Part of the point of my article is to look beyond one-price strategies. There are many ways to effectively charge different consumers different prices, and match value gained with value received - insurance is one.
5) Digital goods are not purely public goods. If anything, they're quasi-public goods. But even that's debatable. To get into this would take a hugely long discussion, so I'll just settle for saying that I think the distinction between public and private goods doesn't hold for digital markets (it's a fairly new one anyways) - and should be replaced by one focused around replication and plasticity (as opposed to private/excludable and public/non-excludable).
6) Approaching digital goods as public goods leads to simplistic strategies where you try and make them private goods - like everybody's favorite, DRM. The point of my article was to try and get past such obvious nonstarters.
Technology economics is nice - but it leads to questionable strategy. I much prefer old-school econ - which is what I based my article on.
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