Information goods are commonly noticed by economist because of its zero marginal cost (Varian, 1995), non-excludability, non-rivalry, and non-transparency (DeLong, 1999). Focused on these features of the product itself, researchers used the copyright system, market power with bundle pricing (Bakos and Brynjolfsson, 1999, Varian, Shaprio, 2004), or gift-exchanging models to solve the trouble brought by them so as to draw information goods back into the classical economic analysis. However, some facts in the modern information goods market cannot be ignored any more. First, copyright system is very costly, not only due to the obvious supervision cost, but also the high transaction cost from the failing to locate rights from occurring (Varian, 2007). Worse, with the piracy's unremitting interruption from all around the world, the copyright system is unstable. In developing countries such as China and Brazil, the music and software have been marked as "free"goods, which, interestingly enough, does not hurt the industry much or even promote it by bring competition (Anderson, 2010); developed countries also do not survive if you think of the world largest piracy's website "The Pirate Bay" who recently declared to move their server onto the moon to avoid any legal limitation. As DeLong(1999) noted, reforming the law to give sellers a property right in information about the prices that they charge appears extremely dangerous; there has never in the past been a legal right to exclude competitors from access to bulk pricing data. Piracy, undoubtedly, proved this well; but it brings another problem, which is showed in the gift-exchanging model that relies highly on the people's gratitude (George Akerlof, 1985): people gratitude is not always trustworthy, and, treating information goods as public goods also needs high transaction cost.
But wait, what on earth bring the tough problem to information goods. The zero marginal cost? Then who cause this low cost? The intangibility of the goods? Close but not exactly. My answer, the thing I want to emphasize in this article, is that: it is the world's easiest last step of the producing process of information goods, which fosters millions of consumers into the sellers' competitors, that drags information goods market into quagmire.
Why do I care much about the producing process? According to the Baumol (1982), the production directly determines the cost structure, which, will have significant influence on the market structure as well as market behavior of firms. Information goods has a high-fixed-cost / low-incremental-cost structure(Varian, 1995) due to its long and complicated R&D procedure but a "click-copy" manufacturing process. Varian had noticed the absolutely low-incremental cost that makes the information goods market into a monopolistic competitive one; whereas, he ignored the relatively large gap of fixed cost and variable cost. Actually, nearly everybody got lost in the miraculous zero marginal cost. But I must emphasize the word "relatively" because it will move people's eye from the small marginal cost to a new view, to one of the most common scene in the economics world, buildings, cars, CPU, iPhone, to what we call: durable goods. Durable goods, sometimes also called investment goods, are defined as "goods that yield utility over time rather than completely consumed at one time" (Sullivan, Sheffrin, 2003). I think this definition needs to be revised. As Thompson (1920) noted, consumers' real target are the utilities in the goods, not the goods itself. This elaboration helps to clarify that the criterion that classified goods in to durable goods(investment goods), non-durable goods( fast-consuming goods), and services, are actually the quantity of utilities embodied in one unit of goods. That means, durable goods, with larger deluge of utilities set in, can not only release the utilities over time, but on space. Under this definition, the word "durable" is not much proper; "investment goods" fits more. Then, information goods, which may wear out as soon as being released but has an infinite potential to feed the whole population's desire by unlimited costless copying, is incontrovertibly an investment good.
The advantage of treating information goods as investment goods is that we could jump out of the thinking of how to price the information goods when the marginal cost is 0 which then brings you into an infinite "Market Power vs. Social Welfare" debate. Investment goods, machines? Yes, information goods like machines, or more precisely, a "die". When firms sold an information good, they do not simply sell one consumption good, they sold them a die, with which and a computer, everybody can manufacture and share (because of non-rivalry) the good. This final production process is so simple, disperse, and technically hard prevented, that completely eradicated them is nearly impossible. So why don't IT firms change the mind to sell their goods only to consumers who want to put an investment on them? Or use the information goods as an investment of themselves and produce more service or non-durable goods? Lots of examples have been created by various markets of information industries: musicians put more attention on concerts and performance than on selling CDs; Google sends more efforts on producing people's effective attention than selling software; and so on.
Is this the bright future of firms in the world of piracy? Is this the hope of firms still suffers the "patent minefield" in the world of copyright and patent? I believe so.
