Saying You Can't Compete With Free Is Saying You Can't Compete Period
from the a-little-explanation dept
Getting back to my series of posts on understanding economics when scarcity is removed from some goods, I wanted to address the ridiculousness of the “can’t compete with free” statements that people love to throw out. If we break down the statement carefully, anyone who says that is really saying that they can’t compete at all. The free part is actually meaningless — but the zero is blinding everyone.
To explain this, it helps to go back to your basic economics class and recognize that, in a competitive market, the price of a good is always going to get pushed towards its marginal cost. That actually makes a lot of sense. As competition continues, it puts pressure on profits, but producers aren’t willing (or can’t for very long) keep selling goods at a direct loss. Sunk (or fixed) costs don’t matter, because they’ve already been paid — so everything gets pushed to marginal cost. That’s pretty well accepted by most folks — but it’s still misinterpreted by many. They tend to look at it and say that if price equals marginal cost, then no one would ever produce anything. That’s a misconception that is at the heart of this whole debate. The problem is that they don’t add in the element of time, and the idea that what drives innovation is the constant efforts by the producers in the space to add fleeting competitive advantages (what some economists have annoyingly called “monopolistic competition,” a name that I think is misleading). In other words, companies look to add some value to the goods that makes their goods better than the competition in some way — and that unique value helps them command a profit. But, the nature of the competitive market is that it’s always shifting, so that everyone needs to keep on innovating, or any innovation will be matched (and usually surpassed) by competitors. That’s good for everyone. It keeps a market dynamic and growing and helps out everyone.
So, let’s go back to the “can’t compete with free” statement. Anyone who says that is effectively saying that they can’t figure out a way to add value that will make someone buy something above marginal cost — but it’s no different if the good is free or at a cost. Let’s take a simple example. Say I own a factory that cost me $100 million to build (fixed cost) and it produces cars that each cost $20,000 to build (marginal cost). If the market is perfectly competitive, then eventually I’m going to be forced to sell those cars at $20,000 — leaving no profit. Now, let’s look at a different situation. Let’s say that I want to make a movie. It costs me $100 million to make the movie (fixed cost) and copies of that movie each cost me $0 (marginal cost — assuming digital distribution and that bandwidth and computing power are also fixed costs). Now, again, if the market is competitive and I’m forced to price at marginal cost, then the scenario is identical to the automobile factory. My net outlay is $100 million. My profit is zero. Every new item I make brings back in cash exactly what it costs to make the copy — so the net result is the same. It’s no different that the good is priced at $0 or $20,000 — so long as the market is competitive.
So why aren’t the same people who insist that you can’t compete with free whining about any other competitive market situation? Because they know that, left unfettered, the market adjusts. The makers of automobiles keep trying to adjust and differentiate their cars through real and perceived benefits (such as brand) — and that lets them add value in a way that they can make money and not have to worry about having products priced at marginal cost. If a company can’t do that, it goes out of business — and most people consider that a good thing. If you can’t compete, you should go out of business. But, when it comes to goods with a $0 marginal cost, even though the net result is identical to goods with a higher marginal cost, suddenly people think that you can’t compete? The $0 price makes no difference. All that matters is the difference in price you can charge to the marginal cost. Everyone else learns to differentiate — why can’t those who produce infinite goods do the same?
The answer is that they already do — even if they don’t realize it. Why do movies still cost more than $0? Because there’s additional value bundled with the movie itself. People don’t buy “a movie.” They buy the experience of going to the theater. People like to go out to the movies. They like the experience. Or people buy the convenience of a DVD (which is another feature bundled with the movie). They like to buy DVDs (or rent them) in order to get the more convenient delivery mechanism and the extra features that come with DVDs. In other words, they like the differentiated value they can get from bundled goods and services that helps justify a price that’s more than $0. Just as people are willing to pay more than the marginal cost (in some cases a lot more) to get that car they want, they’re willing to pay more for a bundled good or service with content — if only the makers of that content would realize it.
So the next time someone says “you can’t compete with free” ask them why? Every company that’s in business today competes with those who aim to undercut the price of their product — and the situation is absolutely no different when it’s free. It’s just that people get blinded by the zero and forget that the absolute price is meaningless compared to the marginal cost.
If you’re looking to catch up on the posts in the series, I’ve listed them out below:
Economics Of Abundance Getting Some Well Deserved Attention
The Importance Of Zero In Destroying The Scarcity Myth Of Economics
The Economics Of Abundance Is Not A Moral Issue
A Lack Of Scarcity Has (Almost) Nothing To Do With Piracy
A Lack Of Scarcity Feeds The Long Tail By Increasing The Pie
Why The Lack Of Scarcity In Economics Is Getting More Important Now
History Repeats Itself: How The RIAA Is Like 17th Century French Button-Makers
Infinity Is Your Friend In Economics
Step One To Embracing A Lack Of Scarcity: Recognize What Market You’re Really In
Why I Hope The RIAA Succeeds
Filed Under: techdirt feature
Comments on “Saying You Can't Compete With Free Is Saying You Can't Compete Period”
Love this series
I have really been enjoying this series on scarcity. I know very little about economics but you break it down in a way that I can understand it, and overlap the subjects of your posts just enough to drill the concepts in. Very education and interesting. Thanks!
