Competition, Profit Rates, and Freeness
Having read some excerpts (e.g.) from Chris Anderson’s Free and also Malcolm Gladwell’s takedown review, I think the whole subject could stand to benefit from a little less good writing and a bit more plodding distinction-drawing. There’s a basic valid point underlying what Anderson is talking about. In a competitive market, the price of a good ought to converge toward its marginal cost of production. And in a digital universal, the marginal cost of production is close to zero. In other words, there are fixed costs involved in creating a blog post or a song or a film or a piece of software, but the cost at the margin of distributing the good to a new consumer is almost zero. Anderson adds to this shopworn piece of economic knowledge, the insight from behavioral psychology that while people react similarly to a price of $10.15 and $10.25, human behavior when faced with a price of free is quite different from human behavior when faced with a price of ten cents. Consequently, when market competition starts pushing prices down to nearly zero, someone will realize they can gain a huge competitive advantage by pricing the good at free.
Where Anderson goes off the rails is in his suggestion that this “give it away” business model is actually a promising business model. Gladwell demolishes some of Anderson’s examples, but the problem with Anderson’s argument is completely theoretical. The convergence to marginal cost of production is predicated on the idea that you’re operating in a highly competitive marketplace. But the thing about operating in a highly competitive marketplace is that it’s impossible to make tons of money by doing this. That fact tends to get obscured in popular discussion of business in the United States, because we (or, perhaps I should say, because journalists who want to make money getting corporate speaking gigs) are very invested in a heroic model of capitalism in which wealthy entrepreneurs get rich through their competitive awesomeness. In reality, the reason that competition is good for customers is that it destroys profits. The way you make real money is by getting into situations where you’re insulated from competition. A license to operate a bar in Adams-Morgan is like a license to print money—no new bars are allowed to operate, and restaurants that make too much money off booze are getting shut down. On a grander scale, Microsoft has been able to entrench its position through “network effects” and price key software way above its marginal cost.
As sectors turn to a Free business model, they’re just going to become way less lucrative. That doesn’t mean the sectors will vanish. Nobody makes a fortune running a dry cleaning business, precisely because dry cleaners operate in a highly competitive marketplace. But dry cleaning services are very widespread, and customers benefit greatly from the fact that it’s relatively cheap. But the mere fact that dry cleaning is very successful as a technique doesn’t mean that the dry cleaning business is a good business to be in. Consider the case of YouTube, which Anderson labels a quintessential example of Free. Gladwell points out that YouTube actually loses money—it’s a terrible business. But what’s really noteworthy about YouTube, to me, is that as it exists it’s actually competing with several other, also Free, also money-losing video services. But since Google as a whole can easily afford to cover YouTube’s losses, it’s hard to see the percentage for Google management in shutting down a market-leader, or in destroying its position by trying to charge people to use it. But conceivably YouTube will just operate indefinitely as a money-losing subsidiary of a large profitable firm. And since it’s there losing money but not going out of business, it will probably be impossible for any competitors to ever beat it. And if YouTube does go out of business some new money-losing free video site will become the market leader as long as there’s some investor out there somewhere who believes, wrongly, that he’s smart enough to figure out a way to make money out of this thing. Meanwhile, as the underlying technology gets cheaper the scale of the losses should get smaller, making it ever-more-realistic to run the business at a loss and thus ever-less-likely that the money-losers will be driven out of the market and create the possibility for monopoly rents.
That’s the real lesson of Free. The combination of competition, the near-zero marginal cost of production, and the psychological significance of the zero bound means that the market-leader in video is bound to lose money. To win the market, you need to make your product Free. But while your marginal cost is near-zero, it’s not actually zero, so you’re losing money.
48 Responses to “Competition, Profit Rates, and Freeness”
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June 30th, 2009 at 3:33 pm
In reality, the reason that competition is good for customers is that it destroys profits.
I’m a socialist but profit-destruction isn’t the only good thing about competition. Competition also encourages the competitors to find better and more effective ways to do whatever they’re doing. You know, progress, innovation, that kind of thing.
June 30th, 2009 at 3:34 pm
This is basically right but you are missing one point. Zero cost doesn’t just have psychological significance, it has substantial real efficiencies. If you’re charging at all, you need the same apparatus to collect money, track payments and exclude people who didn’t pay. With free distribution you get rid of those costs.
So while marginal cost may not be zero for a product being distributed free, it’s a lot less than for a product being distributed for even 10 cents.
June 30th, 2009 at 3:39 pm
The crucial distinction is that the cost of production is not zero, the cost of distribution is zero.
So, for instance, an e-book might cost a publisher nothing to distribute after copy one, but there are fixed costs of production, whether that’s paying the author, editorial, marketing (if any), etc. etc.
