The Market for Digital Goods Information Products • Economic characterization of commodities – A good or service is completely characterized by its physical description, the place in which it is available, the date at which it is available, and any contingencies under which it is available. – Like other commodities, digital commodities can be durable (in which case we call them goods) or perishable (in which case we call them services). • Digital goods typically exist in code (software) • Digital services typically involve processing information without the process itself having any permanent existence. Characteristics of Information Products • Information products and digital products – Information products are a broader concept than digital products. – To be shared, information needs to be formatted in some way. When the format is digital (i.e., as a series of 1s and 0s), the information product is called digital product (Belleflamme, 2016). – Most information products can be digitalized. • Examples of information products: newsletters, music, books, software, etc. Characteristics of Information Products • Physical characteristics – Indestructibility • Durable products: Coase problem • Obsolescence issues: What is a used information good? – Transmutability • Intellectual property right issues • Customization and differentiation – Reproducibility • Excludability • Pricing: Product differentiation and market segmentation • Property right issues Characteristics of Information Products • Spatial and Temporal Characteristics – The internet is everywhere and it never sleeps • Enhancement to competition – Arbitrage opportunities across different market locations or across different time periods. – Global markets available to all potential sellers or buyers – Applications of technology to enhance competition: auctions, search. • Breaking of local market power – Information allows replacement of distribution networks with just in time delivery systems. – Many information products are time dependent for some users (e.g., weather forecast). Characteristics of Information Products • Contingent characteristics – Real-time, or near real-time, interactivity can reduce the need to anticipate (and write contracts contingent on) unforeseen random events. – Networked interactions themselves introduce new random events that can increase or decrease the value of a digital product (new sources of uncertainty associated with technology, new problems of information asymmetries leading to problems of moral hazard or adverse selection). – Real-time financial transactions also significantly expand the scope for contingent trades. Markets for Information • Complements or Substitutes? – Information generated in any transaction will have value, at least to the parties to the transaction. This information is complementary to the transaction, and can itself be viewed as a commodity with economic value. – Information and related digital goods having value in and of themselves will compete with other substitute goods or services in the market directly, rather than as an adjunct good or service to some other transaction. Markets for Information, cont. • We focus on both aspects of the market for information, beginning with an analysis of markets for pure digital goods or services, then turning to adjacent markets. Strategic Issues in Markets for Digital Goods • Indestructibility – Innovation or Standardization? • “If you don’t cannibalize your own market, someone else will.” • Updating and licensing – Related issues of pricing and market organization • Cost structure • Market segmentation Strategic Issues in Markets for Digital Goods • Reproducibility – Can you even make a market? • Excluding non-payers • Copy protection versus customer annoyance • Pricing in the face of easy reproducibility – Copyright and Intellectual Property • How to keep rivals from mimicking your success • How to ensure that added value gets compensated Pricing Digital Goods Microsoft vs. Britannica • Pre-internet: 32 volume set of Encyclopedia Britannica cost $1600 in hardback. • Microsoft’s strategy for marketing electronic encyclopedic services: – purchase Funk & Wagnalls Encyclopedia – use the content of F&W to produce a CD with multimedia enhancements and a user friendly search facility – market the result as MS Encarta for $49.95 Microsoft vs. Britannica • Result: – Britannica loses significant market share to the search features and multimedia enhancements of Encarta and other electronic encyclopedia’s. – Britannica fights back: • Online version for libraries (cost: $2000) – But households, smaller schools and libraries continue to defect to cheaper electronic encyclopedias and online encyclopedia services • Britannica offers an online subscription for individuals for $120/yr and CDROM for $200. – Households still not willing to pay 4 times the cost of Encarta Microsoft vs. Britannica – Shake out • Jacob Safra purchases Britannica’s parent company, disbands sales network, and begins aggressive pricecutting. • Britannica’s CDROM version currently sells for $49.95 after mail-in rebate Wikipedia vs. Microsoft • Nonprofit Wikimedia Foundation launched Wikipedia online in 2001. Wikipedia is free for everyone on the internet. • Encarta’s popularity faded. • Microsoft made Encarta free online with advertisement gradually after 2005. • Results: Microsoft discontinued both the Encarta disc and online versions before 2011. Experiment • Supply and Demand Analysis • Conclusion: With even a small amount of competition, prices are driven down to marginal cost. The Cost of Information • The cost of producing the first unit of a digital good is generally not small, and can be substantial. • As we have seen, the indestructibility and reproducibility of digital goods means that the marginal cost of producing an additional unit of the good is close to zero. • Because the cost of storing and transmitting stored information is cheap (and continues to get cheaper), there are also no effective capacity constraints on the production of digital goods. Cost Diagram Implications • Globally declining average costs imply significant