Not really
Your movie analogy is invalid. The production company is the factory, the movie is the car. The cost of making a movie is a marginal cost.
With all due respect, you misunderstand the idea of it all going toward marginal cost. Technically, it will never reach it, even in perfect competition which is highly theoretical and hard to define. It will get closer and closer to 0 as volume increases.
At least this is what I was taught, I would love to see some resources that say otherwise; would really change the outlook.
Re: Not really
The production company is the factory, the movie is the car. The cost of making a movie is a marginal cost.
Yes, that’s true before the movie is made. Once it’s made, however, the marginal cost of making a copy is zero.
With all due respect, you misunderstand the idea of it all going toward marginal cost. Technically, it will never reach it, even in perfect competition which is highly theoretical and hard to define. It will get closer and closer to 0 as volume increases.
I’m not sure why you think I’ve misunderstood price moving towards marginal cost. I agree that perfect competition is hard to define, but that doesn’t actually matter. The point is that as you move towards more competition, the price moves towards marginal cost, and that’s the incentive that companies have to innovate and offer something new and different that helps drive the price higher than marginal cost.
Re: Not really
But you don’t have to pay $100 million dollars to make the movie every time you sell a copy of it, so how is the movie the “car” in this analogy? The .avi file or the dvd is the car!
Re: Not really
the price of a good is not what it is sold at, but what consumers are willing to pay for it. a BMW costs more than hyundai because people are willing to pay more for BMW. BMW charges what they do, and the keep getting away with it… hence the street price for a BMW.
companies increase (or stop losing) profits two ways: 1) raising prices 2) lowering costs.
if i hand make cars in my garage, they will cost me way more to produce (per unit) than a $100 million dollar automated factory will be able to produce them for. that’s the ecconomy of scale.
the point at which net profit in sales (sale price minus marginal costs) is equal to fixed costs is the break even point.
natually, reducing marginal and fixed costs at a greater rate than reducing the sales price will help you hit the break even point faster.
mike’s point is that with digital content and digital distribution, all costs are fixed costs. the price of producing the film is paid at production time, and then the film itself can sell and sell and sell until the break even point is reached. at which point, all sales are pure profit.
long tail ecconomics means that a given work has unlimited time to generate profits so long as the cost of distribution is near enough to zero, which digital distribution makes possible.
how long will it take for a $2 download to offset the cost of a $100 million movie? probably a long time.
it will take a lot less time than the sale of a $20 dvd that costs $18 to press, package and seal, haul across the country in trucks, and sit on a store shelf for 6 months before going in the bargain bin to be sold for $10.
Re: Re: Not really
the price of a good is not what it is sold at, but what consumers are willing to pay for it.
No, that’s not quite true. It’s true in the absence of everything else, but if there’s perfect competition, then those competitors will seek to offer the same good at a lower price — and eventually it will end up at marginal cost.
a BMW costs more than hyundai because people are willing to pay more for BMW. BMW charges what they do, and the keep getting away with it… hence the street price for a BMW.
Right… but that’s different. What’s happened there is that BMW has provided a benefit above and beyond the commodity level car (in this case, a Hyundai). Some of that value is real (it’s just a better car) and some of it is perceived (the BMW brand). That’s exactly the point I made in the article. The way you compete is by adding value and differentiating.
One common misconception in this area is that the marginal cost of making and distributing a digital good is $0. That is not true at all. While the cost is a lot lower than making and distributing a physical good, it is still not $0. This is especially true in the ‘record’ business, where a cut of every download sold goes to the artist or other rights holder.
There are two big problems in the market right now that are keeping things from heading towards the normal scenario you describe.
1) There are not good tools available (or executives aren’t using them well) to determine what the marginal cost is. This should hopefully change soon, and fixing it will be a natural result of fixing #2, which is:
2) The current competition level is not very good. Your choices are Apple, ‘piracy’, or some other much smaller competitor that has to base their price negotiation with record labels on what Apple has been able to do. And Apple, at least for the moment, doesn’t really have to compete with them, at least on price, and is happy with the status quo.
Because of this, and because the labels form a cartel to avoid competing with each other on price (Oh, you want 65 cents per song? Ok, but I was able to get 55 from BMG, so all their songs will be 10 cents cheaper at the store). Once that situation every improves, then we can start talking about pricing songs near marginal cost.
Re: Re:
One common misconception in this area is that the marginal cost of making and distributing a digital good is $0. That is not true at all. While the cost is a lot lower than making and distributing a physical good, it is still not $0. This is especially true in the ‘record’ business, where a cut of every download sold goes to the artist or other rights holder.
Well, that’s only true in the case where you do have to pay the rights holder — which is putting in place artificial costs. I’m saying the actual marginal costs are extremely close to zero if not zero.
1) There are not good tools available (or executives aren’t using them well) to determine what the marginal cost is. This should hopefully change soon, and fixing it will be a natural result of fixing #2, which is:
Honestly, it doesn’t matter what the marginal cost is as long as you realize that a competitive market will push the price in that direction.