All of these free arguments seem to miss this distinction. And all of these free business models are predicated on the cost of distribution being zero but overlooking the cost of production. The Internet version of The New York Times should be free! Provided of course you don’t pay the reporters.
June 30th, 2009 at 4:04 pm
Nathan: you have just rephrased Matt’s argument less precisely: he says everywhere marginal cost of production, the marginal cost of producing the million and oneth widget–this concept is all we need.
Indeed some clear thinking helps. (It might even be a mark of good writing.)
June 30th, 2009 at 4:19 pm
Well this arguement assumes fixed rationality (or irrationality). I agree that people act irrationally over when given free, but what if a producer could convince some of the market that their product offers 10-cents of product betterment. (Maybe a YouTube with faster downloads or a better algorithm that predicts your tastes).
In any case I find the reasoning to be solid but I still have doubts that free can continue forever. The day YouTube becomes a monopoly is the day the begin forcing you to watch commercials before you view a video.
June 30th, 2009 at 4:19 pm
I wasn’t disagreeing with Matt’s point, but thanks for the condescending reply.
June 30th, 2009 at 4:25 pm
The problem is that the videos attracted by psychological Free—pirated material, cat videos, and other forms of user-generated content—are not the sort of thing that advertisers want to be associated with.
This is Gladwell’s explanation of why YouTube doesn’t make money. But I don’t see this as a hard and fast rule or anything. Why shouldn’t, at some point in the near future, advertisers begin to see the benefit of having an ad next to a popular YouTube clip that gets hundreds of thousands of views?
June 30th, 2009 at 4:31 pm
“Anderson adds to this shopworn piece of economic knowledge, the insight from behavioral psychology that while people react similarly to a price of $10.15 and $10.25, human behavior when faced with a price of free is quite different from human behavior when faced with a price of ten cents.”
I wouldn’t say this is a new insight nor is it ignored by economists. Economic theory acknowledges that the price elasticity of demand for a given good is different at different prices. Point-price elasticity is an old concept in economics. It can be said that the demand for a good priced at or near zero is extremely elastic. Anderson views his argument as a critique of traditional economic theory but the two are not incompatible.
June 30th, 2009 at 4:32 pm
So what is Google’s motive for keeping Youtube going? Is it just because they want to have one of everything internet related? Is it a gamble that someday it will become profitable?
June 30th, 2009 at 4:39 pm
It’s really not conceivable that Google will continue to operate YouTube as a money-loser indefinitely. The only reason Google is still at it is because it hopes that eventually advertisers will pay desirable rates for YouTube’s page views. That hope is probably predicated on a bet that as more print media closes shop, the supply of ad space will fall and rates will rise.
As soon as Google thinks that scenario is unlikely to occur, it will close YouTube or sell it if possible and use the proceeds and saved operating costs perhaps to buy The New York Times or start its own movie studio.
June 30th, 2009 at 4:42 pm
2 Points:
1. Economics. Theoretically, a perfectly competetive market cannot exist in the long run. In such a market the price equals the marginal cost of production and therefore no one makes a profit. That is why no perfectly competitive market exists.
2. Accounting. For accounting purposes, variable cost is more relevant. Since fixed costs are ‘fixed’, i.e. don’t change with increased production, if variable cost is zero, no additional cost is incurred by producing more units.
If Google considers upkeep of Youtube a fixed cost (it is incurred even if no new videos are produced), and the new videos are produced by others, then new videos indeed cost Google nothing.
June 30th, 2009 at 4:43 pm
So what is Google’s motive for keeping Youtube going? Is it just because they want to have one of everything internet related? Is it a gamble that someday it will become profitable?
Apparently something like 25% of google searches go to youtube. If youtube was independent of google, they may have been able to block google from searching the site or something. Also, as the cost of running youtube decreases youtube may still become profitable, or not.
June 30th, 2009 at 4:51 pm
“That’s the real lesson of Free. The combination of competition, the near-zero marginal cost of production, and the psychological significance of the zero bound means that the market-leader in video is bound to lose money. To win the market, you need to make your product Free. But while your marginal cost is near-zero, it’s not actually zero, so you’re losing money.”
Anderson, Gladwell, and Yglesias are all impressive in their lack of understanding of what’s going on here.
There is a history to refer to.
Radio has been Free for 80 years now. The cost of broadcasting to a million listeners isn’t much more than broadcasting to a couple of thousand. The marginal cost of a listener in radio rounds down to Free. Same with television. That’s been Free for 60 years now.
The radio and TV folks both managed to make lots and lots of money over decades upon decades using Free.
The basic rules of economics haven’t changed because now we’re approaching a new world with universal high bandwidth over fiber instead of the old world of universal low bandwidth over the air spectrum. The specifics of our time are unique, but intellectual property distributed at Free cost for a profit really does have a track record to refer to.
It would be a lot more interesting if folks writing about these topics bothered to think about them first.