Reference
Bakos,Yannis, Erik Brynjolfsson, Bundling Information Goods: Pricing, Profits, and Efficiency, Management Science, Vol. 45, No. 12, 1999, pp. 1613-1630
Baumol, William, Contestable Markets: An Uprising in the Theory of Industry Structure, American Economic Review, Vol. 72, No. 1, 1982, pp. 1-15.
DeLong, J. B., A. M. Froomkin, Speculative Microeconomics for Tomorrow's Economy, 1999, presented at Brian Kahin and Hal Varian's January 1997 Harvard Kennedy School conference.
Sullivan, Arthur; Steven M. Sheffrin. Economics: Principles in action. 2003, Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p.302. ISBN 0-13-063085-3.
Thompson, Charles. M., Elementary Economics, Chicago, B.H. Sanbom & Co., 1920
Varian, Hal R., Pricing information goods. Proc.Scholarship Nezv Infornm. Environment Sympos. Harvard Law School, Cambridge, MA.,1995, Differential pricing and efficiency, SIMS Working Paper, Berkeley, CA.
Varian, Hal R., J. Farrell, C. Shapiro, The Economics of Information Technology, 2004, ISBN: 0521844150
Varian, Hal R., Copyright Term Extension and Orphan Works, Industrial and Corporate Change, Vol. 15, No. 6, 2006, pp. 965-980
Sherry Xiao Wang
@COPYLEFT ALL WRONGS RESERVED
7/19/2013
7/09/2013
Market of Information Goods
When talking about the economy of information goods, we usually treat
them as a single kind of commodity. Lots of articles illustrated their
theory with facts in software or folk music industry but seldom
clarifying the possible difference between those markets and whether
other markets can apply the same theory. Varian, Farrell, and Shapiro
(2005) are supporters of "copyright" which transform the information
goods market into a situation where invisible hands works tolerably
well, arguing that the classical economy is able to explain all about
information goods. Yet, DeLong (1999) and Anderson(2010) votes for
respecting the initial features of information goods - nonexcludability,
nonrivalry, and nontransparency, and operating the market with a
gift-exchanging mode or a free goods plus compensated service mode.
Anderson even appreciated China and Brazil where the pirates are not
controlled well, as the pioneer of "free", the new economy.
Actually, we cannot tell who is more reasonable until clarifying the
domain of each view, since a rule for the apple market is not always
good for the car’s because of different attributes of demand and supply
groups. So here, I divided the information goods market into 4
categories depending on their level of competence intensity within the
demand group and the supply group. This segmentation helps to describe
the market structures of different information goods and we can see that
both Varian and DeLong can be right.
4 Kinds of Markets
How can I have 4 kinds of market? First, I divided the supplier's group into two parts according to the potential scale of competition. For products easy to be made, like a song, their production scale is usually very small, which also results in a large number of triers and an intense competition. On the contrary, products with complicated producing process and usually also a high fixed cost have a large producing process, which built a high barriers of entry that reduce the number of competitors. Then, I divided the demands' groups, also into two parts, according to their potential scale of demand. Information goods such as games can be widely demanded since they have higher order on most people's preference list; whereas, the demand of software that focuses only on some groups, for example, kid's education, will be more elastically, which can result in a very narrow demand. Thus, we have table 1:
Table 1
4 zones are formed in this table. First is small-wide zone. Both supply and demand can be plenty, the large number of participants in both sides helps the small-wide zone to become a competitive market. A typical product in this zone is a piece of pop music. Next, production becomes scarce and the scale gets large due to the limitation of a single person’s ability and the huge power of group cooperation. A barrier of entry that limits competition was formed, which can also be fortified by the complexity of the product itself since it causes users a great learning cost which lock consumers in (rf. Varian lock-in). So obviously, large-wide zone is a good place for monopoly and oligopolies. Then, if demands instead of production become less, we will switch to the small-narrow zone. Advertisement is a good example of products in this zone. Finally, when both supply and demands are small, we will enter the large-narrow zone. A customized made software belongs to this zone. This zone is proper for negotiation and investigating because of a relatively low transaction cost due to small market size.
DeLong and Froomkin(1999) concluded 3 basic features of property and exchange that makes the invisible hand a powerful social mechanism: excludability, rivalry, and transparency, which corresponds to the three basic economics assumptions in Adam Smith’s system: scarcity, individual rationality, and perfect information set. But information good, as a good whose value is contained in the information itself, cannot be transparent. Furthermore, Varian(1995) points out that information goods have such perfect copies that they can be created and distributed almost costless. This physical attribute gives information important economics features: non-excludability and non-rivalry, which violates the first two features that guarantee Adam Smith’s sysem.Worse, costless copy also make the marginal cost pricing system crash.