2) The current competition level is not very good. Your choices are Apple, ‘piracy’, or some other much smaller competitor that has to base their price negotiation with record labels on what Apple has been able to do. And Apple, at least for the moment, doesn’t really have to compete with them, at least on price, and is happy with the status quo.
Yes, this is absolutely true, but I think it’s a market anomaly that will be corrected over time. It just presents too big an opportunity.
never thought of it like that
Wow. I hadn’t thought of it in terms of profit instead of absolute price, which makes sense. Profits matter, and through differentiation, value is created, so even if marginal costs are theoretically $0, there is still a value proposition of greater than $0 for making a profit.
“All that matters is the difference in price you can charge to the marginal cost. Everyone else learns to differentiate — why can’t those who produce infinite goods do the same?”
Are you saying that a marginal cost of zero is the same as free? In you example the marginal cost of the movie is $0, but it still costs me $8.5 to see the movie, so it’s not free. What is there for the producer to get if the difference in price is absolutely nothing? No revenue = no inovation = no competition
Re: Re:
Are you saying that a marginal cost of zero is the same as free?
No. I’m saying that when the marginal cost is zero, the pressure will always be towards pricing the good at zero.
In you example the marginal cost of the movie is $0, but it still costs me $8.5 to see the movie, so it’s not free.
Right. I explained that in the post. Because the movie theater can present additional value (the experience of going to see the movie), they can charge a higher rate.
What is there for the producer to get if the difference in price is absolutely nothing? No revenue = no inovation = no competition
Revenue is meaningless here, as the example in the post showed. All that matters is profit. And as the post explains, companies compete to differentiate themselves (making their product better or making the cost of making it cheaper) and that drives innovation.
Misconceptions of a misconception
“One common misconception in this area is that the marginal cost of making and distributing a digital good is $0.”
No, I don’t think that’s been a misconception. As others like Some Guy seems to not understand, you derive the idea that competitive pressures drive prices towards marginal costs from the theoretical example of having a $0 marginal cost (or $100 marginal cost – the actual number doesn’t matter). No one is saying that we live in a theoretical world and that there actually is a $0 marginal cost on digital goods. What’s being said is that prices are driven towards marginal costs, and for all intents and purposes, digital goods have a marginal cost of $0, but that doesn’t change the profit outlook of that good as seen in Mike’s example of two $100MM investments. Whether the marginal cost is $0 or not, your profits are derived from your ability to innovate and differentiate, and has no relation to the actual marginal cost even if that may or may not be $0.
So, while prices are driven down to marginal costs, there are always ways to create profit no matter the marginal cost.
Small problem
When competitors have different marginal costs for the exact same product, and not because of ‘manufacturing’ differences (which a free market should fix), there exists an insurmountable advantage for one of them.
Say iTunes and AllOfMP3.com.
IMS pays royalty fees, which drives up the marginal cost of each song download, whereas AOMP3 does not. That would be like, in your car analogy, one company using slave labor while the other pays market wages. No matter how much they refine their manufacturing process, they can’t compete without breaking the law.
So since neither IMS nor AOMP3 are the original producers of their product, they just resell it, the fact that one company licenses the product contractually and legally creates a huge competitive advantage for the company that doesn’t.
Also, there’s a much larger problem:
The market forces the price toward the marginal cost over time. There’s no business in the world that doesn’t include recovering the cost of the initial investment into its products’ pricing. After enough sales, the price drops toward the marginal cost, but if somebody else can skip the initial investment recovery period entirely, and head straight for the marginal costing strategy (as in the case of digital distribution), the model really is broken.
Re: Small problem
When competitors have different marginal costs for the exact same product, and not because of ‘manufacturing’ differences (which a free market should fix), there exists an insurmountable advantage for one of them.
Why is it insurmountable? If anything it should be a challenge.
As I said, the way companies profit is by differentiating — and one good way of differentiating is decreasing the costs of production for yourself. However, if you can do it, so can someone else eventually. That’s what progress is all about.
The market forces the price toward the marginal cost over time. There’s no business in the world that doesn’t include recovering the cost of the initial investment into its products’ pricing. After enough sales, the price drops toward the marginal cost, but if somebody else can skip the initial investment recovery period entirely, and head straight for the marginal costing strategy (as in the case of digital distribution), the model really is broken.
Not so. The market isn’t broken at all. And, you’re wrong to say that “after enough sales, the price drops toward the marginal cost.” The number of sales has nothing to do with it. What you describe only is true in a static market — but markets are dynamic. So the profit is made by continually differentiating and adding value. The profit is made by being able to convince people that there’s more value in your product and making them willing to pay for it.
Not really
I see what you mean by moving towards marginal cost Mike, and I wholeheartedly agree that is what happens as a market matures. An excellent example is the PC market, from computers with a thousand times the computing power selling for a quarter of what they used to 10 years ago.
My point, which I now see is not as eloquent as I hoped, is that moving toward 0will always happen, but it will never get there. In fact many times it will take a step back. An example of this which is pretty appropriate is movie theatre ticket prices. The market has highly matured, many theatres being bought to make a huge chain. Mom and pop theatres are quickly becoming no more. Yet prices have almost doubled in the last 10 years.
