Humane Economics

Some thoughts, by Baldur Bjarnason, on the economics of insubstantiality, free and digital markets.

The argument here might sometimes get a bit involved but, I hope, still accessible and clear. Enjoy and let me know what you think.

If you're new here and want to get to know this blog, it'd be best to start with all the posts in chronological order. You don't have to read them all, just scanning over them will give you a good idea of my stance, perspective and argument.

23 July 2009

Irreversible

Free is inevitable. Just not in the places we’d like it to be.

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…

  1. And if you believe that, I have a deed here for the Northern Lights I’m willing to sell to you for a reasonable price. ↩

  2. Mainstream media are some of the worst perpetrators of this, so don’t start claiming that they’ll ride in on their big white horse to save the day. After all, the news industry invented the concept of a wholesaler of fungible content, AKA the wire services. ↩

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Baldur BjarnasonBaldur Bjarnason has a BA, MA and PhD in literature and interactive media (specialising in structure and experience design). He lives in Bristol, UK and works in web development, research, design and marketing.