questions and answers on the book rethinking the new economy

8/6/2019 Questions and Answers on the Book Rethinking the New Economy

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E-Business

(FED 014)

Rethinking the Network EconomyBy Stan Liebowitz

Submitted by

Nnaemeka Ononiwu Diana J. MosqueraEmail: [email protected] Email:

[email protected] Student ID: 770711-P238 Student ID: 770919-P782

Department of Msc. in Business Administration

28th December 2005

Ronneby, Sweden

Blekinge Institute of Technology
mailto:[email protected]:[email protected]:[email protected]:[email protected]


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1. Is Internet economics very special or is it not?

When the Internet just started, there were misconceptions that lead some companies topush themselves to become part of this revolution at any price. No company wanted tobe part of the laggards (the Brick-and-mortar) who appeared to be missing the wavebeing compared to lumbering dinosaurs, and for which failure was supposed to be theironly fate in the years ahead. A typical "dot-com" company'sbusiness model relied onnetwork effects to justify losing money to build market share, or evenmind share, throughgiving their product away in the hope that they could eventually charge for it. This causedInternet-stock collapse and brought forth so many of the first generation of Internetcompanies crashing and burning, and with Internet stock market valuations now so muchreduced (The infamous bubble burst).

These misconceptions were based the economic principles and assumption that it was aNew Economy, and should not be comparable to the traditional bricks and mortarseconomy. However, the truth is the Internet is changing in many aspects of our lives, but

the economic and business rules that worked in previous regimes will largely continue towork in the new regime. These rules of business endure because economic forces do notchange and cannot be changed because technology is changing. Companies still needto determine how to incorporate the Internet into their business models. Even with, theInternet is being an important tool, and business managers need to understand theeconomic forces at work in Internet-based markets.

As the authors of the book Information Rules, by Carl Shapiro and Hal Varian put it,"Ignoring basic economic principles is at your own risk. Technology changes. Economiclaws do not." Understanding these laws and their relevance to information goods iscritical when fashioning todays successful competitive strategies.

Internet doesnt necessarily lead to above-normal profits for those who invest inInternet activities, whether the investors are companies or individuals. The idea thatlarge technological advances must be accompanied by above-normal profits forcompanies wise enough to invest in these markets is not a law of economics anhence is based on flawed reasoning. This idea was derived from a belief that Internetmarkets were first-mover-wins, a concept that is itself derived from theories known aspath dependence and lock-in.

Networking effectsNetwork effects are present when a product becomes more useful to consumers inproportion to the number of other people using it. Nevertheless, many businessmodels applied to e-commerce were often based on unsupported and ultimatelyincorrect assumptions that ALL of e-commerce was subject to powerful networkeffects. These firms operated under the belief that when a new market comes intobeing which contains strong network effects, so firms should care more aboutgrowing theirmarket share than about becoming profitableat the first stage.

Network effects clearly exist, but their strength is often overestimated. These aretheories that exhort companies to take advantage of network effects to lock in winningpositions. These are theories that suggest that getting to market first and generating alarge market share and installed base is of the most importance. These are theoriesthat imply that losing money to gain sales and share is a worthwhile investmentbecause companies that succeed in generating large sales will have easy sailing in

the future with their customers locked into their products. These are theories thatmake claims that are inconsistent with the way markets have actually worked.
http://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Network_effecthttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Mind_sharehttp://en.wikipedia.org/wiki/Mind_sharehttp://en.wikipedia.org/wiki/Markethttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Profithttp://en.wikipedia.org/wiki/Profithttp://en.wikipedia.org/wiki/Business_modelhttp://en.wikipedia.org/wiki/Network_effecthttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Mind_sharehttp://en.wikipedia.org/wiki/Markethttp://en.wikipedia.org/wiki/Market_sharehttp://en.wikipedia.org/wiki/Profit


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Economies of scale, a concept that has been taught in microeconomics classesfor many generations, implies that average costs decrease as the company sellsmore and gets larger. Many companies with large market shares, such as Packard-Bell in computers or General Motors in automobile manufacturing, did not have thecost advantages over their rivals that were expected of large companies. But, forsome reason, this possibility was thought not to apply to Internet companies.

Winner-Take-AllNetwork effects and economies of scale have almost identical impacts. Each works tothe advantage of large companies over small ones. Large networks, by definition,have stronger network effects than do small networks, meaning that, everything elsebeing equal, consumers should be willing to pay more to join a large network. Thisshould enhance the profitability of the large network relative to the small network.Similarly, economies of scale imply that large companies have lower costs than dosmall companies, thus providing them with larger profits. In terms of outcomes, thesetwo economic forces are virtually indistinguishable from one another since each

provides an advantage to large companies and networks relative to their smallerrivals.

This advantage of large over small is sometimes referred to as increasing returns.Increasing returns was normally thought to lead to winner-take-all results, particularlywhen products from different vendors were considered to be identical, as economictheories often model them to be. Increasing returns, therefore, was inconsistent withthe ideal of having many competitors in the market, one of the fundamentalassumptions in economists basic model of competition. It was also inconsistent withthe observation that many industries had far more than a single dominant company.

Network effects do not come about just because business is conducted on

a network. Nor are economies of scale likely to be greatly enhanced for most e-commerce companies. Yet, without these preconditions, winner-take-all results will beno more likely for Internet incarnations of these industries than for their bricks-and-mortar counterparts. And if markets are not winner-take-all, then being first shouldimpart no extra advantage relative to bricks-and-mortar versions of these industries.But even when markets are winner-take-all, that doesnt translate into first-mover-wins.

There is yet one more factor that was believe to lead to winner-take-all results,instant scalability which is the ability of a company to meet market demand in almostno time, tending to cause any favoured product to get the lions share of the market.Instant scalability arises when the production process requires non-specific inputs.

Unlike economies of scale and network effects, instant scalability does notnecessarily lead to winner-take-all results. If consumers do not uniformly agree thatone product in the market is superior to the others, instant scalability will not lead todominant market shares.

Whether a companys production has the characteristics of economies of scale,network effects, or instant scalability depends on the specifics of its products and themanner in which it conducts business. The exact manner in which it uses or does notuse the Internet can also determine the existence or non-existence of these economiccharacteristics. One has to examine each industry on a case-by-case basis to

determine whether winner-take-all is a likely result.


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Being first usually could provide some advantage, whether we are talking aboutbricks-and-mortar companies or Internet companies. The problem arose with theadvice from Internet gurus telling people to get to market first so as to lock incustomers was not correct.

E-commerce companies do not need to expend resources on physical stores,providing them with what should be a cost advantage over their bricks-and-mortarcounterparts. But this does not imply that Internet companies will be more profitablethan their higher-priced bricks-and-mortar versions. They however are in a betterposition to operate on lower overhead costs. Above-normal profits are normally dueto a lack of competition. The Internet, with its free entry, would be expected topromote competition, which is good for consumers but bad for producers.