Since we have four different kinds of market and each with unique attributes, in the next article, I will try to put these special attributes: non-excludability, non-rivalry, and non-transparency, into them separately, and see what will happen.
See you.
References
The Economics of Information Technology, Varian, Hal R., J. Farrell, C. Shapiro, 2004, ISBN: 0521844150
Speculative Microeconomics for Tomorrow's Economy, J. B. DeLong, A. M. Froomkin, 1999, presented at Brian Kahin and Hal Varian's January 1997 Harvard Kennedy School conference
Free: The Future of Radical Price, Anderson, C., 2010, ISBN: 9781410322908
Copying and copyright, Varian, Hal R., The Journal of Economic Perspectives, Vol.19, No.2, Spring, 2005
Pricing Information Goods. Varian, H., Proceedings of Scholarship in the New Information Environment Symposium. Harvard Law School. 1995.
Towards a theory of property rights, Harold Demsetz, The American Economic Review, Vol. 57, No. 2,May, 1967, pp. 347-359.
4 Kinds of Markets
How can I have 4 kinds of market? First, I divided the supplier's group into two parts according to the potential scale of competition. For products easy to be made, like a song, their production scale is usually very small, which also results in a large number of triers and an intense competition. On the contrary, products with complicated producing process and usually also a high fixed cost have a large producing process, which built a high barriers of entry that reduce the number of competitors. Then, I divided the demands' groups, also into two parts, according to their potential scale of demand. Information goods such as games can be widely demanded since they have higher order on most people's preference list; whereas, the demand of software that focuses only on some groups, for example, kid's education, will be more elastically, which can result in a very narrow demand. Thus, we have table 1:
Table 1
Scale
of Producers
|
Number
of Participants
|
|||
Small
|
Large
|
|||
Scale
of Demand
|
Wide
|
“Music”
|
“Operating System”
|
Many
|
Narrow
|
“Ads”
|
“Custom Made”
|
Scarce
|
|
Number of
Participants
|
Many
|
Scarce
|
||
4 zones are formed in this table. First is small-wide zone. Both supply and demand can be plenty, the large number of participants in both sides helps the small-wide zone to become a competitive market. A typical product in this zone is a piece of pop music. Next, production becomes scarce and the scale gets large due to the limitation of a single person’s ability and the huge power of group cooperation. A barrier of entry that limits competition was formed, which can also be fortified by the complexity of the product itself since it causes users a great learning cost which lock consumers in (rf. Varian lock-in). So obviously, large-wide zone is a good place for monopoly and oligopolies. Then, if demands instead of production become less, we will switch to the small-narrow zone. Advertisement is a good example of products in this zone. Finally, when both supply and demands are small, we will enter the large-narrow zone. A customized made software belongs to this zone. This zone is proper for negotiation and investigating because of a relatively low transaction cost due to small market size.
DeLong and Froomkin(1999) concluded 3 basic features of property and exchange that makes the invisible hand a powerful social mechanism: excludability, rivalry, and transparency, which corresponds to the three basic economics assumptions in Adam Smith’s system: scarcity, individual rationality, and perfect information set. But information good, as a good whose value is contained in the information itself, cannot be transparent. Furthermore, Varian(1995) points out that information goods have such perfect copies that they can be created and distributed almost costless. This physical attribute gives information important economics features: non-excludability and non-rivalry, which violates the first two features that guarantee Adam Smith’s sysem.Worse, costless copy also make the marginal cost pricing system crash.
Since we have four different kinds of market and each with unique attributes, in the next article, I will try to put these special attributes: non-excludability, non-rivalry, and non-transparency, into them separately, and see what will happen.
See you.
References
The Economics of Information Technology, Varian, Hal R., J. Farrell, C. Shapiro, 2004, ISBN: 0521844150
Speculative Microeconomics for Tomorrow's Economy, J. B. DeLong, A. M. Froomkin, 1999, presented at Brian Kahin and Hal Varian's January 1997 Harvard Kennedy School conference
Free: The Future of Radical Price, Anderson, C., 2010, ISBN: 9781410322908
Copying and copyright, Varian, Hal R., The Journal of Economic Perspectives, Vol.19, No.2, Spring, 2005
Pricing Information Goods. Varian, H., Proceedings of Scholarship in the New Information Environment Symposium. Harvard Law School. 1995.
