did you say new economy?

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Eric Briys Who’s Afraid of the Big Bad Wolf?: Internet and the Content Industry in the New(?) Economy IPADE International IPADE International Week Week October October 2005 2005

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Page 1: Did you say new economy?

Eric Briys

Who’s Afraid of the Big Bad Wolf?: Internet and the Content Industryin the New(?) Economy

IPADE International IPADE International WeekWeekOctober October 20052005

Page 2: Did you say new economy?

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Content

n Flashback: The elusive quest for prosperity: What history has in its bag for us

n The New Economy: From perspiration to inspiration: The economics of ideas

n Consequences: From the optimizing manager to the adaptative manager

n The content/media industry: Wrong or right?

n Paving the way to the future: Some guidelines

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The quest for prosperity

n Whatever the perspective taken, the paramount question is that of wealth:The wealth of nations, shareholders’ wealth, managing for value etc…

n This is a challenging quest: Why is it that some are wealthy and successful,and some fail and stay poor?

n Yali’s question and the cargo cult: « How is that you have so much cargoand we so little? »Jared Diamond

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The quest for prosperity

n Yali’s question haunts also corporate boards.

n Tons of acronyms and buzzwords were crafted that define value metrics:SVA, EVA, ROI, EBIT, CFROI, balanced scorecards, value chain, corporategovernance…

Joel Stern

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Back to basics

n Let’s get back to basics:

« Put simply, prosperity is the consequence of one thing and one only:

Matching talent with capital, and holding both sides accountable.

n In a nutshell:

K T

Reuven Brenner

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Flashback: The history of prosperity

Change is a newphenomenon indeed!

Malthus was right for 55 centuries out of

the last 57.

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Flashback: A parsimonious model

n Robert Solow’s model (1956, Nobel Prize 1987)

n K = Capital

n L = Labor

Y = GDP = F(K, L) = Production Function

Max Y - rK - wL with respect to K et L .

n Outcome: Production grows with population in the steady-state: Hence, nowealth per capita growth.

n Does yield cross-country differences

n But this is more a model of « perspiration » than « inspiration ».

Robert Solow

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Flashback: « Perspiration economics »

n Industrial Revolution: Muscle Power: « Why is that whenever I ask for a pair of hands, abrain comes attached? » Henry Ford

n In Henry Ford’s days, capital was the scarce resource that organisations were designed touse efficiently, as his assembly lines did: OPTIMIZATION

n Alfred Marshall: Principles of Economics: Optimization, Calculus, Marginalism…

n Gilded Age/Robbing Barons: Yes, the Industrial Revolution was also « inspired ». But,this inspiration, this knowledge was « pegged » to capital. Lots of people had a thoroughknowledge of chemistry, few corporations were producing chemical products though. Henceknowledge was not « free »!!!

Henry Ford

Alfred Marshall

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Perspiration is not enough!

n Hence: In a perspiration world: K T

n The only way to genuine prosperity is to have technological improvements,that is inspiration, namely IDEAS.

n This leads us to the Economics of Ideas and the New Economy

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New economy: Inspiration leads!

n How to best define the new economy?

n Two Keys

Atypical cost structure: The first unit is costly toproduce (significant initial outlay), the next units havea low or zero marginal cost

Ideas: Ideas improve the technology of production. A newidea allows a given bundle of inputs to produce more orbetter output

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New economy: Ideas

n Are ideas a good just like any other economic good?

n Excludability-Rivalry scales

PYTHAGORE THEOREMFISH IN THE SEANon excludable

SOFTWAREMildly excludable

TV CABLECD PLAYERExcludable

Non rivalrous/Nondivisible

Rivalrous/DivisibleShapiro / Varian

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New Economy: Atypical cost structure

n What defines New Economy, according to Daniel Cohen, is its atypical coststructure, namely a significant (not to say massive) initial outlay and a lowmarginal cost for the next units

n Consequence: The pure and perfect competition model falls apart. Firms willenter only if they can charge a price higher than marginal cost, hence a moveaway from perfect competitition.

n Why?:

– With increasing returns to scale average cost is always greater thanmarginal cost

Daniel Cohen

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New Economy: Wrap-up

Ideas ---> Non Rivalry ---> Increasing returns ---> Imperfect competition

n Brad DeLong: « We now have an economy that is more specialized in thehigh-value added role of creating and commercializing ideas. »

n In a nutshell:

K TBradford DeLong

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Managerial consequences

Consequences for the manager: optimisation vs adaptation

OPTIMISATION ADAPTATION

Alfred Marshall Brian Arthur

Perspiration Inspiration

Value Chain Value constellation, networks

Producers --> Consumers Producers competing orco-opeting with consumers

Decreasing returns Increasing returns

Victorian values of stability Non-linearity, instability,winner take-all

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Managerial consequences

n To put it in John Kay's words " goals are most likely to be achieved whenpursued indirectly ." Obliquity is the name for this. What does it tell us aboutbusinesses and the goals they shoud be pursuing?

n The current fad is for businesses to concentrate on maximizing shareholdersvalue. Metrics have been crafted that supposedly measure the failure ofsuccess in achieving this target.