The movie cost is a sunk cost once the movie is made, and a per user selling basing would be the cost of the DVD. But a big hole in the “toward 0” theory is large competition. The automobile market is huge, competition is large, and price is a major differentiation.
For movies, no matter what the cost, it will cost you the same at the theatre, and a DVD price will generally be in the same scope as one another regardless of the budget (maybe a 5-10 dollar difference at most). There just isn’t enough competiton, and some could easily argue that they are not meeting the market need. Demand is high, supply is low, price goes up.
But all companies will abide by the general pricing rule (price scaling omitted such as DVD vs. Theatre) of:
Price = (Overhead/(Expected # sold) -Cost) + demanded profit/(Expected # sold).
The demand being high will drive demanded profit up, and the supply being low will up the expected sold. So the price being high speaks that there is poor competition, and low volume. The demanded profit has the luxery of being higher for a theatre.
I hope I was more cleare this time around. Regardless, I do agree that the argument of “can’t compete with free” is silly. You have to compete with free in everything. Cars companies even consider walking to work as competition, and they are doing just fine.
Re: Not really
My point, which I now see is not as eloquent as I hoped, is that moving toward 0will always happen, but it will never get there. In fact many times it will take a step back.
The only way it “steps back” is if there isn’t enough competition or if the companies continue to differentiate.
An example of this which is pretty appropriate is movie theatre ticket prices. The market has highly matured, many theatres being bought to make a huge chain. Mom and pop theatres are quickly becoming no more. Yet prices have almost doubled in the last 10 years.
Right. The consolidation of movie theaters has actually reduced competition greatly — hence a big part of the increase in costs. Also, there are marginal costs involved in running a movie theater — and some of those costs have gotten more expensive over time which helps explain the rising cost of tickets — but still fits with the model I’m describing.
But all companies will abide by the general pricing rule (price scaling omitted such as DVD vs. Theatre) of:
Price = (Overhead/(Expected # sold) -Cost) + demanded profit/(Expected # sold).
Not if there’s real competition it won’t. And, competition doesn’t just need to be other movie theaters, but could be DVDs, the internet, other entertainment options (concerts, plays, video games, TV, etc.). Why do you think movie chains are struggling these days? They haven’t been able to compete effectively against all of those other things.
So, we’re not disagreeing here — you’re just pointing to examples that still support the model, not disagree with it.
What hes saying
Mike isn’t saying that the item should be sold for $0. He’s saying that if the production price is $0 (Or at lease so close that there really is no difference) than the only thing that anyone should be looking at is the added value, like the movie or music itself. There is no reason to have the price set at what it was when the margin was higher. And with downloads the margin price douse drop to $0. (I am not counting the server, internet connections, or web development prices since they are investments not cost. Plus they would still be an insignifigent price in the long run.) All that’s left to bring up the price is the added value of the object being downloaded.
I believe I have that correct.
I think I get what you're saying...
Ford designs a car that costs $20k to make. Each car from that design has $20k worth of parts in it. In order for them to compete with a car by Chevy that also costs $20k per car Ford has to add some unique value to their car to pull customers away from Chevy. Let’s say that both Ford and Chevy each spent $2mil in labor (paying the R&D departments), testing, etc. to come up with their designs.
MGM makes that cost them $100mil to make. Each DVD does not cost $100mil but in fact only costs perhaps $2.
It would seem that part of the confusion in this is that Ford and Chevy are spending $20k for each and every car they produce whereas MGM is only spending $1 for each and every DVD they produce and people are trying to compare MGM’s $100mil cost to Ford’s $20k. I’ll have to ponder this some more.
Thoughts
While I’ve really liked your articles, I do have a few issues with this one. Sunk and Fixed Costs are different things. To quote Wikipedia, which words it far better then me:
–Fixed costs are expenses whose total does not change in proportion to the activity of a business, within the relevant time period or scale of production.
–Sunk costs are costs that have already been incurred and which cannot be recovered to any significant degree.
So for example (mine):
–Research is a sunk cost; you can’t recover it, and when you think about whether or not to continue to develop the product, an NPV should not factor it in.
–Factory leases are a fixed cost; they don’t vary no matter how much you produce.
So how is something priced? A product has a price and value – on the value exceeds the price, you have a potential transaction. Now someone keeps that delta between price and value; market forces generally dictate who (the seller or buyer) extracts what percent of that value. In a perfectly competitive market, the buyer generally extracts all the value. Monopoly situations are different (at outside the scope of what we are talking about).
A perfectively competitive situation DOES NOT drive the price down to the marginal cost. For example, you factory costs you $10,000 a year in leases, and a $1,000 a car. In a perfectively competitive market, if the price was driven to $1,000, you wouldn’t cover the $10,000 lease, and go out of business. Therefore, a perfectively competitive market covers MC+(FC/units). If unit sales are infinite, then FC would go to zero, but this is never the case.
Additionally, sunk costs are a red herring. Sunk costs are useful in decision making, as they cannot be recovered. But they can often be thought of a fixed cost (just convert them to a perpetuity fixed cost). If not, then someone is eating this loss. Therefore, if someone is forcing you to sell at zero, you are eating all fixed costs.
I’m not an economist, so please, any comments would be great on my analysis.