The Internet is a great advance in lowering the cost of information. Information isavailable in unprecedented simplicity, unprecedented quantity, and unprecedentedvariety. But information transmission does not change the laws of economics.Transmitting information is one of the most valuable functions in an economy.

The creation of the Web site is a fixed cost, so this component of cost mightproduce an economy of scale effect. But if the cost of Web-site creation is smallrelative to other costs such a warehousing, shipping, production, sales, customerrelations, and so forth, then the fixed cost of Web-site creation is unlikely to result inmuch of a scale economy and thus unlikely to result in winner-take-all. However, theinternet web site and facilities can reduce the need to have a large warehouse, so theinternet company can have a direct link with their supplies which can considerablyreduce their operating cost and give them more advantage over the traditional firms.

Some companies, such as eBay with its online auctions of used products, and thevarious Internet Messaging services by the likes of AOL, Yahoo, and Microsoft, do

have strong network effects, but they seem to be more the exception than the rule forInternet companies. Buyers will tend to flock to auction markets, such as eBay, whichhave the largest number of items for sale since a consumer is more likely to find whathe is looking for, especially used and obscure items, if many items are being sold.Similarly, sellers will prefer to have the broadest possible exposure to buyers. Sinceinformation is the key to these markets, there is every reason to believe that Internetsellers of used items will come to dominate the market, besting the classifieds foundin most newspapers. The powerful effect of network externalities has really made thesited companies progress astronomically in the last couple of years.

The majority of Internet companies do not have strong network effects. Certainly

this is true for almost all online retailing. Customers want to buy the most appropriateproducts at the best price. Very little of that decision will depend on the number ofother consumers patronizing a particular retailer. One exception to this, but probablynot the most important, is product reviews listed on the Web site.

For the most part, online retailing will not have the characteristics of winner-take-all orfirst-mover-wins. Most online retailers will not exhibit characteristics of network effectsor instant scalability. Economies of scale, on the other hand, could be important, butthere is little reason to think that bricks-and-mortar companies in the same industrywould not possess equivalent economies of scale.

As the most important conclusion, there is a very strong relationship between those

companies producing the best quality product and those companies that are most


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successful, measured by above-normal profit, large market shares, or high stock marketreturns. This is true for both, brick and mortar businesses and Internet businesses.

References:

http://en.wikipedia.org/wiki/Network_effect

Carl Shapiro and Hal R. Varian, Information Rules,A Strategic Guide to the NetworkEconomy
http://en.wikipedia.org/wiki/Network_effecthttp://en.wikipedia.org/wiki/Network_effect


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2. What are the advantages and disadvantages to be first on a market?

During the American Civil War, the Confederate general Nathan Bedford Forrest was askedwhat is the key to military success. His answer was succinct: "To get thar fustest with themostest men." More refined students of military strategy refer this as the doctrine that armiesshould seek to occupy and hold defensible ground. In business, the concept has beendistilled into what is known as first-mover advantage.

The idea that being first is essential, while being an advantage, could also be a perniciousassumption, because it makes companies throw themselves madly off a cliff, thinking theywere bound for glory on reaching a virgin land. It was a misconception thinking that beingfirst was of paramount importance in the Internet age, far more important than it is for bricks-and-mortar industries. A common advice was: get established first, at any cost. You have tobuild up market share and user-base to lock in that market. With this misconception, itseems that technical brilliance, low prices, and high quality are taken as less important tolead to success, after all, once you get there first you are guaranteed.

The point we are trying to make at this juncture is that being the first is not solely enough toguarantee success, nothing is better than an astute, efficient, and proper business practice.The assumption of success by being the first could actually constitute the most dreadeddisadvantage of being the first mover the ownership of a detrimentally flawed assumption.

The intellectual underpinning for this notion of the benefits of early entry has to do with theconcept of lock-in where the winner not only takes all, he keeps taking it, even in the face ofa better rival. In this view of markets, if the initial entrant gets the largest market share, lock-in will then work to keep the companys customers immobile and the company entrenched inthe leading position. In the lock-in concept, network effects play the key role. Network effectslead to winner-take-all, and once the winner is established, network effects keep competitorsat bay.

According to Geoffrey Moore in his Hi-Tech book crossing the chasm , he pointed out thatonce there is a first mover into the market, and consumers perceive them as the marketleader, all other smaller companies and suppliers build their network around the leader. Thismakes it very difficult for a competitor because the market leader will be a mark for industrystandards. An example of this is Microsoft.

The conclusion is consistent across many different high-tech markets: being early does notportend success if there are rivals with superior products. That does not mean, however, thatthe concept of winner-take-all can be discredited. There is a good deal of evidence that high-tech markets do incubate conditions that lead to very large market shares for the companiesthat are most successful in these markets. A company with a dominant market position,

however, can expect to maintain that position only as long as consumers regard its productsas the best.

However, it needs to be understood that many, and perhaps most, Internet markets are nomore likely to be winner-take-all than the bricks-and-mortar counterparts of these companies.For industries, the Internet will offer an enhancement to business, but it will not bring about afundamental restructuring of the business model. Just doing business on the Internet doesnot create the conditions for winner-take-all results. This was, and still is, a commonmisconception among the Internet companies. Finally, what is probably the leading strategyfor Internet companies is the same as the leading strategy for bricks-and-mortar companies:produce better products at lower costs. This strategy has worked numerous times, both inlow-tech and high-tech industries and it is not easy for competitors to copy successfully sincetalking quality is much easier than producing quality.


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Advantages and disadvantages of being first-mover:

The advantages and disadvantages of the first mover are applicable to both bricks andmortar and internet businesses. However, it is important to recognise that first-moverstatus is not an end in itself, but rather the beginning of a longer and much morecomplex strategy in which the initial advantage has to be defended againstcompetitors and imitators.

Advantages:

By being the first to enter a new market, the business gains an advantage over itsactual and potential rivals. This is true whether it is seeking to develop geographicaland demographic markets or segments for existing products, or to introduce newproducts to its existing market segments.

If the business is first into a market, the thinking goes; it can establish what themilitary thinkers would call 'defensible ground'. First, it can capture market sharemuch more easily without having to worry about rivals trying to capture the samecustomers. Second, when the rivals do come along (as something inevitable), the

first-mover and its management team will have advantages in the ensuingcompetition, such as familiar products, brand loyalty, the best retail outlets, up-and-running distribution systems, and so on.

By beating rivals into the market, the first-mover can consolidate its position andcompete more effectively, not only defending its previously acquired share but alsoeven continuing to expand.