(Of course, folks like Matthew are opposed to the concept of intellectual property, an opposition which if followed by the lawmaking bodies of the nation, would actually result in a world where the market leader in video couldn’t make money. But the concept of intellectual property has a 450 year successful track record that I don’t think is about to come to end.)
June 30th, 2009 at 5:01 pm
Petey, while your citation of the examples of radio and television is somewhat provocative, the Internet is substantively different in that it puts the controls of reproduction in the hands of the consumer, not the distributor. A million people on youtube watching a million different things is a very different system than a million people listening to one of a very few things offered on the television.
June 30th, 2009 at 5:14 pm
Petey — “Radio has been Free for 80 years now. The cost of broadcasting to a million listeners isn’t much more than broadcasting to a couple of thousand. The marginal cost of a listener in radio rounds down to Free. Same with television. That’s been Free for 60 years now… The radio and TV folks both managed to make lots and lots of money over decades upon decades using Free.
This is certainly true. It is also true that free radio and free tv operators held extremely valuable licenses to operate a very limited range of channels which, in turn, drove up the value of advertising on any given site. This is where the analogy to pay internet service offerings breaks down.
Free radio and (especially) free tv have also been bleeding market share to pay services, largely because there were a limited number of stations competing for the same banal mainstream audience, and most people were willing to pay to improve their choices. Again, this cuts against the analogy to the internet, where the lack of a significant barrier to access generated enough high-quality free content that few people are willing to pay extra for name-brand content from established media enterprises.
June 30th, 2009 at 5:14 pm
Broadcast TV was free, to me anyway. There was no guarantee that I was going to pay attention to the ads. In print media, I might pay some, but advertisers also pay on the assumption that I will read their ads. Revenue streams do not have to come from quid pro quo exchanges, nor do revenue streams need to be singular.
Why does that have to be explained at this late date?
I think that nesting advertisement content in the free content of text and video online media is a creative challenge that some of the older people in media just aren’t up to.
June 30th, 2009 at 5:17 pm
“the Internet is substantively different in that it puts the controls of reproduction in the hands of the consumer, not the distributor. A million people on youtube watching a million different things is a very different system than a million people listening to one of a very few things offered on the television.”
Substantively different in what way? Different for the consumer? Sure. Different from the perspective of broadcasters being able to offer a Free product at a profit? Almost definitely not.
YouTube’s serving costs will decrease radically every year. Same for Hulu. Drop your serving costs by 50% every year while advertising remains flat, and after a short interval, you’re making bucket loads of money.
You own the railroad.
I don’t think Google bought YouTube for stupid reasons. I don’t think the content providers blowing money into Hulu are doing so for stupid reasons. There will be a shake-out. There will be winners and losers. But someone is going to make lots and lots of money serving content for Free in the new world, just like they did in the old world.
(Of course, in the unlikely scenario where folks like Matthew are successful in their quest to destroy the wonderful centuries old tradition of intellectual property, then no one will make money serving content for Free. And no one will make money serving content for a price either. Of course, no one will be able to make content anymore, other than folks born with a trust-fund who don’t need to earn a living. Which is precisely why Matthew prefers that situation – it means less competition for him.)
June 30th, 2009 at 5:24 pm
But the costs of production have also been collapsing during the internet revolution, and not necessarily because of it. DIY tech for audio and video (and the typesetting software you’re reading this on now) eliminated lots of infrastructural jobs long before free distribution began squeezing from the other end.
June 30th, 2009 at 5:28 pm
Also, calling it a “highly competitive market” misses the point. Content is also being sold in an increasingly atomized market. So, managers brought up in a lowest common denominator model are still looking for the blockbuster, an astrological enterprise that excuses them from the hard work of identifying their customers and addressing them directly, and/or identifying the advertisers that are most compatible with their customers and hooking the two of them up.
Instead, they’re contemplating law-subsidized models that will help them keep revenues from Coke, advertising to customers who might think they’re too cool for Coke, all while employing as few content providers as possible.
This is dumb.
June 30th, 2009 at 5:44 pm
“It is also true that free radio and free tv operators held extremely valuable licenses”
Valid point.
As stated, the specifics of our time are unique.
But in most markets, there will be a competitive fiber and coax wire going into every house. Once those networks are built out, the corporations owning the wires will hold extremely valuable toll roads. They’ll make back the cost of laying the wire in short order, and then we’re back to where we started.
Things change, but things stay the same.
June 30th, 2009 at 5:52 pm
The Canadian Geo-Sphere-Diversification, business model, for the (XXI)Twenty-First Century, Competition, Profit Rates, and Fairness
THE SKINNY AMERICAN !
(Skinny Says, Triathlon Answers)
(SkinnyAmerican09): What to do…..what to do about that pesky 4000 plus mile border.
