11 July 2009
Bring us your joy
And the varieties of circumstances which influence these reciprocal interests are so endless, that all endeavour to deduce rules of action from balance of expediency is in vain. And it is meant to be in vain. For no human actions were ever intended by the maker of men to be guided by balances of expediency, but by balances of justice. (John Ruskin – Unto This Last)
Economics and finance are an art and a craft which ask us to bring our greed, fear, anger ad mistrust to the fore and, through perverse incentives, drive us to separate ourselves emotionally and intellectually from other human beings.
This blog is about the humane side of economics, as seen through the lens of media, art and design. I won’t leave out the pragmatic, complex or difficult aspects of economics or argue based on unrealistic or naïve models. Instead I expect our understanding of work, marketing, sales and economics to be based on the premise that our lives and work should bring us joy, meaning, satisfaction and compassion.
I’m looking forward to writing about:
Digital and virtual value
Publishing and art in a digital economy
Romer’s theories on new growth and how they apply to media and software
Akerlof’s ideas on the quality of a market
The consequences, good and bad, of piracy
How to deal with and use those consequences
How economic forces shape art, style and writing on the web
And more, of course. Hope you will find it useful, relevant and, more than anything else, optimistic.
Baldur Bjarnason – Follow me on twitter because otherwise you might miss an update, and you don't want that, now do you?
19 July 2009
We are always wrong
Last year the Icelandic currency “króna” collapsed with a devastating effect on Icelandic businesses and individuals. But it wasn’t the first time the króna collapsed, bringing ruin to Icelanders. As a currency it has, as measured against the Danish kroner, fallen to less than 1/1000th of the value it had when first instated. Nor is it the first time its collapse had a devastating effect on me and my relatives.
Back in 2001 the króna took a dive in value. The immediate effect was, of course, a sudden surge of inflation. A less immediate but no less destructive effect was a curious consequence of timing and of quirks in the Icelandic student loan system.
Student loans in Iceland are paid in króna at the end of each semester, but the amount is based on the value of the króna and cost of living in the country in question at the start of the semester. The time between is covered by taking out expensive overdrafts.
You can already see where that went wrong.
So, me and my sister faced a situation where we had around 60% of whatever was accepted as needed for a student to live in the countries we lived in (me in Bristol, UK and my sister in Florence, Italy).
Over the next few months, my sister lost enough weight to drop a dress size and I turned into a gaunt, hostile and bad-tempered shadow of myself. We both got through it and recovered from the financial and psychological consequences of the event, but it took years and I, at least, was left with additional debt that I only managed to pay off completely sometime in 2008.
One event reduced the value of everything I owned (and didn’t own but had borrowed) by more than a third and had repercussions that afflicted me and my relatives for almost a decade.
This was possible because money has no value in itself, it is a promise of value backed only by the word and trust of the issuing government.
In short, it is a virtual, digital good made by a monopoly producer.
All the recent proclamations of gurus, economists and pundits on the inevitable zero price of all things electronic are largely invalidated by the fact that all this value is measured against a virtual good that is guarded by law and encryption and bartered and traded in markets like any other good. It behaves somewhat differently, of course, but it doesn’t operate under any semblance of the “inevitable” rules set out by the punditry.
Value in the marketplace is governed by varied, diverse and contradictory forces and institutions. The physical context of value is tough to gauge and is an inexact science to begin with. Value in the digital context becomes an art, governed by so many institutions, traditions, spaces and forces that any one idea and any one model is benevolent only to specific and isolated instances and is a tyrant to the general, inapplicable as a catch-all explanation for the whole. To debate digital economics, as with any other field of ideas that touches upon human thoughts and actions, you need to argue with passion, be ready to change your mind in an instant—because certainty is impossible—and be able to understand that in the long-term we are always wrong.
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.
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One of the problems with ‘eventually’ is that in any economic model of this sort most of the actual profit is in the inefficiencies before this ‘eventually’. That is, most of the money in the industry will be made before the forces of competition manage to drive the prices down to marginal cost. That’s assuming everything goes according to the theoretical model, which, as with all best-laid plans, rarely happens. ↩
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Freemium is just a buzzword for a mishmash of older economic concepts, the most important one being ‘versioning’. Most of the users get the product for free, some pay for additional features, some pay much more for really exclusive features and so on. ↩
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.
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This is, for the most part, Tolstoy’s definition of art from his excellent What is Art?, not mine. Me, I’m not that clever. ↩
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…
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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. ↩
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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. ↩
