bus 516 session economics of it part i

Copyright © 2009 Mohammad Mahboob Rahman – North South University

BUS 516

Computer Information Systems

Mohammad Mahboob Rahman, PhDSchool of Business | MBANorth South University


Session 7/12Economics of IT Part I


Why learn about the economics of IT?IT changes (fast)But the economics of IT does not necessarily change (as fast)

Useful for managing technology“proof” comes next


Information Rules:

A Strategic Guide to the Network Economy

Carl ShapiroHal R. Varian

(the next several slides are all borrowed from these authors)


Google hired Hal Varian as their chief economist

Useful insight:Analysis of consumer data is crucial for successSame rigor as that of analyzing financial markets


Varian said that two years ago

BusinessWeek article“Mapping a new mobile Internet”

A nascent industry involving the likes of Google and Nokia is pinpointing the movements and behaviors of millions of cell-phone users


Imagine that your business had a complete log of your customers’ wanderings—every trip to the grocery store, every work commute,… What would you learn about them? Armed with that knowledge, what sorts of goods and services might you try to sell them?

Privacy issues?!

ImplementationBehavioral/geographic clustering


A decade ago, marketers extolled the potential of the mobile Web: zapping customers with digital coupons just as they passed stores

This vision fell flat in much of the world, largely for two reasons

Early phones offered rudimentary tracking and data service


The iPhone changed thatShifting computing to mobile machinesApp store now offers more than 8,000 programs

Data collectedAs people connect to wi-fi, etc. GPS systems/devicesPeople are regarded as points…Facebook becoming much more popular on mobile setsTwitter


First topic in the economics of ITWhat is IT?

What is information?What is technology?


Information (Goods)

There are “goods” in economicsProduction/markets/sales/consumption

And there are information goodsAnything that can be digitized

Text, images, videos, music, etc.a.k.a. content, digital goods


But what is special about information goods?

Unique cost characteristicsUnique demand characteristics


Cost structure

Expensive to producecheap to reproduce

High fixed cost, low marginal costNot only fixed, but sunkNo significant capacity constraints

What are the implications?


Implication no. 1: market structureMonopolyCost leadershipProduct differentiation (versioning)

Implication no. 2: rights management


Rights ManagementLow reproduction cost is two-edged sword

Cheap for owners (high profit margin)But also cheap for copiers

Maximize value of information good, not protection


Consumption characteristics

Experience goodBrowsingAlways newReputation and brand identity

(information) OverloadEconomics of attention


Technology

Infrastructure to store, retrieve, filter, manipulate, view, transmit, and receive informationAdds value to information

Web = 1 terabyte of text = 1 million booksIf 10% useful = 1 Borders BookstoreValue of Web is in ease of access

Front end to databases, etc.Currency


System

Complementary productsHardware/softwareClient/serverViewer/content

FeaturesDifferent manufacturersStrategy for complementors as well as competitorsCompatibility as strategic choiceStandards and interconnection


Systems Competition Microsoft-Intel: Wintel

IntelCommoditize complementory chips

MicrosoftCommoditize PCs

AppleIntegrated solutionWorked better

But why wasn’t it popular?


Lock-In and Switching Costs

Example: Regular serverCostly switch to virtualization

Systems lock-in: durable complementsHardware, softwareIndividual, organizational


Network EffectsValue depends on number of users

Positive feedbackFax (patented in 1843)Internet (1980s)

Indirect network effectsSoftware

Expectations managementCompetitive pre-announcements


Policy

Understand environment

Competition policyRegulationAntitrust

Electronic commerceContractsPrivacy


Information is Different…but not so different

Key conceptsVersioningLock-inSystems competition, Network effects


Pricing


Britannica v. EncartaBritannica: 200 years, $1,600 for set1992: Microsoft purchased Funk & Wagnalls to make EncartaBritannica response

Online subscription at $2,000 per yearSales dropped 50% between 1990 and 1996Online subscription at $120CD for $200, since 1996 $70-$125


Production Costs

First-copy costs dominateSunk costs - not recoverable

Variable costs small; no capacity constraints

Microsoft has 92% profit marginsSignificant economies of scale

Marginal cost less than average costDeclining average cost


Implications for Market Structure

Cannot be "perfectly competitive"

2 sustainable structuresDominant firm/monopolyDifferentiated product

…and combinations of above


Strategy

What to doDifferentiate your product

Add value to the raw information (good) to distinguish yourself from the competitionGP charges more than BanglaLink

Quality?