(TRIATHLON): You defend it the best that you can, or channel the attacker into areas were numbers are not a factor, the Swedish took on the Soviet Russian Army, in the winter and the Russians took a beating, in Afghanistan, another boarder country to Russia, the Russians were forced to retreat. War is not about boarders’ lengths, numbers of units or strength it is about the will to win, and strategy backed with tactics. YOU DEFEND YOUR BOARDERS.
(SkinnyAmerican09): Plus, well, Canada’s tiny population is not capable of truly defending a nation of such vast size. If someone is incapable (through no real fault of their own in this case) of defending themselves and/or their territory, that really puts a damper on ambitions.
(TRIATHLON): Tell that to the North Koreans, the boarder is at the (38th) Parallel, tell that to Vietnam, no French, no Japanese, no Americans, a nation that sells almost all of it Rice to the Empire, beyond its needs. It is the RIGHT of Canada to be Free and choose its own path.
(SkinnyAmerican09): Canada needs nukes; like the gun being the great equalizer, they would allow a nation like Canada, with it’s small population, to offer the ultimate defense.
(TRIATHLON): The Empire has not attacked or taken Cuba because? Do you really believe the government of Cuba does not have Nukes? If that is the price of Freedom that price must be paid. Which region should take priority in Canada’s future trade strategy? Asia (52%), Europe (24%), and the Empire (24%), (76%) of Canada what’s a change, that’s a Super Majority.
(Canadian Geo-Sphere-Diversification)
Canada should remove itself from (FTA, NAFTA, NACC, SPP Security and Prosperity Partnership for a move toward a common security perimeter an deepening of the (DIA), Deep Integration Agenda constantly being pushed by the corporate-political elite of the Trilateral Commission and the Canadian Council of Chief Executives,)), and in fact is a serious asymmetrical disadvantage driven by the Empire. Mistakes are made but it comes time to rectify them, and now is the time. As, these programs are cutting the heart out of, and wasting the precious natural resources Canada will need in the New Geo-Economic-Sphere of Canada, benefiting only the Empire.
It must be made clear to the Empire, that it will no longer have the support of Canada in its quest to establish the (NWO) New World Order, with the Imperial Media Messiah World President and (CEO), as the head of the World State, a State that would not share power with any other State, viewing the world as needing this type of hierarchical structure, to create a better behavioral and efficient structure, for the good of the Global Community.
Canada must open up free trade with the Geo-Economic-Spheres, of the (BRIC) Brazil, The Russian Federation, India, The (PRC) Peoples Republic of China, widening its Economic Alliances, outside of the (DIA), with protectionism tariffs’ if necessary, not a bad concept but a prudent business idea, within the normal mix of those interests, but not the preferred, a strong production force is necessary within the Canadian, State Geo-Sphere business mix, a pure across the board diversification both Domestically and in the Geo-Sphere-Economic Mix, of industries, based upon (FAIR) completion, Domestically and Internationally is the New Business Model, and being tied at the hip, with all of Canada’s Eggs in the Empires Basket is certainly not part of this new World Geo-Sphere-Diversification, business model.
(Recommended Reading)
(WWW.TheGlobeAndMail.Com.)
(We are not the Canada we think we are.)
Doug Saunders Last updated on Saturday, Jun. 27, 2009 03:30PM
Doug Saunders is a member of The Globe’s European bureau.
(Proximity, reality, strategy, destiny, Globe essay)
Allan Gotlieb, From Saturday’s Globe and Mail Last updated on Saturday, Jun. 27, 2009 02:56AM EDT
Allan Gotlieb has had many years in the Canadian government, serving as Canada’s ambassador to the Empire from (1981 to 1989), and member of many corporate-political elite establishments, Senior Adviser to the law firm Bennett Jones LLP, Chairman of the Canadian Group of the Trilateral Commission and its North American Deputy Chairman, Standing Member of the Carlyle Group’s Canadian Advisory Board (the Carlye Group made infamous in Michael Moore’s Fahrenheit 9/11), and former Director at Hollinger Inc. Gotlieb has a vision of a Manifest Destiny, with a vision of a deep trilateral relationship in North America, The new North American reality.
TRIATHLON
June 30th, 2009 at 5:53 pm
I will note that the concept of a fucking blogger asserting that you can’t make money by offering content for Free in the New Age absolutely slays me.
I mean, seriously. Have Andrew Sullivan and Mickey Kaus and Josh Marshall and Markos Moulitsas been doing charitable work all these years? Are the concepts here really so difficult to grasp?
June 30th, 2009 at 6:14 pm
Petey, I think the virtually unlimited number of potential content producers is not so much the unique “specifics of our time” as it is a serious roadblock toward applying the old business model of advertising-driven free media to the internet. It’s doubtful that anyone would have made any money in radio if there had been thousands of stations in each market.