economies of scale. • Minimum efficient scale can be on the order of the whole market • We should not expect the see highly competitive market structures. Implications • What market structures should be expect to see? – Markets with a dominant firm • Microsoft comes to mind – Differentiated Product Markets – Commoditized information markets • Digital goods selling at marginal cost • Free information products (maps, telephone information, email addresses, news, stock price quotes, etc.) Two-sided markets • A two-sided market is an economic platform having two user groups (two sides) that benefit from the increase of each other, and the platform charges at least one side to operate. • Platform exists as a more efficient way to match both parts of the platform, and creates value by minimizing the overall cost (e.g., transaction costs) and making impossible trades happen. • Network effect User group A Join Two-sided platform Join User group B Direct interact with high costs Network effect • Network effect refers to the effect that an additional user of goods or services brings on the value of that product to other users. • Positive network effect & negative network effect – Positive network effect: The more people who use the phone, the more people you can connect through the phone, and the more valuable the phone is to you ( See the figure in next slide). – Negative network effect: The more vehicles on the road, the more congested the traffic is, and the less utility for each driver who uses the road. Positive network effect Network effect • Two-sided markets represent a refinement of the concept of network effects. • There are both same-side and cross-side network effects. Each network effect can be either positive or negative. – Same-side network effect: The utility obtained by users on one side is affected by the number of users on the same side – Cross-side network effect: The utility obtained by users on one side is affected by the number of users on the other side – E.g., Taobao on the next slide Taobao Same-side network effect Join Cross-side network effect Taobao Join Same-side network effect Cross-side network effect Network effect • Positive cross-side effect – Users are more inclined to join a platform with more users on the other side, so having a larger user base brings a competitive advantage to the platform. • Chicken-and-egg problem: how and on which side to attract the first user? – Users on either side are less willing to choose the platform when there are few users on the other side. This has caused the famous chicken-and-egg problem that plagues many start-up platform companies. – The platform needs to adopt certain strategies to attract users on at least one side, and then continue to expand the scale of the platform through network effects. Competition • Successful platforms enjoy increasing return to scale. – Network effect: Users pay more to join the bigger platform. – Economies of scale: Initial investment in technology is costly and risky, but successful platforms can provide services to users at costs that are extremely low or even zero. • Because of increasing returns to scale, competition between platforms can be fierce. • Winner takes all! – E.g., browser wars Browser Wars • First Browser War: Netscape vs. Microsoft (1995-2001) – Netscape Navigator dominated before 1996 (80% market share). – Microsoft issued Internet Explorer (IE) 1.0 and 2.0 in mid-1995 – Unlike Netscape Navigator, IE was free of charge for all Windows users. – The First Browser War began, Netscape Navigator became free of charge, and new versions of Netscape Navigator and IE were released rapidly over the following years. – The tide-turning event: IE 4.0 was released in October 1997 and preinstalled in Windows (over 90% market share in OS), bringing a huge user base. – Results: In 2001, the market share of IE reached 96%. IE 4.0 Browser Wars Source: Wikipedia Browser Wars • Second Browser War (2004-2017) – Netscape open-sourced their browser code at the start of its decline, and later entrusted it to Mozilla Foundation to create a successor to Netscape. – In several years, Mozilla released Phoenix with some new features, and then changed the name to Firebird, and finally to Firefox in 2004. – Firefox continued to gain an increasing market share until 2010. • Second Browser War (cont.) – Over the following years, Microsoft, Mozilla and other firms kept updating browsers to incorporate new features and support new technologies (see the table below). Year Microsoft 2004 Mozilla Google Firefox 1.0 2005 2006 IE 7 Firefox 2.0 IE 8 Firefox 3.0 2007 2008 2009 Firefox 3.5 2010 Firefox 3.6 Chrome 2011 IE 9 Firefox 5.0 - 9 Chrome 9-16 2012 IE 10 Firefox 10 -11 2013 IE 11 • Second Browser War (cont.) – Google released Chrome for Windows in late 2008 with a faster JavaScript engine. – Later, the open-sourced version was released for Windows, Mac OS X, and Linux. Market share was then increasing rapidly. – In 2011, Chrome 9 introduced Chrome Web Store that hosts extensions and web apps for browser users. – In 2015, Chrome overtook all other browsers as the browser with the highest usage share. – Microsoft discontinued production of newer versions of IE, and the shift from IE to Microsoft Edge began in 2015. • Second Browser War (cont.) – Results • By 2017 usage shares of, Firefox and Internet Explorer fell well below 5% each, while Google Chrome had expanded to over 60% worldwide. • On May 26, 2017 Andreas Gal, former Mozilla CTO publicly stated that Google Chrome won the Second Browser War: – “Google makes the best horses in the world and they clearly won the horse race.” Pricing • Take network effects into consideration when set the prices for two sides, since demand curves shift outward with the increase in user base on the other side. • A key rule of two-sided market pricing: – Subsidize the more price sensitive side and charge the side that benefits more from the growth of the other side. – Examples: Taobao, eBay, WeChat, Visa (see next slide). Pricing Source: Hagiu, A., 2014. Strategic Decisions for Multisided Platforms. MIT Sloan Management Review, 55(2), p.71.
