Making a Buck on the Web

Economics of the Web: Lesson Number One

It's Cheaper To Move Bits Than Atoms

"The best way to appreciate the merits and consequences of being digital is to reflect on the difference between bits and atoms."
"The information superhighway is about the global movement of weightless bits at the speed of light."

Nicholas Negroponte: Being Digital

One consequence of web economics: What's the real product of the Encyclopaedia Britannica? Paper books or information?

A Cautionary Tale of Letting Your Content Get Stuck In Atoms

"In 1768, three Scottish printers began publishing an integrated compendium of knowledge--the earliest and most famous encyclopedia in the English-speaking world. They called it Encyclopaedia Britannica. Since then, Britannica has evolved through fifteen editions, and to this day it is generally regarded as the world's most comprehensive and authoritative encyclopedia.

In 1920, Sears, Roebuck and Company, an American mail order retailer, acquired Britannica and moved its headquarters from Edinburgh to Chicago. Ownership passed to William Benton in 1941, who then willed the company in the early 1970s to the Benton foundation, a charitable organization whose income supports communications programs at the University of Chicago. Britannica grew under its American owners into a serious commercial enterprise while sustaining its reputation as the world's most prestigious and comprehensive encyclopedia. The content was revised every four or five years. Brand extensions, such as atlases and yearbooks, were added. The company built one of the most aggressive and successful direct sales forces in the world. By targeting middle-income families and focusing on their aspirations for their children, the company developed a marketing proposition as compelling as the intellectual content of the product itself.

By 1990, sales of Britannica's multivolume sets had reached an all-time peak of about $650 million. Dominant market share, steady if unspectacular growth, generous margins, and a two-hundred-year history all testified to an extraordinarily compelling and stable brand. Since 1990, however, sales of Britannica, and of all printed encyclopedias in the United States, have collapsed by over 80%. Britannica was blown away by a product of the late-twentieth-century information revolution: the CD-ROM.

The CD-ROM came from nowhere and destroyed the printed encyclopedia business. Whereas Britannica sells for $1,500 to $2,200 per set (depending on the quality of the binding), CD-ROM encyclopedias, such as Encarta, Grolier, and Compton, list for $50 to $70. But hardly anybody pays even that: the bast majority of copies are given away to promote the sale of computers and peripherals. With a marginal manufacturing cost of $1.50 per copy, the CD-ROM as freebie makes good economic sense. the marginal cost of Britannica, in contrast, is about $250 for production plus about $500 to $600 for the salesperson's commission.

Judging from their inaction, Britannica's executives at first seemed to have viewed the CD-ROM encyclopedia as an irrelevance: a child's toy, one step above video games. This perception was entirely reasonable. Microsoft had licensed the text for its encyclopedia from Funk & Wagnalls, whose third-rate, nearly defunct product, surviving as a periodic promotional item in the aisles of supermarkets, was perceived to be a brand so pathetic that Microsoft dropped its name in favor of the ad agency coinage Encarta. The addition of public-domain illustrations and scratchy sound recordings too old to bear a copyright (and therefore available at no cost) hardly made for a serious rival to the Britannica--or so it seemed.

As revenues plunged, it became obvious that whether they ought to be or not, CD-ROM encyclopedias were serious competition. Britannica executives reluctantly considered creating their own CD-ROM product, only to encounter a technology constraint: the content of Britannica was too big for the medium. Encarta, with its seven million words, could fit easily onto a CD-ROM, with plenty of room for illustrations and interactivity. Britannica, however, had more than forty million words. It was impossible to create an interactive version within the capacity limits of a CD-ROM. The technology was not ready for the content, so the company's executives decided to wait.

Months passed. Sales continued to plummet. In response, the company put together a text-only CD-ROM version of Britannica, only to encounter another crisis: a revolt by the sales force. Even if priced at a significant premium over Encarta, A CD-ROM version of Britannica could not possibly generate $500 to $600 sales commission of the printed product, from which it would so obviously take sales. Indeed, a CD_ROM product would have to be sold through a completely different channel. To avert a revolt by the sales force, Britannica executives decided to bundle the CD-ROM as a free bonus for buyers of the multivolume set. Anyone who wanted to buy the CD-ROM alone would have to pay $1,000.