An awful lot of people have burned through an awful lot of venture capital and old media money trying to make this business model generate profits, with an extremely low success rate. I expect that plenty of individuals and small organizations will make a modest amount of money, but whether a major multimedia outfit like YouTube can turn a consistent profit is still an open question.
June 30th, 2009 at 6:39 pm
Petey, the difference between a tightly-limited broadcast market in which a small and finite group of broadrcasters compete and a wide-open infinite internet pipe where the costs to enter the market are miniscule isn’t just a superficial difference of “the times”; it’s the whole freakin’ point.
In TV and radio, “free” was an acceptable price because of the premium that each owner of spectrum enjoyed when they subletted their bandwidth (i.e. sold ads). With no legal way to purchase airtime other than through existing spectrum-holders, and no incentive for any such broadcaster to price ad space below what they needed to survive, you essentially get spontaneous semi-cartelization: no meaningful competition can arise and the existing market players all make decisions that ensure their continuing viability.
On the internet, competition is significantly easier to bring about because there’s no bandwidth problem limiting entry to the market; as a result, sale price moves down towards the marginal production cost of each piece. Or, y’know, exactly what the original blog post said.
But the concept of intellectual property has a 450 year successful track record
No. The concept of copyright, a limited grant of exclusive monopoly over the distribution of content, has a 450 year track record; the concept of intellectual property , a legally-enforced perpetual monopoly of all forms of control over ideas, is a very recent invention that has largely served to make things more difficult for people.
June 30th, 2009 at 6:53 pm
“An awful lot of people have burned through an awful lot of venture capital and old media money trying to make this business model generate profits, with an extremely low success rate.”
So it was for the introduction of cars.
So it was for the introduction of radio broadcasting.
So it was for the introduction of internet shopping.
And so it will be for this as well. Everyone throws money at it because being a winner holds so much value. Amazon.com is worth $35 billion right now. They won.
How many years did it take for Amazon to turn a profit? Somewhere around five years, IIRC. The VC money that supported Amazon until it turned a profit is not unhappy VC money today.
I expect Hulu will be a big winner here since they own the content, and that’s where they’ll separate themselves. But it’s still very early in the game, and no one knows how it’ll play out. I expect the YouTube model will have at least one big winner as well, and it’ll probably be YouTube, since they have Google’s efficiency of scale behind them. There’s probably a third and/or fourth big winner that we can’t even see yet.
“whether a major multimedia outfit like YouTube can turn a consistent profit is still an open question.”
It’s an open question only of how long it’ll take and what shape it’ll come in.
“Petey, I think the virtually unlimited number of potential content producers…”
There will always be a market for professionally produced moving picture content, be it Free and/or Paid. It’s difficult to make watchable moving picture content in your basement. Folks have a lot of trouble accepting that notion.
You can write stuff for a wide audience in your basement while in your pajamas, but you can’t make teevee for a wide audience in your basement while in your pajamas.
Folks get home from work, and they want the pros to entertain them in their living rooms, not the amateurs.
June 30th, 2009 at 7:40 pm
The concept of copyright has a 450 year track record, but those years were in a different era.
Copyright is practical when mass production is cheap for a few relatively wealthy entities (those who own printing presses, CD manufacturing plants, etc.) but not for the masses. You can enforce copyright when it only involves keeping an eye on a handful of factory owners who see copying as a business venture (and thus have paper trails, merchant accounts, advertising, etc.).
But copyright is impractical when mass production is cheap for everyone. When the entire demand for distribution of your work can be satisfied by a million individuals sitting at home, sharing your content for free just because they feel like it, there isn’t much you can do.
The solution, IMO, is to separate information from labor. You can copy information, but you can’t copy labor; if you want someone to do work on your behalf, but he’d rather be doing something else, you still have to pay him. If you’re in the business of selling your labor as a writer or artist, you have nothing to fear from the internet.
Copyright attempts to bind those together, promoting a business model where access to information is dependent on paying a portion of the production costs. We need to do the opposite: eliminate the connection between paying for production and gaining access to the work. Collect funds before production (or during production, or after production but before release), and then once the work is produced, release it for free and let others handle the distribution for you.
June 30th, 2009 at 7:53 pm
(Of course, in the unlikely scenario where folks like Matthew are successful in their quest to destroy the wonderful centuries old tradition of intellectual property, then no one will make money serving content for Free.
Did you mean “serving” to be “producing”? I can’t see how intellectual property’s existence or non-existence would have serious consequences for YouTube.
June 30th, 2009 at 7:53 pm
“But copyright is impractical when mass production is cheap for everyone. When the entire demand for distribution of your work can be satisfied by a million individuals sitting at home, sharing your content for free just because they feel like it, there isn’t much you can do.”
I’d suggest you follow the history of the past 10 years a bit more closely.