As we mentioned earlier, first mover advantage guarantees that the company will beseen as the industry standard, as all other networks will build complementary productaround the industry leader, in a bid to produce a whole product for pragmaticcustomers whish is the lifeline of new businesses. Geoffrey Moore inside thetornado.

First mover advantage makes customer lock-in easier, and switching cost higher inthe event that competition begins to build.

Companies should seek to innovate constantly so as to develop new products andprocesses that will allow them to stay ahead of rivals. Knowledge management isanother area where the importance of first-mover advantage is implicit. As Arie deGeus's said: In the future, a company's only sustainable competitive advantage maybe its ability to learn faster than its competitors.

Examples where being first in the market were the winner strategy:

Example 1:

One of the great 'first-movers' of all time was the 18 th-century businessman RichardArkwright, the inventor of the modern factory system. Having devised a completemechanised system for the spinning of cotton yarn, based around his own original patentfor the water-frame, Arkwright threw himself into the diffusion of this system. Not only didhe build a number of factories of his own, he also entered into partnerships with otherentrepreneurs to set up further factories, and licensed his technology to still others.Within five years there were fifteen Arkwright-patent mills operating in the north ofEngland.

The inevitable happened, and Arkwright lost control of the technology; his designs wereheavily pirated, and six years after his original patent a court declared it null and void,

meaning the technology was now free for use by all. But Arkwright had used this sixyears to give himself a priceless first-mover advantage. Not only did he have a dominant


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position in the spinning market, but he also had six years of knowledge and experience inusing the technology - which he used to make continuous improvements and achievegreater efficiency. For the rest of his life, Arkwright would be chased by his competitorsbut never caught.

Example 2:In modern times, one of the most famous exemplars of first-mover advantage as a basisfor corporate strategy is the Japanese electronics maker Sony. Set up by the legendaryIbuka Masaru in the ruins of Tokyo after the second world war, Sony built not only itsstrategy but its entire corporate philosophy around Ibuka's idea of 'doing things that noone else is willing to do'. For Ibuka, as for his friend and successor Morita Akio,developing leading-edge products and getting them to market faster than the competitionwas not so much a strategy as a personal obsession, and is considered one of thecornerstones of Sony's rapid growth and continued success.

Disadvantages:

The first and biggest of these is cost. In order to be a first-mover, an organisation

must be a pioneer, and this means incurring costs in terms of time and investment. Technology must be invented, distribution systems have to be established,

knowledge about new markets must be learned from scratch, sometimes painfully.For those who come to the market later, the costs of acquiring all this knowledge canbe much lower: products can be reverse-engineered and improved on, andexperienced staff can be hired away from the pioneering company to impart theirknowledge.

Another argument concerns risk. Without previous experience to draw upon, firstmovers usually make the worst mistakes in terms of judging whether a product will besuitable for the market. Successive companies can reduce risk by learning from thesemistakes.

Examples where being first in the market were not necessarily the winner strategy:

Example 1:Many first-movers do fail. Silicon Valley, the great hotbed of modern USentrepreneurship, is full of histories of companies that had first-mover advantage but stillfailed; it has been estimated that only about one in a hundred Silicon Valley start-upssurvives for more than two years. The main reason for which they fail is that havingsecured first-mover advantage, they do not devote sufficient resources to keeping it; thefollowing companies learn rapidly from the first-movers and erode their competitiveadvantage before they are able to consolidate it. The second is that first-moveradvantage is no absolute guarantee of success, and for reasons which must remainforever mysterious, late-arriving and sometimes inferior products often take over themarket from the first-movers.

Example 2:Sony learned that first-mover advantage is no absolute guarantee of success, when itsBetamax video recorder system was driven out of the market by VHS.

First-mover advantage is not just about getting there first: speed is necessary to success,but not in itself sufficient. The advantages of being first must be consolidated withresources - money, people and knowledge - to enable the advantage to be maintainedand enlarged upon. No advantage lasts forever, and the wise business know that it ismuch harder to keep an advantage than it is to get it in the first place. First-mover status

must never be a strategy in and of itself, only the prelude to a larger and longer strategicplan.


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Internet companies and the first-advantage

Even though, the advantages and disadvantages mentioned above apply to both, bricks andmortar and Internet business, Internet has special characteristics that are important toconsider creating more barriers for the first-advantage. For example, as it was known that afirst mover has the opportunity to draw customers into their world, creating switching coststhat increase brand loyalty. This is the purpose of frequent buying programs by airlines, forexample. However just as there has been little to stop almost all airlines from creating theirown frequent flyer program, most online start-ups have been unable to keep new entrantsfrom imitating their own customers programs. Switching costs are so low, in fact, that manycustomers rely comparison-shopping websites to seek out the lowest prices on the Internet.

With few barriers to entry, most online start-ups have insufficient time to establish strongmarket positions, and often resort to quick-fix solutions that further dilute profit objectives.

In much the same way, in a highly uncertain emerging field like the Internet, the entry of acompany to a particular sector is a positive signal on the potential of that sector. As a result,investors have been more willing to support a start-up that entered a market populated withcompetitors. That is why a lot of B2C companies have started selling in near-commoditycategories because commodities do not have barriers to entry and so what made it easy forearly movers to enter also made it easy for late movers to enter. Whatever good thingsmight come from being first, they almost always must be followed by effective strategy anddevelopment of subsequent competitive advantages. Execution becomes much moreimportant than simply being first.

As conclusion, to gain the advantage first movers must capitalize on the opportunities thatcome with being a pioneer while at the same time manage the threats that arise. The bottom

line: Being first in a market is only an advantage when you do something with it.

References

http://www.ftmastering.com/mmo/mmo07_6.htm

First-mover advantage for Internet Start-ups: Myth or reality by Sydney Finkelstein.

Geoffrey Moore: Crossing the chasm.

Geoffrey Moore: Inside the tornado.
http://www.ftmastering.com/mmo/mmo07_6.htmhttp://www.ftmastering.com/mmo/mmo07_6.htm


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3. Can you describe products and services, which are suitable to use Internet inthe selling process?

There are several ways in which the Internet can alter a business model:

a. It can alter the shopping experience, replacing actual physical stores andmerchandise with virtual stores and virtual merchandise.b. It can alter the way the product is purchased after shopping has beencompleted.c. It can alter the distribution (including warehousing and delivery) of the product,creating a distribution system to move the product from the manufacturer to theconsumer.

Indisputably, the Internet does provide some advantages to consumers: a large selection, nolines at the register, and perhaps lower costs. But there are also many disadvantages or arestriction such as it is not possible to touch, smell, squeeze, shake, or feel products on theInternet. Transportation costs are likely to be higher, delivery less than immediate, and its

current status as a sales-tax-free haven is likely to be short-lived. Also, some products arebest sold with a hands-on demonstration, and a move to Internet sales could make difficultthe functioning of these markets.

