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

		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.

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.

Shapiro and Varian's Theory on Information Goods (1)

Notes for reading <Information Rules> Chapter 1 The Information Economy

"The thesis of this book is that durable economics principles can guide you in today's frenetic business environment. "

Declare 1: In the information industry, software and hardware are inexorably linked. Neither of them is of much value without the other.

Question 1: Does the economic rules of the information industry lead to a "giant company"? Use transaction Cost theory?

Declare 2: Essentially, anything that can be digitized are all information goods. People can gain different kinds of values from the information goods. But regardless of the particular source of value, people are willing to pay for information.

Question 2: Then what factor causes this "Free goods" market phenomenon?

Declare 3: Consumers differ greatly in how they value particular information goods.
Comment 3: that means bundles and consumer discrimination is very helpful. Market segment for price discrimination is different from giving different goods to different markets.
I want to treat "information service" as different market from "information goods", not just different market segments. Then, in each market, price discrimination can be used.

Declare 4: Information goods are cheap to produce but cheap to reproduce.

Comment 4: Someone may say that it is not closely hold in the modern IT industry because the updating and reversioning becomes daily and a unavoidable part of information goods. These costs should be treated as a marginal cost of information goods.

I don't think so. Reversioning, updating and other service related to information goods should be considered separately. IT firms produce an important input - "information goods"- by themselves. Then, these data are put into a special plant- "the market of information goods"- and be manufactured by IG consumers, which is paid for utilities gained from these IGs. Output of this plant is consumers data (whether on behavior or taste).  This outputs are inputs of the next plant that use these data for produce "information service". Finally, these IS will be sold to other consumers who are always businesses. In this model, consumers use their time and attention to exchange the utility on IGs. This is an exchange without money and price, just like a manufacturing part in a firm.

But, not every IT company can bear this heavy burden of self-production on input. Is this a barrier entry of the IT industry that will cause monopoly? That may be a reason why there are market power in IT industry now.

Can this process be operated with a market when transaction cost is high? I think it is possible. Now, Google pays for writers and musicians to buy their copyrights and then share this information on Google Books and Google Music (without downloading. Not completely open). In this case, the price system of information goods still works. And this requires the existence of Copyright protection.

Declare 5: There is an economy of attention. Selling viewers' attention is an attractive way to support information provision.

Declare 6: System competition. The dependence of IT on system means that firms must not only focus on their competitors but also their complementors.

Comment 6: this property, which I call "system integrated", set an important position to someone in the IT industry. The position for integrating the system. I think it is not iOS or any hardware, but the excellent capability of integration that helps Apple succeed.