Copyright shut down Napster. Copyright shut down Grokster. Copyright has greatly limited stolen content on YouTube. And copyright has managed to start crimping the Pirate Bay.
Copyright lawsuits have scared many individuals away from mass distributing other people’s IP over the net.
There’s a lot that already has been done, and there is a lot still to be done. And it’ll likely get done, because most folks in a position to legislate don’t have their heads up their asses on the topic the way Matthew does.
The validity, rationale, and practicality of IP laws really is no different now than it was in the 17th century. I know folks like Matthew (whose trust-fund was built entirely by IP) is opposed to this basic concept, but it’s the wrong side of the argument to be on. Only stupid folks or folks with Matthew’s particular history who have Oedipal issues think killing IP laws is a recipe for anything but disaster.
(And FWIW, I was opposed to the Mickey Mouse copyright extension bill. Copyright laws should be very strong, but they shouldn’t last nearly as long as that bill specifies.)
June 30th, 2009 at 8:17 pm
If it suddenly became possible for internet users to anonymously share multimedia content that would screw up all the incentives to produce multimedia content, but it would also screw up the capacity of repressive regimes to censor dissent.
A world in which tyranny was impossible, but we were all stuck watching old reruns and shitty independent films still seems like an improvement over the current world.
June 30th, 2009 at 8:23 pm
Ron should go back to his college and demand his money back for his Econ 101 class.
The idea is not that in a perfectly competitive equilibrium you make no profit, it’s that you make the same humdrum piddly-ass profits everyone else is making. That profit is just enough to cover all your costs and keep you in business. You’re making a living, but you ain’t getting rich.
The problem is, like several people have said, that there’s perfectly free entry into the market for copying and disseminating information, and that entry drives the price down. But there’s another factor that drives the price down all the way to zero — the existence of a large cadre of scamps willing to do the copying and disseminating for free. Even a pimply kid in his mother’s rec room is using real resources as he copies and spreads somebody else’s information.
This, in my view, is what confuses traditional economics when addressing the Web. In the usual model, nobody does anything without at least covering his costs, including the opportunity cost of his time. But when a few million people spontaneously decide to do the work for free, we’re driven down to an artificially low equilibrium price that is less than long-run marginal cost.
The surprising thing is that this equilibrium may be sustainable. Suppose all blogging is done by teenagers, who are willing to incur the opportunity cost of spreading information without recompense. Then, on each blogger’s 20th birthday, s/he’s replaced by some kid just turning 13.
I’ve seen this, by the way, in real life. I lived in Northern Idaho for a few years. The market for loggers is apparently very volatile; loggers are in and out of work all the time. A lot of people in Idaho still heat their homes with wood; after all, they’re surrounded by it. You can get a permit to harvest dead wood for firewood from U.S. government lands for essentially peanuts.
What happens? The out-of-work loggers start cutting and selling firewood. The opportunity cost of their time is low, because they’re out of work. So the economic equilibrium price of firewood will be relatively cheap. But the price falls below that level, because these guys do not factor in the wear-and-tear on their trucks, chain saws and whatnot. Why not? Because they view their foray into the firewood market as temporary, and the wear-and-tear on their equipment as trivial. They might even be right about this. But when everybody does it, and new entrants come in as incumbents depart, the price of firewood is parked below its economic equilibrium level.
In both examples, the irony is that the out-of-work guys are subsidizing the prosperous guys.
June 30th, 2009 at 8:30 pm
MY “we are very invested in a heroic model of capitalism in which wealthy entrepreneurs get rich through their competitive awesomeness.”
Yes, the noble entrepreneur, riding his white steed impaling lesser mortals who dare stand in his way.
The problem with Capitalism is that works. Somebody eventually wins, and the winner leaves a shish kebab trail of lanced corpses.
Worse, the victor spends years his remaining years smoking Havana’s and thinking about ways to make it impossible for others to do what he has done, and passes this hard wrought wisdom on to cretinous heirs and sycophants.
June 30th, 2009 at 8:49 pm
Petey, to understand how copyright is different now, see Richard Stallman on copyright:
“”"
“”"
June 30th, 2009 at 8:58 pm
@Petey
You’re making my point for me. Shutting down Napster and Grokster didn’t stop unauthorized copying, even temporarily; it only led to the development of newer, less centralized P2P systems. Clamping down on unauthorized content on YouTube just pushes it somewhere else. The Pirate Bay is one of many torrent sites: it’s not the first to be sued and it won’t be the last, but none of those suits will put a significant dent in unauthorized copying.
The BitTorrent protocol itself seems for now like it’s here to stay, but there are other systems that already exist and grant essentially perfect anonymity (Freenet, for one). They aren’t in widespread use, because that level of security has a big overhead and is currently unnecessary for trading music and movies. But after a few more lawsuits, who knows, maybe P2P users will migrate to Freenet. It’s hard to sue the person who uploaded a file when you don’t have their IP address, and when every attempt to download the file only spreads it around to even more potential sources.