Re: Thoughts
While I’ve really liked your articles, I do have a few issues with this one. Sunk and Fixed Costs are different things.
Jamil, you’re absolutely right. I was simplifying by lumping fixed and sunk costs together — because it was easier to explain that way, but they are different (though, sometimes overlap). However, for the sake of the model I was describing, the sunk costs and the fixed costs were nearly identical. That’s not always true, as you point out.
A perfectively competitive situation DOES NOT drive the price down to the marginal cost. For example, you factory costs you $10,000 a year in leases, and a $1,000 a car. In a perfectively competitive market, if the price was driven to $1,000, you wouldn’t cover the $10,000 lease, and go out of business. Therefore, a perfectively competitive market covers MC+(FC/units). If unit sales are infinite, then FC would go to zero, but this is never the case.
I think you’re mixing up a few concepts here. Perfect competition absolutely does drive price to marginal cost. In the example I gave in the post I was assuming that all of the fixed costs were sunk — that there was no lease to pay, just it was all paid up front. But in your example, you get the basics right, but miss the overall point. If the lease costs a certain amount and there is perfect competition then YES, the company will go out of business. But that’s exactly what the model says will happen.
The way to avoid going out of business isn’t to just “price the product at some price higher than marginal cost, but less than value,” it’s to add value to the product such that you can do so. If you are just selling a commodity offering, you won’t be able to increase the price much above marginal cost because you’ll have no differentiating value. So in the example you’re using, what happens is the factory works on differentiating its offer to justify the higher price.
Additionally, sunk costs are a red herring. Sunk costs are useful in decision making, as they cannot be recovered. But they can often be thought of a fixed cost (just convert them to a perpetuity fixed cost). If not, then someone is eating this loss. Therefore, if someone is forcing you to sell at zero, you are eating all fixed costs.
No, you’re getting confused again by assuming perfect competition is an absolute. It’s not. It’s a force, but the whole point of this article is that companies continually innovate to differentiate away from a perfectly competitive market — and that’s where the value (and money) is. So you don’t eat all the fixed costs because you come up with other ways to differentiate and that’s where you earn back the fixed costs.
long tail economics
As a clarification, long tail economics has little to do with the original producer. Amazon and Netflix are examples of the long tail at work. They can make tons of money off of non-blockbuster items by selling 100 million $1 items compared to instead selling 1 million $100 items. In the first situation, those 100 million are still grabbing a small % for themselves, and not necessarily benefiting as greatly from the economics of the long tail as the distributor is doing. The long tail is about opening up offerings at the bottom end of the spectrum, and some smaller distributors or content creators will be able to set out on their own for more profits by connecting with their markets better than they could before, but in general, the long tail is referring to the larger distributors that open the access to the small creators.
“companies increase (or stop losing) profits two ways: 1) raising prices 2) lowering costs.”
Companies increase long-term profits in one way: innovation. Raising prices and lowering costs are driven by the market and less by a company as industries tend to rely on the same suppliers, so overtime (and without innovation), competitors are working off of the same manufacturing costs, and the only way to raise prices when faced with the same competing product is by producing something different of value that people are willing to pay more for.
“Price = (Overhead/(Expected # sold) -Cost) + demanded profit/(Expected # sold).”
On an individual company level this is true, but not on a market level. Price is set by the competitive forces, and overtime, that is the marginal cost. Movie companies are competing with new industries that aren’t as mature yet. I actually prefer independent productions online over the standard junk out there. For instance I”m a huge fan of the DRM free – no limits after downloading – “Long Way Round” movie store, which has far far better prices than a $10 movie, and more value to me. However, smaller creators and distributors like these aren’t able to put substantial competitive pressure on the large companies yet. Still, that doesn’t mean that over time they won’t, and that’s what Mike has been getting at in this thread of articles. The current movie/music companies are fighting a basic market trend, and if they realize this, then they have a chance to change their business models and benefit us all. Instead we get lawsuits on grandmothers and fans.
correction
“A perfectively competitive situation DOES NOT drive the price down to the marginal cost.”
This is wrong, and you’re example only shows a company that has failed to be profitable. They’re unprofitable because their competition has driven them out of business (kinda like what’s happening to Ford). There is no guarantee of profits on any investment, so when your marginal costs are higher than the market’s marginal costs, you go out of business from price competition. That doesn’t mean that a perfectly competitive market doesn’t drive prices to marginal costs.
Red Hat makes a lot of money off of a free operating system. It seems you can compete with free.
Not so fast...
Net outlay is $100 million.
The first copy published gifts $100 million dollars worth of movie to the public (and every single trader who fancies adding value to a copy at $0 marginal cost).
Adding $5 of brand value onto $0 of marginal cost does not get you off the hook, because you have to compete with people adding their own $5 brand value and/or $5 of convenience to $0 of marginal cost.
By the time the producer has recouped $100 million, all competitors have also made a profit of $100 million. This means the producer has broken even, and their competitors are each up $100 million (and very thankful for the altruistic investment on the part of the producer).
++ DOES NOT COMPUTE ++
The producer MUST sell the movie for at least $100 million to the audience interested in seeing it (or middlemen interested in adding value).
