Humane Economics

29 July 2009

I wake up when I dream of smelling coffee

Some jobs and industries come bundled with coffee addiction. Mine started with the time I worked on the gas pumps at Iceland’s only propane gas plant (a place where I worked part time and during summers throughout, and to pay for, Junior College) where, as with most Icelandic blue-collar jobs, the coffee staple was ‘molakaffi’, where you stick a sugar-cube into your mouth and suck your strong, black coffee through the cube.

My addiction was solidified by my stint as a night watchman (and often bartender) at one of Iceland’s seedier hotels. But the absolute clincher was working as a part of the production team (as a vision mixer) in the Icelandic National Broadcasting Service’s TV newsroom. There aren’t many people on the planet that drink as much, coffee or booze, as news reporters.

It shouldn’t be surprising, then, that coffee doesn’t run out in any household where I live, if the coffee tin is empty, I go out, come rain or snow, to buy some more. One of the habits I’ve developed since I moved to Southville, Bristol (UK) is to buy my coffee at the local deli. The coffee’s good and the people are nice.

The first time I went there to buy coffee, I walked into an empty store and only after a few moments’ wander around did I meet the bright-eyed and chirpy clerk. After a quick conversation, an exchange of laughs about lives being busy as the coffee was ground, the clerk began frantically to look for a marker. The pack of coffee was one of unmarked brown paper and the thing a clerk is supposed to do in these situations, obviously, is to write the name of the coffee on the pack.

“No worries” I said and smiled, the job of a store clerk can be pretty frantic, “I’m sure I’ll remember.”

All our commercial interactions in our offline lives are filled with moments like these. The business of sales and purchases is filled with conversations, simple and complex, short and long, even in the cases where every commercial step of the interaction is automated and computerised, there are still other customers. The only way to avoid words, glances, smiles or frowns is to be dead. Alive, we interact, always with emotion, whether it is joy, anger, curiosity or frustration.

One of the first uses of the net was to transplant these interactions, largely without context, onto dial-up bulletinboard systems. It’s been one of the foundations of the web since inception, anything that is placed on the web will be enveloped by communication. These communications systems take on many forms: Forums on subjects, hobbies, products and companies. Blogs, single or multi-user, with or without comments. Facebook. Twitter. E-mail. These are largely free, for a variety of economic and social reason, but they are plentiful, often easily replaced and addictive, through the intentional integration of operant conditioning into the services’ basic designs.

The business models of these systems are often just plain loss, someone runs and pays for a small forum on a subject they care about, sometimes it is bundling as it is with some e-mail systems, sometimes they are just a cost of doing business as it is with work e-mail. But some of these can and will make money by indirectly competing with advertising. Not through the idiotic health ads such as those you see on Facebook but through offering free communications services to your average user and then selling data and management services to businesses that need to communicate with a large number of people.

These businesses are those that are trying to sell you something. By codifying and commodifying communications, companies hope to measure and manage the basic human interactions that take place in the context of their business, and then to use it to sell us more stuff. My conversation and laugh with the deli clerk becomes and exchange of @replies on twitter, where my response, conversion, traffic and business will be measured and calculated through my replies and clicks on links.

This is why I’m not worried about twitter’s or facebook’s long-term business model. Any sort of collection of user data is a point of value: Measure traffic and replies to the business’s twitter account. Or use url shortening services to mark a particular individual communication and follow the path of the user from first interaction to sale, communications systems. Rampant collection of user data has countless possibilities for premium business services, all at the cost of the customer’s privacy and the basic humanity of the communication itself.

The appeal of these sort of services to businesses when compared to the lousy and risky online ad market is clear. You let your staff interact with the customers as peers, you leverage that interaction, both as increased customer support and as a subtle and non-threatening marketing venue, often without either the employee or the customer realising it.

The online marketing tactics of most businesses will, over time, be largely two-pronged. One part will emphasise search engines, both through search engine optimisation and through search engine advertising. Another will measure and leverage peer-level interactions between the employees and customers to drive brand awareness and sales. Sometimes the two will go hand in hand, as with corporate blogs, and the marketing department will be very, very happy.

Online advertising has problems to begin with, from lousy overall quality to ruthless competition, but its final and decisive adversary is measured human interaction which seamlessly scale from free services to very involved and expensive operations.

Over time, businesses will find that some online writing and communications styles have a higher ‘return on investment’, that some types of interactions will be more ‘valuable’ than others and they will invest in preparation and training to make their employees more effective. But that won’t be much of a loss from our perspective as customers because they do this already with our off-line commercial communications. We will have lost or gained nothing except that when we attempt to interact with the scripted lines of a minimum wage worker online, all of it will be analysed, broken apart and measured in ways not possible with the ‘real-world’ equivalent.