Achieve cost leadership through economies of scale and scope


Commoditized InformationCD ROM phonebooks1986: Nynex charged $10,000 per disk for NY directoryProCD and Digital Directory AssistanceChinese workers at $3.50 daily wageBertrand competition

Start at $200 eachPrice forced to marginal cost


Strategy in commoditized business

Cost leadership

Sell the same thing over againReutersReduces average cost


First-mover AdvantagesAvoid greed

Respond to threat quickly and decisivelyLimit pricing; highly credible with high FCs

Play toughDiscourage future entryProtects expression, not ideasImitation as a strategyConstant innovation (search engines)


Hard to do for Incumbent

May not recognize threat till too lateCP/MWordstarVisiCalc


Personalize Your ProductPersonalize product, personalize price

Personalized ads

Why?


Know Your CustomerRegistration

Required: NY TimesBilling: Wall Street JournalAOL’s ace in hole: ZAG

Know your consumerObserve QueriesObserve Clickstream


Logic of Pricing

Quicken example1 million wtp $60, 2 million wtp $20?Demand curve (next slide)Assumes only one price

Price discrimination gives $10 millionProblems

How do you know wtp?How do you prevent arbitrage?


Demand Curve

Price(Dollars)

Quantity (Millions)

$20

$40

$60

1 2 3


Pricing problem

TR if 0< p < 20, pX3Mif 20< p < 60, px1m0 o/w


Forms of Differential Pricing

Personalized pricingSell to each user at a different price

VersioningOffer a product line and let users choose

Group pricingBased on group membership/identity


Personalized Pricing

Catalog insertsMarket researchDifferentiation

Easy on the Internet‘mass customization’auctions

Easy with ITCRM, emails—coupons, inexpensive campaigns


Internet

AuctionsCloseouts, promotions


Group Pricing

Price sensitivityNetwork effects, standardizationLock-InSharing


Price Sensitivity

International pricingUS edition textbook: $70Indian edition textbook: $5

Problems raised by InternetLocalization as solution


Network EffectsCompatibility

Site licensesVariety of schemes: per client, per user, per server, etc.

Lock-InWall Street Journal’s Newspapers-in-education

Microsoft OfficePer seat, concurrent


Sharing

Transactions cost of sharingVideosDesire for repeat play


SummaryFirms selling information goods need to

Understand cost structureCommodity market: be aggressive, not greedyDifferentiate product and priceUnderstand consumerPersonalize products and pricesConsider selling to groups


Network Effects


Information goods tend to exhibit network effects

You value from using a goodand also

From others using that good


Implication 1:You might end up choosing a good, even though there is a “better” alternative

Simply because others are using itYour choice makes the product even more desirable

Simply because you increased the network effect


Implication 2Network effects can be extremely strongNetworks grow very, very fast

Market becomes “tippy”Winner-take-all situation


ExampleWintel v. AppleIpod vs. Zune

Which product was better?What was relevant?

First move?


Managerial considerationsCan you simply go and compete with a better product?

Change is very difficultMUCH better productMUCH cheaper alternativeTakes a long time

Google is a good example!


Essentially, network effect contributes to positive feedback

Strong gets strongerWeak gets weaker

Interestingly, network effects are not the only source of positive feedback


Other Source of Positive FeedbackSupply side economies of scale

Declining average costMarginal cost less than average cost

Example: information goodsAs more is sold, suppliers are able to reduce prices, and so even more is sold


Lock-In and Switching Costs

Network effects lead to substantial collective switching costsEven worse than individual lock-inDue to coordination costsExample: QWERTY


Likelihood of Tipping

Low Scale Economies

High ScaleEconomies

Low Demand For Variety

Unlikely High

High Demand For Variety

Low Depends


Igniting Positive Feedback

EvolutionGive up some performance to ensure compatibility, thus easing consumer adoption

RevolutionWipe the slate clean and come up with the best product possible


Generic Strategies

Control Open

Compatible ControlledMigration

OpenMigration

Incompatible PerformancePlay

Discontinuity


Fundamental tradeoff: performance and compatibility


Discussion

Why did Google acquire YouTube?Is Google deficient in quality?Why not simply promote Google Videos?


Annual EventWISE

Workshop on Information Systems and Economicshttp://w4.stern.nyu.edu/ceder/events.cfm?doc_id=100267

Key playersEric BrynjolfssonYannis BakosChris DellarocasTridas MukhopaddhayArun Sudararajan

http://w4.stern.nyu.edu/ceder/events.cfm?doc_id=100267

http://w4.stern.nyu.edu/ceder/events.cfm?doc_id=100267


Topics from WISE 2008Do pop-ups pay off?Sponsored searchPricing on Demand Software Competitively in a Dynamic MarketDoes high-skill immigration make everyone better off


Micro behavioral analysisSearch Engine Optimization

Aggregate analysisIndustry-level empirical studies

bus 516 session economics of it part i

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