bus 516 session economics of it part i
TRANSCRIPT
Copyright © 2009 Mohammad Mahboob Rahman – North South University
BUS 516
Computer Information Systems
Mohammad Mahboob Rahman, PhDSchool of Business | MBANorth South University
Copyright © 2009 Mohammad Mahboob Rahman – North South University
Session 7/12Economics of IT Part I
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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
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Information Rules:
A Strategic Guide to the Network Economy
Carl ShapiroHal R. Varian
(the next several slides are all borrowed from these authors)
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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
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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
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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
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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
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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
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First topic in the economics of ITWhat is IT?
What is information?What is technology?
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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
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But what is special about information goods?
Unique cost characteristicsUnique demand characteristics
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Cost structure
Expensive to producecheap to reproduce
High fixed cost, low marginal costNot only fixed, but sunkNo significant capacity constraints
What are the implications?
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Implication no. 1: market structureMonopolyCost leadershipProduct differentiation (versioning)
Implication no. 2: rights management
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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
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Consumption characteristics
Experience goodBrowsingAlways newReputation and brand identity
(information) OverloadEconomics of attention
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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
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System
Complementary productsHardware/softwareClient/serverViewer/content
FeaturesDifferent manufacturersStrategy for complementors as well as competitorsCompatibility as strategic choiceStandards and interconnection
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Systems Competition Microsoft-Intel: Wintel
IntelCommoditize complementory chips
MicrosoftCommoditize PCs
AppleIntegrated solutionWorked better
But why wasn’t it popular?
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Lock-In and Switching Costs
Example: Regular serverCostly switch to virtualization
Systems lock-in: durable complementsHardware, softwareIndividual, organizational
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Network EffectsValue depends on number of users
Positive feedbackFax (patented in 1843)Internet (1980s)
Indirect network effectsSoftware
Expectations managementCompetitive pre-announcements
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Policy
Understand environment
Competition policyRegulationAntitrust
Electronic commerceContractsPrivacy
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Information is Different…but not so different
Key conceptsVersioningLock-inSystems competition, Network effects
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Pricing
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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
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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
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Implications for Market Structure
Cannot be "perfectly competitive"
2 sustainable structuresDominant firm/monopolyDifferentiated product
…and combinations of above
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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
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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
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Strategy in commoditized business
Cost leadership
Sell the same thing over againReutersReduces average cost
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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)
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Hard to do for Incumbent
May not recognize threat till too lateCP/MWordstarVisiCalc
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Personalize Your ProductPersonalize product, personalize price
Personalized ads
Why?
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Know Your CustomerRegistration
Required: NY TimesBilling: Wall Street JournalAOL’s ace in hole: ZAG
Know your consumerObserve QueriesObserve Clickstream
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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?
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Demand Curve
Price(Dollars)
Quantity (Millions)
$20
$40
$60
1 2 3
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Pricing problem
TR if 0< p < 20, pX3Mif 20< p < 60, px1m0 o/w
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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
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Personalized Pricing
Catalog insertsMarket researchDifferentiation
Easy on the Internet‘mass customization’auctions
Easy with ITCRM, emails—coupons, inexpensive campaigns
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Internet
AuctionsCloseouts, promotions
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Group Pricing
Price sensitivityNetwork effects, standardizationLock-InSharing
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Price Sensitivity
International pricingUS edition textbook: $70Indian edition textbook: $5
Problems raised by InternetLocalization as solution
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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
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Sharing
Transactions cost of sharingVideosDesire for repeat play
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SummaryFirms selling information goods need to
Understand cost structureCommodity market: be aggressive, not greedyDifferentiate product and priceUnderstand consumerPersonalize products and pricesConsider selling to groups
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Network Effects
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Information goods tend to exhibit network effects
You value from using a goodand also
From others using that good
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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
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Implication 2Network effects can be extremely strongNetworks grow very, very fast
Market becomes “tippy”Winner-take-all situation
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ExampleWintel v. AppleIpod vs. Zune
Which product was better?What was relevant?
First move?
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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!
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Essentially, network effect contributes to positive feedback
Strong gets strongerWeak gets weaker
Interestingly, network effects are not the only source of positive feedback
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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
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Lock-In and Switching Costs
Network effects lead to substantial collective switching costsEven worse than individual lock-inDue to coordination costsExample: QWERTY
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Likelihood of Tipping
Low Scale Economies
High ScaleEconomies
Low Demand For Variety
Unlikely High
High Demand For Variety
Low Depends
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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
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Generic Strategies
Control Open
Compatible ControlledMigration
OpenMigration
Incompatible PerformancePlay
Discontinuity
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Fundamental tradeoff: performance and compatibility
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Discussion
Why did Google acquire YouTube?Is Google deficient in quality?Why not simply promote Google Videos?
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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
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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
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Micro behavioral analysisSearch Engine Optimization
Aggregate analysisIndustry-level empirical studies