This decision appeased the sales force briefly, but did nothing to stem the continuing collapse of sales. Losses mounted. There was no apparent strategy. In May of 1995, the Benton Foundation finally put the company up for sale. For nearly eighteen months, investment bankers tried to find a buyer. Microsoft said no. Technology, media and information companies all declined. Finally, in 1996, fiancier Jacob Safra agreed to buy the company, paying less than half of book value.

P. Evans & T.S. Wurster, Blown to bits: How the new economics of information transforms strategy. Harvard Business School Press, 2000

Economics of the Web: Lesson Number Two

Marginal Cost Approaches Zero

Marginal Cost

The cost associated with one additional unit of production. also called incremental cost.

One consequence of web economics: There'll be a lot of anything with a marginal cost near zero

"Unwanted commercial e-mail, or spam, has become the bane of the Internet because it is so cheap and easy to send that all sorts of companies and individuals do so, prodigiously. Spammers these days pay as little as 0.025 cent to send an e-mail." Totaling Up the Bill for Spam: Wasted Time,Computer and Human, Is Only Part of the Cost by Saul Hansell. New York Times, Monday, July 28, 2003

"Unfortunately, spam is a cheap game to get into," said Michael Clark, managing partner of Herbal Partners, which sells more than 300,000 bottles a year of Herbal Vigor pills, largely through affiliates. A marketer, he said, could arrange to send millions of spam messages a day through a computer in Eastern Europe for $1,500 to $3,000 a month. And a list containing 10 million e-mail addresses can cost just a few hundred dollars. "That means you only need to take in $150 a day to break even," Mr. Clark said. "If you can send out 10 million e-mails a day from your bedroom, and you make $50 a bottle, you can make a decent profit."...Mr. Richter said the biggest spammers take in $5,000 to $10,000 a day selling penis pills. Saul Hansell "E-Mail Hucksterism, Offensive but Effective, New York Times, Friday July 4, 2003

Is it possible to make a buck collecting pennies?

"A few start-up Internet companies are taking on a problem that goes back to the earliest days of online commerce - micropayments".

"The idea is to enable customers to pay pennies for digital content -- to read a story on the Web, for example -- and to help online merchants collect small fees while still making a profit."

"In theory, such a system would get around the problem created by credit card companies, the primary payment vehicles for online goods and services. Those companies, by charging roughly 25 cents per online transaction, according to industry executives, turn a dime sale into a money-loser." Developing Systems of Online Payment By Bob Tedeschi, New York Times, July 21, 2003

Two companies in the micropayments business:

Something to think about:

We live at the beginning of the Internet age. We are just discovering its economics. If I understood the economics of the Web, i.e., how to get millions of people to legally send me money, I wouldn't be lowly academic who has to teach INFO 100 to feed his children.

Note that Microsoft is not a web-economy company. Microsoft is an old-fashion industrial monopolist. It just looks like a web company because the products it sells deal with the Internet. It has dominated the desktop computing industry by old-fashioned methods of eliminating the competition. John D. Rockefeller did the same thing with the oil industry, etc.

Discovering The Economics of the Web

"Information Wants To Be Free" Stewart Brand, 1983

People seems to assume that the information that they find on the web is free for the taking.
But then you walk into a bookstore and open a book.
The information you find there has always been free for the taking.
Not the book, of course. The book is atoms offered for sale. But the information is free.

Information Wants To Be Free
 p. 202, passim, The Media Lab: Inventing the Future at MIT by Stewart Brand.  Viking 1983
	
	Information also wants to be expensive.
	Information wants to be free because it has become so cheap to distribute, copy, and recombine -- too cheap to meter.  It wants to be expensive because it can be immeasurably valuable to the recipient.  That tension will not go away.  It leads to endless wrenching debate about price, copyright, "intellectual property," and the moral rightness of casual distribution, because each round of new devices makes the tension worse, not better.
	...
	Each new kind of information provider has to get used to the idea of leakage, just as book and magazine publishers had to go through denial, outrage, panic, lobbying, and eventual accommodation when zeroxing came in...Information wants to be free.  When that's totally denied, customers go elsewhere, or they blandly break laws they consider unjust.  The more new media proliferate, the more choices customers have, and the more leverage they have on producers by the ability to shop elsewhere.
	...
	Ithiel de Sola Pool traced the problem in his Technologies of Freedom: "The recognition of copyright and the paying of royalties emerged with the printing press.  With the arrival of electronic reproduction, these practices became unworkable. Electronic publishing is analogous not so much to the print shop of the eighteenth century as to word-of-mouth communication, to which copyright was never applied."

