Re-thinking the network economy

Many analysts once believed that being the first to enter the Internet market was crucial for business success. They argued that early entrants could lock in customers, making it difficult for them to switch to competitors due to high learning and compatibility costs. This "first-mover advantage" was thought to be a key to dominating the market, as early entrants would benefit from network effects, economies of scale, and customer lock-in.

However, real-world evidence has shown that Internet markets are not necessarily winner-takes-all, and being first does not guarantee success. In fact, companies that achieve the greatest market share often do so by offering superior products, regardless of their entry timing. Continuous innovation and quality improvement are essential for maintaining market leadership.

In the early days of the internet, there was widespread speculation that traditional brick-and-mortar retailers would soon be obsolete. However, as time has passed, it's become evident that while the internet is a powerful sales channel for certain products, it is not universally so. Products that are well-suited to online sales include those that can be digitally delivered, such as software, music, and videos, as well as those that can be easily digitized like airline tickets and stock purchases. Items that are consistent across all units, such as books and DVDs, and niche products with a limited customer base, like collectibles, also thrive online.

Stan Liebowitz has pointed out that the internet's advantages include immediate delivery, lower costs, and informed delivery, making it likely that products like computer programs and music, which have been digital for a long time, will move online. Conversely, Liebowitz also notes the disadvantages of internet shopping: the inability to physically interact with products, potentially higher transportation costs, and the likelihood of the internet's tax-free status changing. Some products require hands-on demonstrations, and their sales could be compromised by a shift to online retail.

The Internet is universally acknowledged as a significant source of value creation, potentially the greatest in history. Yet, the distribution of this value between consumers and producers remains uncertain. Three economic principles offer insight into this dilemma. Firstly, creating great value does not guarantee substantial profits. This is illustrated by the diamond-water paradox, where the value of a resource does not always correlate with its profitability. The Internet, much like water, is abundant and accessible, making it challenging for providers of online products and services to achieve high profits due to the value-profit paradox.

Secondly, competition tends to lower profits. The Internet's low entry barriers mean that any profitable online venture can quickly attract competitors, driving down profits. Historically, businesses have sought government-granted monopolies or other barriers to entry to maintain high profits. On the Internet, such measures could take the form of domain name restrictions or regulatory approvals for web-based transactions, potentially disguised as consumer protection efforts.

In the early days of the internet, the prevailing assumption was that the subscription model that had worked for services like CompuServe and AOL would continue to dominate. However, this approach was met with resistance from internet users who were not keen on paying for content. This led to a shift towards an advertising-supported model, similar to broadcast television, where content is provided for free and revenue is generated through advertising. Yahoo! was a pioneer in this approach, offering free information and monetizing through ads. However, this model faced several challenges. Setting up a website is far less costly than establishing a TV station, leading to a proliferation of websites all vying for the same advertising dollars. Additionally, the internet audience was smaller compared to television viewers, suggesting that online ad rates should be lower. Internet ads are also easier to avoid, reducing their potential effectiveness. Moreover, advertisers have limited budgets, and any investment in internet advertising would have to be redirected from other media.

The debate over digital reproduction and distribution of copyrighted materials, exemplified by the Napster controversy, has elicited varied opinions. Alan Greenspan, in his 1983 Senate Judiciary Subcommittee testimony, highlighted the economic harm to copyright owners due to unauthorized copying. He stressed the need for property rights to protect the interests of those holding copyrights in sound recordings and musical compositions, warning that the industry faced significant risks without effective responses to the issue.

Historically, similar concerns were raised with the advent of technologies enabling consumer copying, such as audiotaping and photocopying. However, these did not substantially harm copyright holders. The question arises whether the Internet poses a unique challenge. Stan Liebowitz argued that the Internet exacerbates the issue by facilitating organized, large-scale unauthorized copying, making piracy more accessible and widespread than ever before.

To address these challenges, understanding two concepts is crucial: indirect appropriability and digital rights management (DRM). Indirect appropriability allows copyright owners to charge more for originals, anticipating some unauthorized copying. DRM involves embedding a code in digital materials to prevent further copying without payment.