Some products have no disadvantages being sold on the web, because there is notransportation costs and examination is no required.

Airline tickets, car and hotel reservations and financial instruments such as stocks.All of these are a form of information and, as such, lend themselves to an easy formof digitization. The Internet should be able to allow information to be transmitted moreeconomically, more rapidly, and more efficiently than the telephone or the mail. Italso means that the information that is provided needs to be as flexible and detailed

as that made available by a live person.

Products such as software, music, videos, and other digital intellectual products willbe sold over the Web. Products that are inherently digital are obviously the mostnatural candidates for transmission over the Internet. Computer programs, whichhave always been digital, can be stored on various media and delivered that way butare most conveniently and rapidly delivered over the Internet. Therefore, it would benatural to expect that this would be the primary form of delivery for these types ofproducts.

Thin markets are those that have few buyers (and usually few sellers) of a productbecause the product is just not very popular or perhaps not very affordable. Althoughnot necessarily an intrinsic characteristic of the product itself, this is a characteristic ofthe market for the product. Products that are sold in thin markets are not goodcandidates for bricks-and-mortar retailers since bricks-and-mortar retailers tend toservice a particular geographic area, and most local populations are likely to be toosmall to justify the fixed costs of a bricks-and-mortar retailer. Sometimes, large urbanareas may be able to support a retailer of such products. However, being on theInternet eliminates geographic confines.

The eBay site allows the trading of products that might otherwise have thin markets.By bringing many buyers and sellers to one location, and by providing good searchtools, buyers and sellers of unusual commodities can interact with one another.


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Some products lose their useful attributes over short periods of time being not goodcandidates to be sold over the Internet. The exception would be perishable foodswith a high ratio of value/shipping cost such as steaks, lobsters, desserts, and otherfood items.

The Internet is an ideal way to sell products that may have at one time been sold onlyin specialty shops in larger cities with sufficient population densities to support abricks-and-mortar store. We might be talking about unusual herbs and spices, foreigndelicacies that appeal to a very small number of palates, specialized books, tools,instruments, and so forth.

As Stephen Manes, an expert in technology said for Forbes about the predictions for theNew Year: Advertising will continue to go the Web--and the last few media outlets that havebeen somewhat spared (namely, television and fashion magazines), will start to worry. And itgets worse: Digital video technology will start to empower the guys at the bottom of thebroadcast food chain--the local affiliates. All digital streams--video, voice, text, phone calls-morph together in the devices used by consumers. Consumers will want their information

and entertainment on lots of devices and wont think about these as separate media

References

http://www.forbes.com/2005/12/12/technology-2006-predictions-sneakpeek_sp06_04_smanes_technology.html


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4. What role do the prices and price system play at Internet?

According to the author Internet will have the effect of reducing rather than increasing thecurrent variability in prices. Otherwise it would be a step backward. Posting fixed prices, inits own way, achieves the same end. No negotiations. No concern that you might not get theproduct as long as it is in stock. From a timesaving point of view, posted prices are extremelyfunctional. Posted prices are not ideal, however, for the seller who is narrowly interested inmaximizing revenues.

The Concept of Price Discrimination means charging different prices to differentcustomers, and if they are getting it right, they are charging higher prices to the customerswho are willing to pay more. The maximum price consumers are willing to pay is known as areservation price. Price discrimination allows the seller to earn greater profits than would bepossible if the same single price were charged to all customers. Amazon is a champion inthis pricing strategy, and the use of software in the Internet to better know customers andstudy their buying habits and their price sensitivity makes even more possible todiscriminate.

When different prices can be charged, however, the seller doesnt lose money from the high-reservation-price customers when he attempts to bring low-reservation-price customers intoThe market since he can charge lower prices to only the individuals that he chooses. That iswhy price discrimination can increase his profits. It also allows low-price customers into themarket, and the net result may well be beneficial to society at large if it leads to greater totaloutput being sold.

AuctionsThe success of companies sponsoring auctions or other unusual forms of pricing, such aseBay, Yahoo, and Priceline, have caused some commentators to suggest that auctions aregoing to be playing an increasing role in future sales.

Sellers should only wish to engage in auctions if they can receive a higher price than wouldbe available through any posted price. This means that buyers, being aware of posted priceselsewhere, should not be willing to pay higher prices in auctions. However, some buyershave been paying more than they would have paid purchasing the identical items sold atretail. As information becomes more readily known shifting bargaining power to consumers.,this will lead consumers will become more wary of auctions, that are likely to be relegated tothose items for which auctions make the most sense, this is items that are not currently beingsold at retail.

According to the author, auctions are a good way to sell out-of-season, clearance, and one-replacing bricks-and-mortar discounters who have tended to specialize in such merchandise.

Net auctions are also likely to displace the classified-advertising market, since these areusually heterogeneous products. The Internet allows easy searching, and the Internet allowsnational or international users to enter the market.

Markets that were too thin at local geographic levels with too few buyers or sellers existed toensure that the price went to a reasonable level can function more efficiently on the Internet.Auctions, however, are not a good way for ordinary new products to be sold. The increasedavailability of price information made possible by the Internet should make it increasinglydifficult to sell new, homogeneous products at differential prices. It will just be too easy forconsumers to compare prices and to know what is the best available price for a product.


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New technologies such as personalization technology are making it easier for retailers toknow the identity of their customers in real-time, to access their shopping data, and tochange their prices and offers accordingly. So they can charge different customers differentprices based on knowledge about the customer. The more the information the retailer hasabout a certain customer, the easier it is to adjust the product catalogue to matchpreferences, and charge prices higher than they would sell to unknown consumers, so longas the price is not too arbitrary which can force the consumer to defect to other retailers.

References:

Nir Vulkan, The Economics of e-commerce.


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5. What methods are used of controlling ownership over the Web?

Digital rights management (DRM) is referring to any of several technical methods used tohandle the description, layering, analysis, valuation, trading and monitoring of the rights heldover a digital work. As the name implies, it applies only to digital media. Digital media havegained in popularity over analog media both because of technical advantages associatedwith their production, reproduction, and manipulation, and also because they are sometimesof higher perceptual quality than their analog counterparts

DRM refers the technologies that promise to prevent unanthorized copies of copyrightedmaterials from being made. These mechanisms work with the digital code of the music orother copyrighted material also have the ability to allow copies to be made upon payment orto charge micropayments for each small use of the product. In principle, such technologycould restrict copying or even just reading a copyrighted product unless there were apayment.

Some digital media content publishers claim DRM technologies are necessary to prevent

revenue loss due to illegal duplication of their copyrighted works. However, others, includingcivil libertarians, argue that transferring control of the use of media from consumers to aconsolidated media industry will lead to loss of existing user rights and stifle innovation insoftware and cultural productions.