Mixed up
Mike,
You are right, I was mixed up on a few things, and I spoke to my step-father about the economics on this (he’s a retired very senior level economist). I will try to repeat what he said, but understand sometimes things get lost.
Perfectly competitive does drive to MC, and if there are FC, then the equilibrium as when MC=AC [MC=margin cost, FC=fixed cost, AC=average cost], as MC generally does not have an elasticity of zero. However, this breaks down when MC has an elasticity of zero, because MC will never equal AC (which is where I was getting mixed up). His statement is that when MC equals zero, and there are FC in a perfectly competitive market, you have no private entry, and you have a public good.
I understand (and agree with you) that the trick then is to move away from perfectly competitive markets, and your argument is you do that by differentiating yourself.
My question then becomes — if one of your basic inputs then is this MC=0 good with some fixed costs, who produces this basic input? Is your argument that you must provide a value proposition high enough to subsidize this “public” input? Or that the market in general must provide such a value proposition? Or are you saying that you must move the basic input away from a perfectly competitive market?
Re: Mixed up
His statement is that when MC equals zero, and there are FC in a perfectly competitive market, you have no private entry, and you have a public good.
This is what has traditionally considered true in economics, but it’s not quite true — and it’s a somewhat subtle change that I’ve been trying to get at here. While it does have many characteristics of a public good, it’s not quite the same. I think this is part of the problem that many economists had in trying to figure this out over the past 50 years or so.
My question then becomes — if one of your basic inputs then is this MC=0 good with some fixed costs, who produces this basic input? Is your argument that you must provide a value proposition high enough to subsidize this “public” input? Or that the market in general must provide such a value proposition? Or are you saying that you must move the basic input away from a perfectly competitive market?
I’m saying that anyone can start producing that basic input if they recognize the larger market they’re in (see the article in this series on “recognizing what market you’re in”). In that case, you start to recognize the zero marginal cost good as an input or a resource into a larger offering, and, in fact, the infinite good becomes the differentiator for those other products… Companies will produce those goods because they realize that, while the direct return may be zero, the indirect return in having an infinite resource with which to differentiate other goods is huge.
Re: Re: Mixed up
I hope I’m not being obtuse, and we can certainly move on, but something still doesn’t ring right here for me.
I’m curious what characteristics you are saying are different from a public good. If I remember correctly, a public good has no scarcity and no exclusivity, and derives it’s properties from that.
But more to the point, I’ve been doing some more thinking and maybe this (admittedly silly example) will clarify.
Take for example crossing a river where there existed a bridge lane with infinite (but closed) lanes built by the government, and you could open/take one for free. You could take a lane and charge a toll and make money. However, someone would come in and open another lane, and undercut you, and so forth until someone opens one that was free. At this point, charging your toll to cross the river would be competing with free, and you would be out of business. So you had better realizing that you are not in the business of crossing the river, but rather you could make your lane prettier or have radio and then charge a toll, because you have something other people can’t do. Other can imitate, but now you are competing on something differentiating. If this is your point about people complaining about competing against free, I totally agree.
However, I would submit that many people envision a different scenario when they talk about competing with free (vis-a-vis copyrights). Suppose instead of the government building the bridge, YOU had to build the infinite lane bridge at some cost. And then anyone could come in an open up a lane and do what they want with it. So now you are competing just like before, except for you are massively in the whole with your start-up costs.
This second scenario is what I think people mean about having trouble competing with free. This is the problem I was trying to raise with “who creates the public good?”
Re: Re: Re: Mixed up
I’m curious what characteristics you are saying are different from a public good. If I remember correctly, a public good has no scarcity and no exclusivity, and derives it’s properties from that.
You can see some of the reasoning here:
http://www.compilerpress.atfreeweb.com/Anno%20Romer%20Why,%20Indeed,%20in%20America%20Theory,%20History,%20and%20the%20Origins%20of%20Modern%20AER%201996.htm
in Paul Romer’s discussion of how technology isn’t clearly a public good the way many think it is.
However, I would submit that many people envision a different scenario when they talk about competing with free (vis-a-vis copyrights). Suppose instead of the government building the bridge, YOU had to build the infinite lane bridge at some cost. And then anyone could come in an open up a lane and do what they want with it. So now you are competing just like before, except for you are massively in the whole with your start-up costs. This second scenario is what I think people mean about having trouble competing with free. This is the problem I was trying to raise with “who creates the public good?”
Ah. I had tried to explain this, but I guess it wasn’t clear. The point is that there is still demand to get across the river, right? Therefore, it is in someone’s best interest to build that bridge — but they need to realize that they won’t profit directly from the bridge, but from additional services. And, even if others can take a lane for free and copy, the originator can still do quite well just by being the first and having the associated brand.
For example, when the 9/11 report came out it wasn’t copyrighted, since it’s a government document. However, the government gave the initial printing rights to one publishing company who came out with a purchaseable version before anyone else. Others followed — but the company that came out with the original version still outsold the competitors by a wide margin because people associated the report with them. In other words, there was “perceived” benefit in going with them (this example is used by economist David Levine).
Alternatively, the bridge builder could find someone who greatly needs the bridge — and get them to help finance it. Say it’s a trucking company and the trucking company recognizes they’d save $20 million in having a bridge. They may be willing to give you $19 million to build it — and then you can advertise their brand on it.