The coffee I bought that first day I walked into the Southville Deli was wonderful. It was strong without being bitter or overwhelming and rich without reducing the fundamental ‘coffeeness’ of the taste.

Of course, I can’t for the life of me remember its name, but despite that I manage to buy it every time I’ve gone to the deli since then.

“400 grams of that Fairtrade coffee you’ve got, please. The one from somewhere in Asia, I think. … Yeah, that’s the one … Ground, please—for a cafetière.”

Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?

24 July 2009

Terminal Advertising

Children, teenagers, vibrant, happy and bouncy young adults and economists all have in common an assumption of permanent good health, mental or physical. It’s just one of those things you count on without thinking, until you can’t. You never foresee the possibility of spending your entire summer vacation bedridden with the flu. Your vision of yourself in the future doesn’t include a decades’ long battle with a bad knee, a career plagued by repetitive strain injury or being dogged by depression.¹

Good health is implicit in all of our models of the future, especially our economic models, and yet it is the single thing after job loss that is most likely to badly affect our future finances. We assume our own health, the health of our family, the health of our co-workers, and of everybody who surrounds us in our towns and cities.

We also assume that our markets are and will be healthy, although it’s been clear in economics for a long, long time that markets can become unhealthy, sick and, for all intents and purposes, die.

The best formulation and model for the health of markets was put forward by George Akerlof in his seminal 1970 paper “The Market for Lemons”². In it he described how a healthy market can become unhealthy or a ‘market of lemons’ to use his terms.

It’s a very simple idea (with bonus points for being somewhat common sense): If you have a market that has a mix of good products and duds (‘lemons’) and the buyer has no way of telling a dud from a non-dud, the sellers of ‘lemons’ will drive the sellers of good products out of the market.

Because of the information asymmetry, the buyers have to buy the good to find out whether it is a dud or not, the prices they’re willing to buy at will reflect that risk and be correspondingly lower. Some of the sellers of good products can’t sell their products for what they’re worth and so won’t participate in the market. The number of good products in the market goes down, risk goes up, prices go down, more sellers of good products leave. The cycle continues until either some sort of rock-bottom equilibrium is reached or until no product, dud or non-dud, can be sold in the market for any price.

The market dies. The cause of death is information asymmetry and a mix of bad and good products in a single market: the buyer has to buy to find out if the product is any good.

The online ad market is highly competitive and the prices are strongly trending downward.³ That’s all par for the course⁴ in a competitive, free market, but the sellers of advertising inventory (ads on the page) are in denial of the overall health of the market.

It’s no secret among us who work in marketing that the only way to find out whether an ad venue is effective is to buy ads and then measure the effect. The statistics and traffic information you have access to before you buy are irrelevant noise. Traffic stats are indistinct goops of unusable nonsense that have no relationship to whatever the actual results or what the return on investment will be.

It’s even less of a secret that most of the ad inventory out there is absolute garbage, blog content being almost as notorious as ‘user-generated-content’.

So, that’s a pretty bad cough they’ve got going there.

Given the characteristics of the web advertising industry, the behaviour and secrecy of the behemoths selling the inventory and the overall measurability of the utility and (in)effectiveness of online advertising, anybody planning on basing their business on online advertising will see their livelihood caught up in the industry’s overall terminal decline.

The only way they can avoid that fate is if they specifically take measures to overcompensate for the bad health of the market in general and work hard to differentiate their ‘product’ so that the competitive forces of the market don’t tear them a new arsehole.

But wait … it could be even worse …

Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?

23 July 2009

Irreversible

The free market giveth and the free market taketh. The latest ‘gift’ of the free market is the inevitability of ‘free’ as a price-point. The idea is compelling, that, according to some of our best tested economic theories, competition drives prices downward to the lowest possible sustainable point and when that sustainable point is near-zero, as it is online, we can just round it down and everything becomes free.

Most of these theories on free are based on a competition model developed by Joseph Louis François Bertrand in 1883, which shows, in a rather convincing manner, that in a competitive free market with interchangeable products (fungible in econo-speak) prices will reach an equilibrium that is equal to their marginal cost.

It’s a reasonable assumption if you believe that humans and companies act rationally and are incapable of being self-destructive.¹

The problem with applying this model to ‘free’ products is that costs aren’t rounded down but offset, that is, the marginal cost of the free product becomes part of the operational and capital expenses of some other non-free product. It’s called offset economics.

On the web, that non-free product, is advertising. Web sites and web apps aren’t products of their own right in the economic sense, they are the cost of doing business in the advertising market.

Which happens to be a competitive and standardised market of measurable and interchangeable products…

So it shouldn’t be surprising that the online advertising industry is a poster-child for Bertrand’s competition model. There is an abundance of advertising inventory (supply), the product is highly interchangeable (standardised ad units) and the buyer has consistent ways of measuring the utility of the product. To top it off, the online publishing industry supplying the ad inventory has a long-term disregard for individuality, character and quality, which means that there is little ability among the participants in the market to differentiate their products.²

If Bertrand’s competition model is in any way accurate, the price of all non-search engine advertising will irreversibly trend towards zero.