Since the advent of personal computers, digital media files have become easy to copy anunlimited number of times without any degradation in the quality of subsequent copies. Manyanalog media lose quality with each copy generation, and often even during normal use. Thepopularity of the Internet and file sharing tools have made the distribution of copyrighteddigital media files simple.

The availability of multiple perfect copies of copyrighted materials is perceived by much of

the media industry as a threat to its viability and profitability, particularly within the music andmovie industries. Digital media publishers typically have business models that rely on theirability to collect a fee for each copy made of a digital work, and sometimes even for eachperformance of said work. DRM was created by or designed for digital media publishers as ameans to allow them to control any duplication and dissemination of their content.

To date, all DRM systems have failed to meet the challenge of protecting the rights of thecopyright owner while also respecting the rights of the purchaser of a copy. None hassucceeded in preventing criminal copyright infringement by organized, unlicensed,commercial pirates.

These are some of the well known systems:

Physical protection: Uses separate hardware to ensure protection. Examples includehardwaredongles that had to be attached to the computer prior to using the content, andUSB and smart card devices working in a similar fashion. Physical protection methodsconsistently failed in consumer markets due to compatibility problems and extra level ofcomplexity in content use; however, they did enjoy limited success with enterprisesoftware.

DIVX: Required a phone line, inhibiting mobile use. To take a work for which unlimitedplays had been purchased (called DIVX Silver) to a friend's home, it was necessary tocarry a 14 kg (30 lb) DVD player as well as the light and compact disc; or to telephone the

DIVX service and have the player of the friend transferred to the account of the purchaserof the work, and then call again to have it switched back. The system prevented certainlegal uses such as the creation of compilations, by the purchaser. The system also
http://en.wikipedia.org/wiki/Digital_mediahttp://en.wikipedia.org/wiki/Digital_mediahttp://en.wikipedia.org/wiki/Personal_computerhttp://en.wikipedia.org/wiki/Internethttp://en.wikipedia.org/wiki/File_sharinghttp://en.wikipedia.org/wiki/Donglehttp://en.wikipedia.org/wiki/Donglehttp://en.wikipedia.org/wiki/DIVXhttp://en.wikipedia.org/wiki/Digital_mediahttp://en.wikipedia.org/wiki/Personal_computerhttp://en.wikipedia.org/wiki/Internethttp://en.wikipedia.org/wiki/File_sharinghttp://en.wikipedia.org/wiki/Donglehttp://en.wikipedia.org/wiki/DIVX


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The market mechanism that can theoretically produce the ideal level of public goods whereproducers receive sufficient payment to compensate them for the act of creating titles isperfect price discrimination because it charges each consumer exactly the amount thatconsumer is willing to pay, thus deterring no consumer from consuming. The idealconsumption level for any title is thus a by-product of perfect discrimination. Further, sincethe perfect discriminator generates revenues equal to the value the product provides to theconsumer, all titles with total values greater than the cost of production are likely to beproduced, leading to the production of the optimal number of titles. This is where accordingto the author DRM is trying to take us. DRM promises to make the payment a function ofuse. Those who listen to a song more frequently are likely to also have the higher values.

Although DRM is one solution to copying and may prove central to resolving the issue ofunauthorized copying, there are other potential solutions that might incorporate some ofDRM anti-copying characteristics without the payment mechanisms. The author suggested akind of blanket license as is used in television and radio broadcasts. A blanket license couldallow the purchaser of the license to use any amount of the copyrighted material contained inthe repertoire covered by the license while paying a single fee that does not depend on the

frequency of the use of the repertoire.

Blanket licenses have some very useful economic characteristics since the cost of usinganother copyrighted item in the repertoire is zero; consumers who purchase the license usethe optimal amount of these public goods. From an economic efficiency advantage, this ismuch better than selling the individual items in the repertoire one at a time, except when theseller is a perfect price discriminator.

References:

wikipedia


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6. What are the economic impacts of copying?

The Internet is capable of altering the nature and degree of copying, appearing to threatenthe very purpose of copyright and creating what appears to be unprecedented enforcementchallenges.

The issue at the heart of copyright is the degree to which the copyright owner canappropriate the value produced by the consumption, or appreciation, of his or her work byothers. Economists have tended to focus on the trade-off between consumption efficiencymaximizing the amount consumers get of any produced intellectual product and productionefficiency to preserve incentives to create these products.

The market mechanism that can theoretically produce the ideal level of public goods whereproducers receive sufficient payment to compensate them for the act of creating titles isperfect price discrimination because it charges each consumer exactly the amount thatconsumer is willing to pay, thus deterring no consumer from consuming. The idealconsumption level for any title is thus a by-product of perfect discrimination. Further, since

the perfect discriminator generates revenues equal to the value the product provides to theconsumer, all titles with total values greater than the cost of production are likely to beproduced, leading to the production of the optimal number of titles. This is where accordingto the author mechanism as DRM is trying to go using the payment a function of use. Thosewho listen to a song more frequently are likely to also have the higher values.

Direct Economic Effects of Copying Technology

The pirating of copyrighted materials is normally thought to be harmful to the interests ofcopyright owners. This is because piracy is often expected to prevent the copyright ownerfrom appropriating any of the value created by the work, which goes instead to the usersengaged in piracy.

Potential consumers are no longer compelled to purchase the product from the copyrightowner when the option of using unauthorized copies is available to them. Defections from thelegitimate market are normally expected to reduce the revenues that can be earned in themarket.

In some instances, however, the impact of piracy on the copyright holders ability toappropriate the value of the work will be insignificant. A situation in which copying might behelpful, or at least not harmful to copyright owners, is when piracy results in an exposureeffect, a form of advertising or sampling that might ultimately lead to larger sales oflegitimate versions. For example, in the case of pirated software, users of pirated versionsmight find themselves wanting the manuals and technical support that would only be

available to authorized users.

Even though, where either exposure effects or network effects exists working to actuallyenhance the revenues of the copyright owner, it doesnt mean that appropriability (Indirectappropriability is basically the idea that under certain conditions, copyright owners can collectfor the unauthorized copying by charging higher prices for the originals) is necessarilyenhanced as well. Both network and exposure effects increase the gross amount of the valuereceived by consumers, allowing the copyright owner to generate more revenues withconstant or even somewhat reduced levels of appropriability.


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Indirect Economic Effects of Copying Technology

Copyright owners are sometimes able to collect revenue from unauthorized copiers bycharging higher prices for the originals from which the unauthorized copies are made, aresult known as indirect appropriability. The basic mechanism is simple: If the copyrightowner knows which originals will be used to make copies, a higher price can be charged forthem, allowing the copyright holder to capture part, all, or more of the revenue than mighthave been appropriated through ordinary sales if unauthorized copying could be prevented.