Maxims of Kevin Kelly:

Because prices move inexorably towards the free, the best move in the network economy is to anticipate this cheapness.

If goods and services become more valuable as they become more plentiful, and if they become cheaper as they become valuable, then the natural extension of this logic says that the most valuable things of all should be those that are ubiquitous and free.

Remember the strategies of Netscape and Microsoft to make their browser "free"

Something to read: New Rules for the New Economy by Kevin Kelly, Wired, Issue 5.09, September 1997

Facilitating The Sharing Of Content

When Traditional Economics of Scarcity Make Some People Very Rich

Can Get You In Trouble

"Napster is a so-called peer to peer search service, meaning that it does not keep the music -- i.e. the MP3 files -- on its own servers. Instead people who have downloaded the software needed to use Napster, keep the MP3 files on their own PCs. If these computers are connected to the Internet, any Napster user may download songs from that computer. What Napster does, is to keep a list of MP3-files available, guiding the Napster users to a relevant computer. "

"Napster is reported to have 65 million registered users, of whom 10 million use the service daily. More than 2.7 billion files were downloaded in January alone. The music industry argues that the extensive downloading of copyright-protected music is threatening record sales. Napster, on the other hand, argues that no Napster users are earning money on making their MP3 files accessible. Hence the exchange of files is more like making copies for your own or you friends use, which is assumed to be legal." Napster in deep trouble

Providing Content That Otherwise

Would Embarrass The Purchaser's Sunday School Class

Can Make You Rich

"Last year Danni's Hard Drive made $6.5 million. This year we expect to make $8 million. We now employ 45 people, and the business continues to grow and expand. ... Over the years, we've had to develop a lot of technology to support the business of Danni's Hard Drive -- streaming video technology, hosting technologies, credit card scrubbing technologies, processing, customer service. And all of these things are now working so well that they have value to other companies, and we're beginning to market those technologies to other companies. And that's actually the largest area of growth in our business right now."
"And the other area that we're moving into is taking the Danni brand, which is probably the only pure adult Internet brand in the space, and moving it to other forms of media. We're doing a video and DVD line, I'm writing a book, we're talking about doing a magazine, doing cable and pay-per-view shows. So I'm trying to sort of expand in some more traditional forms of media." PBS:Interview Danni Ashe

Greasing The Skids of Commerce, i.e., Helping Others Get Rich

Can Make You Rich

"In a rosy earnings report, eBay raised its outlook for the year, announced income and revenue that were nearly double that of the year-ago quarter, and unveiled plans for a 2-for-1 stock split."

"The online auction house said it earned $109.7 million, or 33 cents per diluted share, in the second quarter, compared with $54.3 million, or 19 cents per diluted share, for the same quarter last year. The company reported second-quarter net revenue of $509.3 million, a 91 percent increase over $266.3 million in the year-ago quarter." Tide rises for eBay earnings

Traditional Mass-Market Retailing

May Make You Rich

When Amazon.com Inc. (AMZN ) Chief Executive Jeffrey P. Bezos proclaimed a year ago that the money-losing online retailer would finally earn its first operating profit by now, almost nobody believed him. Instead, investors kept hitting the sell button, knocking the stock down 40%, to around $10. Oops. On Jan. 22, the same day traditional retailer Kmart Corp. (KM ) filed for bankruptcy protection, upstart Amazon shocked everyone by reporting not just an operating profit of $59 million but also a net profit of $5 million in the fourth quarter--no ifs, ands, or pro formas. Investors piled back in, sending the stock up 24%, to $12.60. Crows Bezos: "It's a major turning point for us." How Amazon Cleared the Profitability Hurdle