I was a bit skeptical when I first saw this blog post on the microeconomics of the consumer web. However, I was surprised by how it combined a sound understanding of economics with a deep knowledge of the consumer web space– it’s actually hard to find this combination in the industry so I really enjoyed this reading.
Here’s my summary and analysis of it.
The first section provides an economic framework to analyze online media under perfect competition. Economists like to use this model because it’s a very simple (and perfect) model that’s very easy to understand. Of course nothing in this world is perfect, so to make this model more real, we have to make additions to (complicate) it but doing so would make working with the model more unwieldy.
The second section discusses how technology costs continually fall over time and how this phenomenon drives marginal costs to zero. This reverses the slope of the supply curve because the perfect model we discuss above assumes that the unit cost generally rises as you produce more.
As an aside, this is why technology investments are all so front-loaded. It’s better to be closer to infinity than to zero on this curve so that’s why you see hundreds of millions being plowed into the Facebook and Youtubes of the world even when they aren’t making money yet.
If you’re doing business in this space, you want to (or believe that you can) break this economic model or else you’re toast. So how do you break it? And again, the answer is a simple economic concept: preventing commoditization.
This is the driving force behind why the AP doesn’t like Google or why Viacom wants Youtube to take down their clips. Although these firms value the traffic that Google provides them now, they understand that they are mortgaging the future if they make the tradeoff.
Can consumer web products and services be differentiated enough to stave off commoditization? Will the traditional modes of differentiation work online? (via Wikipedia):
* Differences in quality which are usually accompanied by differences in price
* Differences in functional features or design
* Ignorance of buyers regarding the essential characteristics and qualities of goods they are purchasing
* Sales promotion activities of sellers and, in particular, advertising
* Differences in availability (e.g. timing and location).
Although the writer says that:
“perfect competition” … is generally held [by economists] as the goal for all markets
it wasn’t for Michael Porter, who realized that imperfect competition should be the goal for all businesses, and became one of the leading economists to (academically) champion that goal.
Indeed, the writer concludes by saying that the only way to win online is by using strategies which fall under the three strategies Michael Porter recommends in his Competitive Strategy book— first point addresses differentiation via quality, second is cost leadership, and third implies a market segmentation approach.
Don’t misunderstand this– these strategies won’t save your business or the status quo, but they will help you compete in an increasingly competitive environment.