For example, since each original CD will have a copy made from it, and since it is reasonableto infer that the consumers of originals place some value on the ability to make a copy, eachconsumers willingness to pay for the original CD is higher than it would otherwise be. Thecopyright owner can capture some of this additional value by charging a higher price for theCD. This is the basic idea behind indirect appropriability.

There are some complicating possibilities for indirect appropriability take place:

If it is much less expensive to make pre-recorded cassettes commercially than to

have them made one at a time at home, then it would be inefficient for personalcopying to replace commercial production, and the copyright owner will not be able tonet as much from the home-taping consumer as he would from a sale of cassettes.

Indirect appropriability might be capable of securing profits doesnt mean that it willsucceed in any particular case. An important factor that influences the likelihood thatindirect appropriability might work is the variability in the number of copies made ofeach original.

But the greater the variability in the number of copies made from each original, themore difficult the task of identifying how many copies are made from each originaland charging private prices for originals based on that number of copies. In many

cases it will be impossible to charge different prices to different users for identicaloriginals, since sellers will usually not be able to identify the purchasers copyingintent when the original is purchased.

In some instances, legislation may allow copyright owners to collect revenue in amanner other than charging for use. For example, a tax could be imposed on blankaudiotapes or recorders. But this would not directly charge users for the right to copy,since audiotapes can be used to tape works for which copyright clearance was givenor for taping non-copyrighted works.

Impact of peer-to-peer networks on Revenues

Napster is an online music service which was originally a file sharing service created byShawn Fanning. Napster was the first widely-used peer-to-peermusic sharing service, and itmade a major impact on how people, especially university students, used the Internet. Itstechnology allowed music fans to easily share MP3 format song files with each other, thusleading to the music industry's accusations of massive copyright violations. Although theoriginal service was shut down by court order, it paved the way for decentralized P2P file-sharing programs, which have been much harder to control. While these other file-sharingprograms have flourished, none have come close to collective mp3 collection Napster offeredin its peak.
http://en.wikipedia.org/wiki/File_sharinghttp://en.wikipedia.org/wiki/Shawn_Fanninghttp://en.wikipedia.org/wiki/Peer-to-peerhttp://en.wikipedia.org/wiki/Universityhttp://en.wikipedia.org/wiki/Universityhttp://en.wikipedia.org/wiki/Internethttp://en.wikipedia.org/wiki/MP3http://en.wikipedia.org/wiki/Copyright_violationhttp://en.wikipedia.org/wiki/P2Phttp://en.wikipedia.org/wiki/P2Phttp://en.wikipedia.org/wiki/File_sharinghttp://en.wikipedia.org/wiki/Shawn_Fanninghttp://en.wikipedia.org/wiki/Peer-to-peerhttp://en.wikipedia.org/wiki/Universityhttp://en.wikipedia.org/wiki/Internethttp://en.wikipedia.org/wiki/MP3http://en.wikipedia.org/wiki/Copyright_violationhttp://en.wikipedia.org/wiki/P2P


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Irrespective of these justifications, many otherusers simply enjoyedtrading and downloadingmusic for free. With the filesobtained through Napster,people frequently madetheir own compilation

albums on recordable CDs, without paying any royalties to the artist/composer or the estateof the artist/composer.

A new generation of programs plays by a somewhat different set of rules. The importantdifference between these programs and Napster is that these systems are moredecentralized where there are often no central servers keeping track of the downloads-and-

uploads.

This poses an extremely serious problem for copyright enforcement. There may be apossibility of indirectly appropriating revenues but because there is no central server, thesepure peer-to-peer systems are rather like the more traditional exchanges of music or CDsthat occur between friends. But that is not the case. These peer-to-peer networks search outother computers running the relevant software and seem capable of finding an enormousnumber of such computers, far more than any circle of personal friends.

Even if Napster had been as serious a threat to record companies and copyright holdersrevenues as implied by theory, it is not the most formidable threat facing copyright owners.Pure peer-to-peer pirating would seem to be far more dangerous because Napster could

have been tamed by changing its rules taking advantage of its central server, but peer-to-peer networks cannot.

References:

Wikipedia
http://en.wikipedia.org/wiki/Recordable_CDhttp://en.wikipedia.org/wiki/Recordable_CDhttp://en.wikipedia.org/wiki/Recordable_CD


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7. Why will subscription-based advertising come back at Internet?

The online world was originally a subscription-based world. Users of the leading onlineservices, CompuServe, Genie, and AOL, did not encounter advertising to any real extent.Users paid their fixed monthly fee, which usually included five or so hours of use. This washow online services generated their revenues. There was very little advertising.

Prodigy was the first firm that included advertising and removed hourly fees, two trends thatwere later adopted by all of the online services. These companies tried to maximize audiencesize so as to maximize advertising revenues. But an advertising-based model never madesense and was never going to generate sufficient value for all the Internet sites that intendedto use it as their sole source of revenues.

It is not possible to think that the Internet will follow the same the television-advertising modelbecause the profitability for TV did not come from the superiority of its revenue model.Instead, it came from the fact that television was an industry with limited entry. Creation andownership of television stations was restricted by the government and by the limitations inthe available television frequency spectrum. More importantly, television stations did not

have the option of using other models of revenue generation because forecasts wereavailable to anyone with an antenna and a television, making it impossible for televisionbroadcasters to charge viewers even if the broadcasters had wanted to use a subscription-based revenue model.

Magazines can be entirely subscription-based or entirely advertising-based or a hybrid of thetwo. A combination of subscription and advertising revenues seems likely to replace pureadvertising as the revenue model on the Internet because a dual revenue system has manyadvantages. Except for the television market, which is constrained, it is hard to find any othermarkets that choose to survive entirely on advertising alone.

Advertising Effectiveness on the Internet It is also unlikely that advertising revenue could

be sufficient to support all the sites counting on it:

a. Audience (measured in total viewing-hours) is not large compared to that oftelevision, nor is it likely to be terribly large until television migrates to the Net. Currentestimates of time spent on the Web average thirty minutes per day compared to fourhours for television viewing, and more people watch television than use the Internet.

b. Internet advertising will remain less effective than television advertising as long as itis so easy to avoid. If it becomes intrusive, not allowing the Internet user to moveforward until the ad is viewed, there will likely be a backlash from users. But thisintrusiveness is required to make the advertising more effective for those users whoremain to encounter it.