It’ll never become completely free, because advertisers buy in enough bulk, but there will come a time when selling advertising will be a business model only viable for those that have achieved a scale massive enough to eke out some profit from a microscopic margin.

This is one possible future of our web. A small number of international behemoths who offer cheaply made, interchangeable content for free and then sell advertising for next to free.

If we’re lucky. Because it could be worse…

Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?

22 July 2009

Lullaby

Forbearance is the best of ways;
But first dismiss both self and other.
When things occur; make no response —
And thus achieve true enlightenment.

Zen teaching of instantaneous awakening – Hui Hai

We all have our private lullabies, the things we think and say to ourselves to calm us and set ourselves on the path to sleep. I tell stories to myself of made-up people who talk, argue, dance, fight and explore as they fall in and out of love. I know their entire lives, the fears and happiness of their childhoods, the tragedy of their trials, the suffering of their deaths and of the joys that make the rest worth it.

We all have thoughts of our own that are of our own, quiet times of the mind that form a large part of the intrinsic mechanisms that lie behind our outward personalities.

Economic activities lie in the outward, the intersections between people and the exchange of value, while creative activities lie in the codification of inward interactions, internal conflict and private forms of reasoning that cannot be structured as a rational objective argument.¹

The relationship between the two cannot be explained simply, neatly or elegantly, as they are of two different worlds and share no context. The terms of one cannot be used to explain the other, and yet, because we are animals of great joy, irrepressible imagination and coursing passion, what we might call art and creativity will always be an unavoidable part of all human activity. So, economic activity forms around the creative, surrounds it and congeals it at the points of intersection, like oxygen clotting the blood that oozes from a wound.

We can, and must, analyse and understand economics and creativity at these ‘clots’ of ‘monetised’ creativity, but as we pore over the data, form our laws and insitutions, we must not forget which of the two is spurious, fleeting context and which is the lifeblood of our souls and the basis of our very minds.

Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?

21 July 2009

The lucky ones fail early

One of the core concepts behind the statement “everything digital and online will eventually become free” that is being popularised by various hacks and journalists is Marginal Cost, or, how much it costs to manufacture/produce an additional unit of whatever product you are pimping online.

The pitch is that, according to some economic theories, prices will inevitably gravitate towards the marginal cost of production. Add to that the popular myth that the marginal cost of production of anything digital is effectively zero and you have a neat, seemingly compelling argument that everything online will eventually¹ become free so you should just get with the program and stop arguing already.

But, aside from that the theory is just a theory—only applicable in specific circumstances—and that, as I’ve previously argued, we’re already accustomed to having a variety of non-free, virtual goods in our marketplaces, and that this argument ignores externalities, most capital expenses and operating expenses, marginal cost online isn’t zero.

It’s ‘effectively’ zero, which is a completely different thing. There are bandwidth costs and storage costs, which, although amount to little more than pennies per user, are decidedly non-zero.

What makes this non-zero marginal cost even more important is the viral and psychologically compelling nature of ‘free’. A free online product can, at least for a while, gain a lot of users even though the product represents no value or utility to the user and has no prospects whatsoever of ever attaining any semblance of a sustainable business.

Consider the following, simplistic and made up example:

A small group of entrepreneurs create an online social product that takes off through word of mouth. Let’s assume that they have no customer acquisition costs—unrealistic as in the real world customer acquisition costs for a ‘freemium’² web product can easily go over a dollar per eventual paying customer.

It quickly becomes clear that the product is taking off and that they’ll reach a million users within a year or two. They then work to find investors, spend that money to build up an infrastructure that will scale to that many users and optimise the hell out of it.

The usage load on the infrastructure always exceeds their expectations, at least to begin with, as in social networks people spend a disproportionate amount of time setting up and using their accounts at first as they connect with their friends and try things out.

At a (hypothetical) marginal cost of 10 cents per user per year, the entrepreneurs plan to just scale like mad, bind their users with so-called network effects and then figure out a freemium business model with a million-plus users in the bag.

Then, as the plucky entrepreneurs get over the million user hump, the number of active users falls off a cliff. It seems that in most social network most of the users at least try the product out to begin with (it only costs them time as it’s free) but regular and active use is only compelling to a small proportion of the user-base.

The entrepreneurs end up with 100 000 active users in an infrastructure designed for a million, an effective marginal cost of a dollar per user, a rigid system that can’t adapt to new opportunities because it’s been optimised to near-death and still no semblance of a business model.

As sad as the situation of these fictional founders may seem, they are the lucky ones. Imagine having to scale to a 100 million users to learn the same lesson.

Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?