Digitalization! A battle cry in most companies these days. Before entering this battle, managers should know that even so economic rules have not changed, economic factors costs have changed dramatically. Hal Varian, nowadays chief economist at Google, explains the impacts.
Hal Varian is known by about every student of economics. All there was to learn in the field of microeconomics for undergraduates in the last 25 years, chances are they learned it from Varians textbooks. After achieving extreme success with his two textbooks, he went on to co-author “Information rules – a strategic guide for the networked economy” in 1999. In 2002, he joined Google and helped change its strategies ever since.
For me there is quite a bit of nostalgia here. First of all, I studied Varians “Microeconomics analysis” textbooks in my time at the University of Glasgow in 1989. I graduated as an economist in 1994 and spend my first years working for Volkswagen and Daimler as an consultant. After spending the first years on SAP ERP, I honed in on the internet business in 1998 and read everything i could in order to prepare for my start-up. Since time immemorial i took on the habit of summarizing business books and storing the summary for later reference. According to this summary, i wasn’t much impressed with Hal Varians book “Information rules – a strategic guide for the networked economy“. It was the same micro-economic theory again, just applied on things like information. His conclusions sounded all to logical: The rules haven’t changed, just the factor costs. This is just ordinary microeconomics applied on the elusive good “information”. Not very exciting at all. And not to practical in its implications, i thought.
How wrong have i been! I have underestimated the impacts of the insights of this book. I certainly did not underestimate the revolutionary potential of the internet, because i went forward to build internet marketplaces like the “European Logistics Exchange EULOX” and my own start-up, a B2B contracting platform in 2000.But i underestimated that changing factor costs, such as “zero marginal costs to add an additional customer” to a platform will lead to the dominance of B2C Platforms (e.g. amazon, facebook, eBay, google, paypal), of crowdsharing, of powerful online communities of freemium models etc. I continued to think in B2B terms, but noticed that B2C was where the real impact was in the last 20 years.
Information rules: An early map to the digital age
I would not have gone to my book shelve and dusted off my copy of “Information rules”, which has been there for 17 years now, if not for Salim Ismails 2014 book “Exponential organizations“. Salim did what i couldn’t do 17 years ago. He took Carl Shapiros and Hal Varians work and looked used it as an input to draw a map of the digital economy.
Have a look at this map of the “battlefield” of digitalization.
The basic laws of microeconomics dictate that in the long term, competition will drive prices toward the marginal cost to provide it. For information goods, this will be zero. This is the root cause which drove the music and journalism industry to its crisis. Although the music industry has recovered a bit with the emergence of the streaming market, revenues are much reduced and once powerful music studios are marginalized.
Marginal costs to provide information is zero. In 1999, i underestimated the sheer power of this simple change in factor costs. But the implications have proven to be vast – on ever more industries. Lets see the implications in detail:
Managing versioning and digital rights has become a part of the bread and butter skills of information based companies by now. More interesting is lock-in. Google, Facebook, Amazon, eBay, AirBnB etc. have invested billions to build their customer bases – for one purpose only: To lock-in customers to their platforms.
In the 2000 there was a lot of speculation on the viability of this strategy: Will Amazon ever be profitable? Will Facebook be able to earn anything of significance? Will a search engine ever be a business? We know the answer by now. But by now, every other competitor has lost – at least for the foreseeable future.
Network effects log customers in. The more customers are using an information good, the more value this information good has to the customer. This is the power of the platform.
Abundant and exponential
Once a platform is established it is more valuable to the customer, as increasing numbers of other customers are using the platform, too. It is worth exponentially more, as I have described in an earlier post on this blog. Exponentially more, according to the work of Salim Ismail in “Exponential organizations“, too. In fact, the abundance of information goods, the fact that the whole world can be supplied with information goods at virtually zero marginal costs creates a new economy of abundance.
As stated by Peter Diamandis and Steven Kotler in their 2012 book “Abundance: The future is better than you think“: Companies are currently build for the problems of scarcity. They know how to manage scarce resources efficiently, they know how to scale efficiently, they reduce risks and move slow, because their business model is based on scarce resources.
But if something is abundant, as information is in the digital age, their business model fails. In fact, the whole organizational structure fails, the traditional ways of management fails, the speed is way to slow, their focus on supply side synergies is wrong, their focus on demand side synergies lacking.
Of course, this theory is for information goods. Not everything is abundant, right? After all resources are limited. Peter Diamandis answer:
Something is scarce until it gets abundant
Three examples of traditional physical businesses where abundance has replaced scarcity:
- Hotel Rooms: Used to be fixed in a location until a new hotel has been build. Nowadays, rooms are abundant and respond to demand, as they are dynamically added as needed by home owners with platforms such as AirBnB. At zero marginal costs to AirBnB.
- Consumer goods: The availability of consumer goods used to be fixed by sortiment availability at a location. Now, with commerce and Amazon, eBay etc. anyone can shop anything anywhere – abundant availability
- Finance: Choices have been limited by the few local financial institutions available at a location, by the amount of capital required or to be invested. In the digital age, the choices are no longer limited by the supply site, but by the financial literacy of the consumer. Supply is abundant in online banks and ever more emerging Fintechs
This has fascinating implications – give the video 2 minutes of your time.