Towards a theory of property rights, Harold Demsetz, The American Economic Review, Vol. 57, No. 2,May, 1967, pp. 347-359.
11/08/2012
How can an IT firm survive in a kingdom of piracy?
"China is a country where piracy has won. Years of halfhearted crackdowns under diplomatic pressure from the West have had no apparent effect on the street vendors or countless sites that host MP3s for downloads."
-- Chris Anderson <Free - the Future of Radical Price>
That is really true. In China, people seldom buy CDs or an iTunes music just for listening a piece of song because they can download it easily from websites. Neither do to software or e-books. At first, some people stand out arguing for their copyrights. But as more and more people share their initial works online voluntarily, which develops the consumers' habit to get information goods for free, these voices almost disappear. Instead, they begin to think, how can I survive in a kingdom of "piracy"?
In the book <Free>, Anderson the author enumerates several business models of information industry. He describes the economics model of music industry in China and Google in US. Here I want to discuss the situation in software industry in China. Software, same as music, can be downloaded free just with a claim "Please delete it within 24 hours" which is ignored by most users. On the one hand, this piracy forces the market price of software to its marginal cost 0, which impels firms to think of other ways for profit. Yet on the other hand, piracy becomes the best marketing of high quality software. However, fame and attention are just a small part of the consumers' repayment for 'free'. The big bonus is their behavior's data.
In China, most software firms choose to use consumers' data or attention to gain revenue from another part of their consumer, mainly advertisers, to cover their research cost, depreciation cost (fixed cost) and marketing cost, administration cost (variable cost). As long as the coverage is successful, the company can survive. It seems that this business model has the same nature with Google's. But actually there is a huge difference: Google still has a chance to set a price, while IT firms in China have no choice when facing the crazy pirates. And this difference is extremely thorny for small firms. This two-side market has a required condition: big data. Big data is necessary for analyzing consumer behavior. And the required large number of users also collects attention. These are the most charming part for consumer on the "profit" side. Obviously, small firms is hard to get big data in a short time. That means they will lose the chance to gain profit until their database is set and their product for "profit" market is ready. So, just as we see in the information technology industry in China, Angel Investment for a certain period of time is mandatory for small firms.
Since the direct consumer to the software won't gain a penny for firms, firms must turn their attention to servicing profitable consumers as well as the price strategy on them. Service cannot be pirate. That is the only way to survive in a kingdom of piracy.
-- Chris Anderson <Free - the Future of Radical Price>
That is really true. In China, people seldom buy CDs or an iTunes music just for listening a piece of song because they can download it easily from websites. Neither do to software or e-books. At first, some people stand out arguing for their copyrights. But as more and more people share their initial works online voluntarily, which develops the consumers' habit to get information goods for free, these voices almost disappear. Instead, they begin to think, how can I survive in a kingdom of "piracy"?
In the book <Free>, Anderson the author enumerates several business models of information industry. He describes the economics model of music industry in China and Google in US. Here I want to discuss the situation in software industry in China. Software, same as music, can be downloaded free just with a claim "Please delete it within 24 hours" which is ignored by most users. On the one hand, this piracy forces the market price of software to its marginal cost 0, which impels firms to think of other ways for profit. Yet on the other hand, piracy becomes the best marketing of high quality software. However, fame and attention are just a small part of the consumers' repayment for 'free'. The big bonus is their behavior's data.
In China, most software firms choose to use consumers' data or attention to gain revenue from another part of their consumer, mainly advertisers, to cover their research cost, depreciation cost (fixed cost) and marketing cost, administration cost (variable cost). As long as the coverage is successful, the company can survive. It seems that this business model has the same nature with Google's. But actually there is a huge difference: Google still has a chance to set a price, while IT firms in China have no choice when facing the crazy pirates. And this difference is extremely thorny for small firms. This two-side market has a required condition: big data. Big data is necessary for analyzing consumer behavior. And the required large number of users also collects attention. These are the most charming part for consumer on the "profit" side. Obviously, small firms is hard to get big data in a short time. That means they will lose the chance to gain profit until their database is set and their product for "profit" market is ready. So, just as we see in the information technology industry in China, Angel Investment for a certain period of time is mandatory for small firms.
Since the direct consumer to the software won't gain a penny for firms, firms must turn their attention to servicing profitable consumers as well as the price strategy on them. Service cannot be pirate. That is the only way to survive in a kingdom of piracy.
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