Every generation of P2P is more resistant to legal muscle than the one before. The fundamentals are against copyright holders here: from a technical standpoint, it’s simply not possible to stop online file sharing without destroying the internet. You can’t ban encryption like Freenet’s without destroying e-commerce.
All the legislation in the world won’t change the facts on the ground.
June 30th, 2009 at 8:59 pm
Petey, do you really think that they can put the genie back in the bottle? Infringing media like movies, music etc is only becoming more widespread not less. If you don’t agree then to my mind you fundamentally misunderstand the internet or you are imagining the very bleak future of a police state.
I think you’ve only sidesteped Jesse’s very interesting comment about the practicality of copyright in todays world.
June 30th, 2009 at 9:05 pm
The anti-YouTube advertising profitability argument is predicated on a false premise, which is the idea that advertisers won’t pay to advertise on low production value reality TV. That’s just not true.
Almost everything on American TV these days, particularly for after-season replacement programs, is low production value reality TV. And there are companies paying for commercials.
What Google can monetize, because they have the technology to do it, is the ability to target an aggregate market in a flood of small shows, video clips, and other content which, individually, is not worth targeting without the metadata that identifies underlying demographics so that ads can be as effective as they would be otherwise.
So they could not deliver a single viewership which could be directly correlated with, for example, the “Lost” viewership or the “24″ viewership, etc.. But in the aggregate, they can deliver that demographic; they just have to do it on a much smaller viewership basis — which means repeatedly delivering it rather than delivering it once.
That works out to having the infrastructure and marginal cost per set of consumer eyeballs to which the advertising message is being delivered being, in total cost with the content they are voluntarily seeking, being less than revenue that placing that ad gets them.
I expect that there are a number of already break-even or break-positive “channels” on YouTube because of that, if they were to be able to convince an advertiser that they could actually deliver a particular demographic unit. Music videos might be the most obvious, since there’s a known correlative demographic, but I suspect you could say the same for “Ask a Ninja”.
And on the back end, it’s the information about the person viewing the video, not the video they are viewing, which they’re going to be able to sell. YouTube is, I think, on track to profitability because of this. Google may just have to take a somewhat longer view than most companies would be willing to, for it to get there. I suspect that that’s in fact exactly what they are doing.
– Terry
June 30th, 2009 at 10:26 pm
Petey, I’m not saying it won’t be possible to earn money giving content away for free on the internet. I’m saying that it’s just unlikely to be a highly lucrative field. My analogy was to dry cleaners. Obviously, there are lots of people in the United States earning a living in the dry cleaning field. But at the same time, there’s no dry cleaning billionaires and nobody writes business guru books about the lessons from the corner dry cleaning shop.
It’s a highly competitive marketplace. And I think the future of media is a lot like the future of dry cleaning. Without the ability to restrict competition through licensing (as the radio and TV stations of yore were able to do) it’s just not going to be a very profitable line of business. Which is fine, lots of sectors of the economy — dry cleaning, breakfast cereal, etc. — aren’t very profitable.
June 30th, 2009 at 11:19 pm
charlequin, you’re right is saying that the free-to-air broadcast model is no longer a licence to print money due to increased competition. But you should also consider that while their service is uncharged, it is not free.
There are time and psychological costs involved in watching ads, which more and more people are avoiding through channel surfing, mute buttons, DVRs, DVDs, music & video downloads, non-commercial & ad-free subscription media, etc. Ad avoidance will become more and more common as the world becomes wealthier and more educated.
Ad rates will keep falling, which will further dent this
“Free” distribution model.
July 1st, 2009 at 1:51 am
2 points (read article, not comment thread, apologize if already made):
1. A seemingly ignored economic reality of newspapers is that subscriptions have always operated at a loss. Forgetting creation (authorship) costs, the act of producing and distributing the paper cost more than the subscription price. The business model is/was advertisement. Subscription cost was earnest money.
2. Investing in unproven technology is a must for any large successful company. For a silly amount of time the only things making Microsoft money was its operating systems and its office suite – its online ventures, gaming systems, server software, multimedia software were all money losers. Some of them are making money now as they were long term investments.
July 1st, 2009 at 6:45 am
[...] lately of Chris Anderson’s Free. Malcolm Gladwell didn’t like it. Matt Yglesias had a sharp and critical response, and here at TLF Cord offered a strongly negative take on the [...]
July 1st, 2009 at 7:59 am
Petey: The validity, rationale, and practicality of IP laws really is no different now than it was in the 17th century.
Practicality unchanged?
IP laws strike a balance between the monopoly-right-owners and the public.