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Total streaming media subscription revenue is forecast at $608 million dollars in2005, including Real Networks' SuperPass and Rhapsody streaming subscriptionservices, AOL's MusicNet service and other independent streaming services, but notincluding music and movie download revenue, or broadband subscribers who play acontent fee to AOL per month for access

Streaming subscription revenue is forecast to rise by 35% in 2006 to $821 milliondollars (excluding download revenue)

Total streaming media subscription and download revenue is estimated at $641million dollars in 2004

Total streaming media subscription and download revenue is forecast to grow by110% in 2005 to $1.35 billion dollars

Total streaming media subscription and download revenue is forecast to grow by 35%in 2006 to $1.8 billion dollars

Streaming media represents an aspect of the Internet that gives it more meaning andmore capabilities. It has the potential to increase productivity in every aspect ofhuman endeavor. By promoting the delivery of just in time training, it makes everyonemore productive.

Consumers will use streaming media on the Internet to achieve improved access toentertainment. Games, music, movies, and videos can be shared inexpensively. Thequantity of media available easily is phenomenal.

Productivity gains are huge with streaming media for the enterprise. Meetings can beconducted remotely. Training can be offered on a just in time basis. Internet mediaconsumption is being driven by desires to productively conduct business all over theworld. More members of a team can participate in the conduct of business with lesstravel using streaming media.

The streaming media server, advertising, subscription services, and online musicshipment market is expected to grow to $14.9 billion by 2009. Demand for streamingmusic and movies are a primary market drivers. These are delivered on asubscription and download basis.

References:

http://www.researchandmarkets.com

http://www.iab.net/standards/popup/index.asp
http://www.researchandmarkets.com/http://www.iab.net/standards/popup/index.asphttp://www.researchandmarkets.com/http://www.iab.net/standards/popup/index.asp


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8. What is the value-profit paradox?

"The value-profit paradox" explains why products sold over the Internet aren't perfectsubstitutes for their equivalent at bricks-and-mortar stores. The author explains why hedoesn't believe Internet companies will be able to generate above-normal profits with theirbelow-normal operating margins because competition forces them to spend above-normalexpenses which is not good for profits, in the long term.

Value is typically shared between consumers and producers. The total sum of thesedifferentials between the maximum that consumers are willing to pay and what they actuallypay is known as the surplus that consumers receive. Second, producers usually receiveprices that are higher than the minimum that they would be willing to accept that is anotherform of surplus.

If producers invest too little from the perspective of economic efficiency, more of the surpluswill go to them. If producers invest too much, more of the surplus will go to consumers.Competition is what forces producers not to invest too little. Overinvestment occurs when

producers misjudge the market and provide too much of what they are selling, forcing pricesdown. It tends to drive companies out of business because it removes any surplus fromproducers.

Profit generation in product markets works just the opposite of stock market profits. In thecase of stocks, the more people who jump on the bandwagon, the higher the stock pricegoes and the greater everyones profits. For companies who are competing with one another,however, the more that enter the industry, the lower everyones profits turn out to be. Thewillingness of the capital market to fund so many untested Internet companies and theenormous publicity and expectations surrounding the Internet augured poorly for thelikelihood that these companies would do well in the real market. As water, just because itproduces great value does not mean that it will also produce great wealth.

The key elements in competition are whether other companies can enter the industry easily ifthey desire to compete with incumbent companies and whether it is easy or difficult to mimicwhat the incumbent companies have already accomplished.

Companies doing business on the Internet are captives to the same forces that are at work inthe bricks-and-mortar economy where competition works to reduce prices and profits inan industry. Potential entrants examine the financial returns they might generate if theywere to enter a particular industry. The market becomes less profitable because the entry ofnew companies and new productive capacity increases the output available for consumers topurchase.

Some producers always do a better job than others, and those who can better meet thedemands of the market will earn higher returns than others. But the typical company will nolonger be able to earn above-normal profits in this market because competition has removedthose profits. This is why competition is so good for consumers but so bad for producers.Noting the resources that companies are willing to spend while attempting to reduce theamount of competition they face lays the importance of competition.

Profitability for companies doing business over the InternetIt is important to consider the following

The seeming ease of entry into Internet businesses does not bode well for long-termprofitability. The idea was that consumers would find it easy to comparison shop onthe Web, using bots or just manual searches. The presumption was that Web siteswould have to match the lowest price and that profits in this world would be hard to


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come by. This scenario is very close to what economists have in their model ofcompetition, and a zero economic profit is the predicted outcome.

The main advantage of virtual stores relative to bricks-and-mortar retailers is the noneed of physical storefronts translated into lower costs. It has often been presumedthat these lower costs will translate into above-normal profit margins for a lengthyperiod of time.

Here it is important to understand that, industry margins will tend to fall as costs fall,which is the opposite of what is often assumed. Although it is true that a companythat can reduce its costs will generally increase its return on investment, its returnswill not increase if all competing companies also experience similar reductions incost. In other words, if all the companies in a competitive industry achieve areduction in costs, their profits, after an initial and temporary rise, will return to normalwhen new capacity and new entrants suck up any excess profits.

Most analysts have assumed that, because companies doing business on the Net willhave lower costs, this will translate into the ability to generate higher investment

returns and higher margins than their bricks-and-mortar counterparts. But the costadvantage of online retailers over bricks-and-mortar retailers is largely irrelevant forprofitability because competition in each segment will occur largely betweencompanies in a segment.

Assuming that each market is competitive, every drop of excess profit will besqueezed out of the market for the typical company in each segment. That meansthat the investment returns will be similar in both, but since the investment per dollarof sales is lower for Internet companies, so too is their average margin on sales.

It is possible that while the transition was occurring, bricks-and-mortar companieswould be earning below-normal profits, and Internet companies might be earning

above-normal profits. But after the Internet companies had vanquished the bricks-and-mortar companies, profits for the Internet companies would return to a normallevel.

Given the cost structure of Internet firms, one would expect that their advantage willactually lead to lower margins, as they are normally measured, not the highermargins as it was believed with implicit assertion that competition will largely occurbetween Internet firms on the one hand and brick-and-mortar firms on the other. Inreality, Internet firms will largely compete with other Internet firms, and brick-and-mortar firms will largely compete with one another. Therefore, even if online retailershave lower costs than brick-and-mortar retailers, it is inappropriate to conclude that

online retailers will be more profitable.

What is important to remember, companies that have figured out how to give consumers themost suitable products according to their needs and preferences, how to lower their costsbelow those of other companies in their industry, or how to find a niche that is difficult forpotential competitors to imitate will earn above-normal returns as has always been the casefor any company brick and mortar or virtual one.


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9. Can you describe the logic behind the concept lock-in?

The intellectual underpinning for the notion of the benefits of early entry has to do with theconcept of lock-in where the winner not only takes all, he keeps taking it, even in the face ofa better rival. In this view of markets, if the initial entrant gets the largest market share, lock-in will then work to keep the companys customers immobile and the company entrenched inthe leading position. In the lock-in concept, network effects play the key role. Network effectslead to winner-take-all, and once the winner is established, network effects keep competitorsat bay.