That’s just a simple example, but the point is that if the product is needed, there will always be a business model that can be designed to make it worthwhile to build that initial resource — and then to set it free.
Re: Re: Re: Club goods
Jamil, I wouldn’t classify digital goods as public good, but as club goods. That being that they are non-rivalrous, but still excludable. Non-rival because “consuming” a digital good doesn’t take away from the whole, but I could still be excluded from buying a Beatles album for instance if the owner so chose.
So, using your lane analogy, if a person uses a lane it doesn’t take away from another person being able to use that same lane. However, you might choose to block people with SUVs from using your lane, which could be of value, or you might do something else to add value, and charge a toll to use your lane (listen to your music, or watch your movie). There is still a cost in production, but a sunk cost because the lane has to be built first, but the marginal cost of people using the lane is $0.
Re: Re: Mixed up
There are no perfectly competitive markets, so MC never quite equals 0. But regardless, there seems to be some confusion with MC and Price. Just because MC=0, doesn’t mean price = 0. In addition, its a fallacy that companies won’t enter a business with MC=0. They will if they believe they can get a price over 0. Look at eBay as an example. What is their MC? It’s got to be pretty close to 0. Yet their price is above 0 and there are plenty of other companies doing online auctions.
RE Mixed up - Jamil
Actually, the end result to what he’s saying is that “perfect” markets don’t exist. Further, music and books and movies aren’t commodities (e.g. one is no different from another).
Argue fixed vs. sunk vs. production costs all you want, but if the consumer ultimately pays less than those costs then the producer will stop incurring them. However, you’ll never reach that point, because, one way or another, consumers will pay those costs, if only to ensure that they have a choice.
There is one difference at 0
An excellent series, and this one is especially fascinating.
It seems there is one difference at 0 price: The vendor can no longer differentiate on price. So differentiation has to be functionality, branding, service, etc. (i.e. components of perceived value).
I guess you could go to negative price (pay people to take it) but this model has not been very successful in most situations. An example: radio stations that run lotteries.
Another point: Some commenters said the marginal cost of copies is not 0. You don’t need to argue about fixed costs here. The relevant cost is the cost to the vendor. Using bittorrent, etc. most or all of the copying costs are borne by the customer, not the vendor, so the vendors’ marginal cost is truly 0.
Re: There is one difference at 0
It seems there is one difference at 0 price: The vendor can no longer differentiate on price. So differentiation has to be functionality, branding, service, etc. (i.e. components of perceived value).
Yes, that’s a very good point, that I definitely did not make clear enough. Thanks!
The relevant cost is the cost to the vendor. Using bittorrent, etc. most or all of the copying costs are borne by the customer, not the vendor, so the vendors’ marginal cost is truly 0.
Another excellent point.
Real l example
I was travelling in South East Asia where pirated copies of movies can be found everywhere. You could buy a cheap VCD on a blank CD for about fifty cents, a labled one for maybe a dollar. DVDs can be had for a couple bucks on a cruddy looking disk, a buck or two more for a nice disk and jewel case. Shoppers were happy to pay a LOT more for the same movie in a box with some text wrapped around it.
Go figure.
wow
Oops, sorry about the lack of formatting in the previous posting. New to this 🙂
usemonoply… not a right over every copy
resource for club goods
I’ll admit that I haven’t read this one in full (maybe tomorrow after some sleep), but it looks like the best resource out there, and includes things such as movie theaters in at least one reference as a club good.
http://www-1.mtk.ut.ee/doc/Sepp_Klubiteooria.pdf [PDF]
Adding value to copies is a secondary market
There are two markets:
1) Production and sale of a public good to interested members of the public
2) Production and sale of added value copies
You can have producers competing with each other to provide similar movies to similar audiences. However, the movie gets financed for sale to its interested audience (consequently becoming a public good).
It is only after this transaction (producer recouping their costs + profit) that the secondary market occurs, and the producer and anyone else can compete to add value to copies (packaging, etc.).
A $100m dollar movie is produced because there are 10m members of the public who’d pay $10 each to see it released.
Once released people can download copies for $0, or buy copies in the shops for $5.
1) Art for money, money for art.
2) Copies for free. Copies+value for money.
I’m continually mystified as to why people think that without copyright it’s impossible to sell a digital work to a large audience.
Don’t sell copies, sell the original!
But!
Thanks for the link, Mike, and I’ll take a look at your link when I get a chance (work calls soon).
“Jamil, I wouldn’t classify digital goods as public good, but as club goods. That being that they are non-rivalrous, but still excludable.”
Matt, I agree with you 100% on the Club Goods, and I believe that is an appropriate model for thinking about digital goods with MC=0. However, my understanding was that this whole thought exercise was about removing scarcity. Adding exclusivity adds scarcity, which truly changes the game.
“For example, when the 9/11 report came out it wasn’t copyrighted, since it’s a government document. However, the government gave the initial printing rights to one publishing company who came out with a purchaseable version before anyone else.”
Mike, in this example, you have also introduced some initial scarcity into the problem, and allowed someone to gain an initial brand, which changes the dynamics of the problem.