In the 17th century do you really think the public was able for zero cost to reach most of the rest of the world through a home-made blog post, a picture or a video?
In short you believe technical progress has no impact on “practicality”?
I’m surprised…
Anyway initial capital costs are now near zero for creation, initial capital costs are the main econ 101 barrier to entry and they’re just gone. Marginal costs are also down to near zero (all relative to people income).
So IP laws need to go the way of the dodo.
And there are many better substitutes for creation support by the state, with tousands of years of successful history, not mere centuries.
July 1st, 2009 at 11:16 am
I do think Gladwell has one thing right though:
I think musicians are going to make money on touring and merchandise rather than record sales— it’s generally how they actually made ’serious’ money anyway– and music will still be made. The newspaper/television/film industries though…they don’t run on the same model, at all, and there’s no quick and easy solution.
July 1st, 2009 at 12:25 pm
Two points:
1) The Credit Suisse study that Gladwell cites regarding Youtube’s profitability has been heavily criticized. It assumed that Google pays an absurd amount for bandwidth, when in reality, Google likely pays either nothing or actually gets paid for bandwidth, due to peering agreements.
2) Theoretically, the justification for copyright is clear. Without IP protections, other people will free-ride off of the work of content providers, so not as much content will be produced.
But there are two competing effects as copyright effects increase. On one hand, an artist can make money off a work for a longer period of time, and so there is a greater incentive to produce. On the other hand, an artist can “coast” off of past work, decreasing incentives to produce.
Economists have estimated that the “Optimal Copyright Period” which optimizes incentive to produce content is roughly 14 years (Though it depends on the type of media, and decreases over time as production costs fall). Everything above that causes production to decrease.
Of course, the profit-maximizing rate for artists is a lot higher, but if the well-being of artists is of national concern, than direct welfare is a more efficient way of going about it.
July 1st, 2009 at 5:56 pm
[...] anybody “destroyed” anyone else’s argument, it was Matthew Yglesias, who destroyed everything: I think the whole subject could stand to benefit from a little less good writing and a bit more [...]
July 2nd, 2009 at 12:22 am
[...] anybody “destroyed” anyone else’s argument, it was Matthew Yglesias, who destroyed everything: I think the whole subject could stand to benefit from a little less good writing and a bit more [...]
July 2nd, 2009 at 6:18 am
“I think musicians are going to make money on touring and merchandise rather than record sales— it’s generally how they actually made ’serious’ money anyway”
This is flat out false.
Touring has traditionally been a loss leader to sell recordings. A break-even tour has traditionally been regarded as a financial success.
July 2nd, 2009 at 12:29 pm
[...] Free: The Future of a Radical Price. Malcolm Gladwell reviewed the book in the New Yorker. Matthew Yglesias put a post up on the subject and then a second post. Yglesias also links to Seth Godin and Tim Lee, [...]
July 2nd, 2009 at 10:38 pm
Petey, your statement regarding touring is incorrect. Touring is the main source of income for musicians. Google a research paper titled Rocknomics if you’re interested.
July 6th, 2009 at 6:34 am
“It’s difficult to make watchable moving picture content in your basement.” Actually it’s difficult to make great moving picture content any where, with any tech. The reality is that making great communication content is very hard because the skill required is very rare.
The skill to make great content is still very rare. It’s been said that everyone has a story to tell but that very few have stories that anyone else wants to listen to.
When a few communications companies can share an oligopoly, the content is not that important as the way to aggregate a following. Once the technology is accessible to masses, the rules change from regularly delivered content to interesting content.
When a Google news search quickly reveals that newspapers mostly re write AP stories all looking at events through the same lens, it’s pretty clear that unique content is nice but never has explained the newspaper’s business success.
There have always been many examples of Free-to-the-user. But free-to-the-user has never meant free to produce. If one doesn’t earn the money to support production, it dies. Just as the energy to produce art disappears if the artist can’t feed themselves.
Ever decreasing margins is a fundamental stress on competitive capitalism. Every economist since Adam Smith has pointed it out. That reality is the stress under which business people choose to live. From society’s point of view, it drives innovation, higher living standards and democracy. But from the business point of view, it makes life much harder.
The easiest way to relieve that stress is to limit competition. When that fails the business has to reorganize to find new ways to earn the money to keep the whole thing going. GM is the most visible recent example. My bet is that being forced to face the reality of succeeding in a competitive market they will do great things, because hidden in a legacy organization there are great people.
As it is with GM so it will be newspapers, cable channels, TV and advertising. The defensible advantage are the pockets of talent. How that talent is monetized will be different in different places at different times.
As Anderson points out bands make predictable money from the concerts and t-shirts. The music is what makes fans. The money comes from selling fans the stuff they want. People buy art – t shirts, baseball caps – with no regard to cost of production. That’s why they are high margin businesses.