Lock-in costs can themselves be classified into two different types. First, there are the costsinvolved with just changing to another brand or version of a product, such as relearning oldhabits, becoming familiar with the new product, and also possibly being able to use the newproduct with old work products, such as using a new word processor to read your olddocuments. These are the costs of being compatible with one s self. Second, there arecosts involved in possibly losing compatibility with others. These two factors are essential indelineating the crucial distinction between weak and strong forms of lock-in. The strong form

of lock-in supports the concept of first-mover-wins. The weak form does not.

A strong form of lock-in exists when there is a new product that is not adopted eventhough its superiority can overcome any self-compatibility issues for consumers. In such acase, the switch would occur if consumers didnt care about compatibility with others.Network effects, if they exist in a market, bring compatibility with other consumers to the foreand therefore the issue of whether superior products can overcome the lead of inferiorincumbents has been closely associated with network effects.

The basis for the belief in first-mover-wins is that if strong lock-in exists, it might be wise forsellers to try to get a large market share even if the costs of doing so are very high. That isbecause challengers, even those with superior products, may not be able to overcome the

lead of the early birds. Potential incompatibility with other users can prevent a superiorchallenger from vanquishing an incumbent, at least in principle. With this strong form of lock-in, even though all consumers would like to switch if enough other users would also switch, acoordination failure among users prevents consumers from actually switching.

Compatibility with ones old behavior imposes costs on a switch. And the incumbent, bydefinition, has a larger market share. However, when consumers go through a calculationabout the value of switching, it would be rational for them to try to project what the future willlook like. It is the expectation of the size of the networks that actually matters. If consumersbelieve the challenger will do well in the market, then the market shares at the time ofpurchase need not be particularly relevant. So, in fact, the importance of compatibility withothers does not necessarily favour the incumbent. Challengers who are able to demonstrate

the superiority of their product and gain momentum in the eyes of consumers may very wellprevail, as would be required if the market were working efficiently. Therefore, it is uncertain,in theory, whether strong forms of lock-in are likely to occur.

In Weak Lock-In, it is possible that a company might produce a product that is superior tothe incumbent but is not sufficiently superior to cover the self-compatibility costs of switchingto a new and different product. Weak lock-in has nothing to do with network effects oreconomies of scale. Weak lock-in shouldnt require new business strategies since it hasbeen around for so long that old business strategies should have taken it into account.

The final difference between the two forms of lock-in is that it is efficient for the economy tostay with the incumbent while the incumbent is weakly locked in. The costs of learning a newsystem are real costs, and if the new product is not sufficiently better to outweigh thosecosts, then it is efficient for society to stick with the old. Strong lock-in, on the other hand,


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causes inefficiency. If we could get all the users to switch to the new product, they would allbe better off even after the costs of switching are included.

Impacts of Lock-In on First-Mover-Wins

Proponents of the strong form of lock-in essentially assume that, even if consumers wantedto switch to a better product, their fear that others might remain with the old productconstrains them to remain with the old product. The challenger not only has to produce abetter product that can overcome self-compatibility, but it also needs to overcome theconsumers cost of being incompatible with almost everyone else since it is assumed that noone else switches.

Critics of strong lock-in, on the other hand, believe that the expected market shares willdepend mainly on self-compatibility. In other words, if the new product is sufficiently betterthan the old product that it pays individuals to switch (ignoring network effects), then theexpectations of consumers will be such that they will expect other consumers to switch forthe same reasons that they would want to switch. The new, superior product is thus able to

dominate the market. If the strong form of lock-in were to hold, the object lesson forcompanies would be to get to market first and largely ignore relative quality since even asignificantly better product would not allow the challenger to dislodge the incumbent.

The conclusion is consistent across many different high-tech markets: being early does notportend success if there are rivals with superior products. That does not mean, however, thatthe concept of winner-take-all can be discredited. There is a good deal of evidence that high-tech markets do incubate conditions that lead to very large market shares for the companiesthat are most successful in these markets. A company with a dominant market position,however, can expect to maintain that position only as long as consumers regard its productsas the best.

However, it needs to be understood that many, and perhaps most, Internet markets are nomore likely to be winner-take-all than the bricks-and-mortar counterparts of these companies.For industries, the Internet will offer an enhancement to business, but it will not bring about afundamental restructuring of the business model. Just doing business on the Internet doesnot create the conditions for winner-take-all results. This was, and still is, a commonmisconception among the Internet companies. Finally, what is probably the leading strategyfor Internet companies is the same as the leading strategy for bricks-and-mortar companies:produce better products at lower costs. This strategy has worked numerous times, both inlow-tech and high-tech industries and it is not easy for competitors to copy successfully sincetalking quality is much easier than producing quality.


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10. Why is the concept of the new economy not so new to many economists?

The general rules that have formed our understanding of markets have been developed overa period of centuries. Even this, a new paradigm is presented as a replacement wronglyand a new economy has been prematurely announced numerous times.

Some of the misconceptions to claim a New Economy in the Information era were:

Thinking that the sources of wealth had changed: For many industry analysts prior tothe Internet meltdown, these claims seemed perfectly reasonable. Economists wereoften accused because the basic premise of economics has always been that scarcityis an unfortunate fact of life, Internet or no Internet.

Creativity and Knowledge are overtaking capital as the principal elixir of growth. Andcreativity, although precious, shares few of the constraints that limit the range andavailability of capital and physical goods: These ideas are no new. Economists havelong known that capital is not the major ingredient in growth and that new knowledgeis the most important factor in economic growth.

Fundamentals of pricing and distribution had changed concept under the banner ofincreasing returns. Increased supplies cause lower value.

Network effects somehow naturally led to advertising-based revenue models:apparently as a result of the facile comparison of television networks with theInternet network.

The laws of supply and demand are not so fragile as to be overcome by anything so small asa new method of communicating with each another. After all, economic laws have survivedmany economics revolutions and facts. New theories and ideas that have been put forwardsuch as technological developments are not more powerful alternatives that tell somethingnew and truthful about the world.

However it is not accurate to say that there is nothing new or different about conductingbusiness on the Internet. Internet enhances the transmission of information, so the role ofinformation is enhanced. Information has some characteristics that are very different fromthose of more traditional products.

What is important to understand is that business on the Internet is likely to be at least ascompetitive as business in the bricks-and-mortar world. There will be no easy cornucopia ofprofits. Instead, companies will need to create superior and more difficult-to-imitate businessmodels. They will have to discover the products that work best when sold over the Internet.They will have to figure out efficient pricing mechanisms. They will have to refrain fromwasting vast resources in a mad race to be first in a market because being first are not the

key to long-term success.

To understand both the high-tech variety and the more traditional kind and how it is thatmarkets generate profits, it is necessary to understand the demand and supply of a specificmarket.

questions and answers on the book rethinking the new economy

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