John Kay

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Managerial consequences

n The increasing-returns world is a world were things tend to wander off,where things that get ahead, get further ahead, where things that get down,get further down.

n How do people, corporations behave in such a world? Should they optimize àla Marshall, strive for the maximization of some metrics such as EVA or rathershoot for more holistic approaches à la forest rangers?

n Well, it seems that the best option you can go for in a complex world (which isa mixture of Marshall's and increasing returns') is to develop a strong senseof adaptation.

n After all, when you look at earthquakes or floods, rather complex phenomenaindeed, it is hard to predict them but easy to avoid building your house in anearthquake or flood prone area.

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Examples

n Dilbert: Scott Adams and his e-mail

n Intel: Andy Grove: Only paranoïds survive!

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In a nutshell

n « Anything can happen! »

n « No one knows anything! »

n A good metaphor is the Call Option metaphor: Convexity effects

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Content industry in the new economy

Tech Industry(Infrastructure

HardwareSoftware)

Content Industry(Culture/Media)

We, the people

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Content industry

• Vertical view of the world

• From producer to consumer

• Copyright / Litigation

The moguls

We

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Tech industry

This is a fast growing industry including:

-Infrastructure: Fiber optic, cable networks, satellites etc…

-Hardware: Computers, mp3 players, DVD players, CD burners, cellphones, digitalcameras etc…

-Software: Media and publishing softwares, XML, RSS, blogs, wikis, VoIP etc…

The techies

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Content industry vs. Tech Industry

2Contentwebsites

32Video games

38Music

45Radio

90Movie(except TV)

220Newspaper

260Television

Sales 2003($Bn)

Contentindustry

280Retailelectronic

1328Software

1182Telecom

Sales 2003

(†Bn)Techindustry

Sources: Bureau of Census, Sreen DigestWorld Bank, Idate

Source: Idate

Content Industry = less than 1/5 th of Tech industry

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We the consumers

n Technology has given us tools that allow us to do things that the contentindustry does not like:

– Peer to peer networks: Napster, Kazaa– Skype– Blogs– Wikis….

n As a matter of fact, boundaries are blurring: consumers become producers,worse they compete with them. The traditional notion of value chain becomesobsolete.

n Dan Gillmor goes as far as to title his latest book: We The Media

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We The Media

n At the end of his life, famous movie actor Jean Gabin sang a song where hesaid that at last he knew that he knew nothing but this he knew!.

n As a matter of fact, what he should have said is that we all know somethingbut more often than not we do not realize it or more precisely that what weknow has value to some people.

n This is for instance what blogs are about among other things.

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The squeeze of the content industry

n The content industry is squeezed between a fast evolving tech industry thatempowers consumers and consumers that compete with it.

n All this is very reminiscent of the gradual erosion of the market power of theRobbing Barons. When financial markets and funding became easily available,talent could go his own way and start its own ventures. The financialrevolution made it possible (see Luigi Zingales, U of Chicago)

n Other things being equal, consumers have been empowered by the techrevolution ( + the massive wealth surplus transfer from shareholders toconsumers during the Internet bubble). This has helped them challenge theMedia Robbing Barons.

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The squeeze of the content industry

n How has the industry tackled the challenges it is facing? As usual, in thewrong (vertical) way!

– First, litigate, litigate, litigate: Sue your customer! Don’t listen to him or her.

– Next, merge!: AOL/Time Warner, Vivendi/Universal: Namely vertical integration:Content + Pipes

n But, this is exactly what should not have been done: Content wants to be seen,listened to by as many people as possible and pipes need content as varied aspossible.

n In a nutshell: They played vertical when they should have played horizontal.

n They did not adapt, they just tried to optimize under constraints.

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The squeeze of the market industry

n To put it in Andy Grove’s words:

« How many years of sequential 5 percent revenue declines will the musicindustry take before they’re going to scratch their heads and say: You know,maybe we ought to get serious about digital distribution of music ? »

« And, they will discover what is obvious to the ponytail folks. »

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Paving the way to a new future: Some guidelines

n Pricing: How and how much?

n Content versioning: What?

n Copyright management: Where?

n Loyalty / Lock-in: Be adaptative

n Network effects: Critical mass

More on this in Hal R. Varian, Joseph Farrell and Carl Shapiro

« The Economics of Information Technology », Raffaele Mattioli Lectures,

Cambridge University Press 2004

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Pricing content

n Understand cost structure

n Be aggressive not greedy(Share of the pie vs. Growing the pie)

n Differentiate product and price

n Understand consumer and personnalize

n Sell to groups

Yahoo Unlimited

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Versioning content

n The automobile industry vs. the digital content industry

n Versioning north vs versioning south

– Adjust characteristics of content products to extract clients’ surplus

– Strengthen editorial skills

– Version along multiple dimensions (delay, interface, speed, supportetc…)

– Add value to bits

– Explore the Long Tail: Aggregate thin demands

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Rights management

n Reproduction/Distribution costs: use cheapness to youradvantage

n Be open and flexible: Maximize the value of yourintellectual property, do not maximize protection

Creative Commons: From All Rights Reserved to Some Rights Reserved)

Lawrence Lessig

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Lock-in

n Value constellation approach

n Get your customer to invest in you (remember he/she knows things too!):Books and blogs, movie reviews etc…

n Sell complementary products

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Networks and positive feedbacks

n Positive feedbacks: get bigger, get stronger

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Conclusion 1 : Adapt !

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Conclusion 2 : Stay tune!