But, let me back up, and say I think there are multiple issues going on here. Mike, I think your initial point is that competitive pressures drive excess profits (I think that’s the right economic term) down. The firm’s goal is to drive them up. It doesn’t matter if at perfect competition the price is being driven to zero or not, it’s the fact that in all situations the excess profits are being driven to zero (with perfect competition). No quibbles there.
I think the relevant question – the question being implicitly posed with “I can’t compete with zero” is does there exit a market when MC=0 and scarcity is removed? They key assumption I’ve been working on (given this series) is that scarcity has been removed– no exclusivity, no exhaustion. I believe there are two different scenarios:
1) Secondary market — When you are taking a good that currently exits with no scarcity and no MC, then you must add value to the good to realize excess profits. What you are essentially doing is creating a secondary good (with your added value) that has scarcity. Example – as mentioned earlier, Red Hat takes Linux and adds value with technical know-how that not everyone has. No question a market exists.
2) Primary market – When you must create the good that will be available with no scarcity, no MC, but does have a Fixed Cost, then in order for their to be a market, there must be a “secondary market” (maybe not the right word) that the producer of in primary market can extract enough excess profits to cover the FC of creating this primary market. Example – I create music and release it free to the world knowing that I can make enough money from my own concerts to cover my music writing costs, because no one else is me. So the critical point here is that the market exists only if the excess profits in the secondary market will cover the fixed costs of the creation of the primary market >for the creator
>cont
end got chopped off, sorry.
So the critical point here is that the market exists only if the excess profits in the secondary market will cover the fixed costs of the creation of the primary market >for the creator
sorry again.
formating thing… with my brackets. was trying to stress the creator.
So the critical point here is that the market exists only if the excess profits in the secondary market will cover the fixed costs of the creation of the primary market for the creator. Potential a market exists. And that is where the question, “can I compete with zero” has valence.
Re: sorry again.
So the critical point here is that the market exists only if the excess profits in the secondary market will cover the fixed costs of the creation of the primary market for the creator. Potential a market exists. And that is where the question, “can I compete with zero” has valence.
Yes, but the point I’m getting to is that by using the primary market as promotion for the secondary market, there will always be ways to make sure that the fixed costs of the “primary” market are covered. I think the terms “primary market” and “secondary market,” while useful in picturing things, later cloud the picture — because the primary market is no market at all, but rather a resource to promote the secondary market.
Re: Re: sorry again.
Ahh, now I think I see where I disagree with you. Two places:
‘there will always be ways to make sure that the fixed costs of the “primary” market are covered.’
I don’t agree that with this statement — if it were true it would have very resounding policing implications. I think this is a calculation that needs to made and determines entry into the market. I can imagine extremely high fixed costs that cannot be recouped by the secondary market. Perhaps the classic example, National Defense.
“the primary market is no market at all, but rather a resource to promote the secondary market.”
I disagree here as well. The primary market MUST be a market, otherwise you have involved scarcity in that resource. It’s generally IP rights that make this a resource and not a market.
But it’s really the first thing disagreement that I think is the important one — because it has implications on whether these markets will exist in the first place. It gets to the crux of the problem, can a song be created while being free of IP from the get go by a profit minded individual? Yes, IF the secondary market adds enough value to the creator of the music that will be free. However, the answer to the question is not a clear cut yes.
With that said, your point is well taken: not enough people consider the goods we are discussing as inputs into another good to create value. There is no need to keep splitting fine hairs unless people are particularly interested (except I love intellectual hair splitting — keeps me from getting dopey). 🙂
Re: Re: Re: sorry again.
I don’t agree that with this statement — if it were true it would have very resounding policing implications. I think this is a calculation that needs to made and determines entry into the market. I can imagine extremely high fixed costs that cannot be recouped by the secondary market. Perhaps the classic example, National Defense.
I disagree. I hope that soon I’ll be able to show why there will always be the opportunity to recover the fixed costs (though, it still depends on execution, which doesn’t always happen).
I think it’s even true with National Defense, though there are many other (more important) policy reasons for supporting government-backed national defense. However, if you did want to make it a for profit business, I believe you absolutely could. It would just have other consequences that most people probably would not appreciate. 🙂
Re: Re: Re:2 sorry again.
“I hope that soon I’ll be able to show why there will always be the opportunity to recover the fixed costs”
Mike, with all due respect, we must be missing each other here. Your statement just cannot be true as I am interpreting it. I believe I was saying there are situations where a product does not exist, has a MC=0, is non-exclusive, and non-rivalrous, but has significant FC. You are saying a private entity can ALWAYS create that initial product, and then make enough to recover the fixed cost.
I offer the following (silly) business proposition: if you pay me $100 billion, I will irrevocably transfer the full rights to the Beatle’s “Let it Be” to the public domain. Anyone and everyone can do what ever they want with it. Your fixed costs are $100 billion. How do you make your $100 billion back?
Are we getting too far off topic?
Re: Re: Re:3 sorry again.
You are saying a private entity can ALWAYS create that initial product, and then make enough to recover the fixed cost.
Not quite. If there is the demand, there will be a way to recover the fixed costs. You are misinterpreting what I said (and it might be my fault for the way I stated it). But, if there is real demand for the product, there will be a way to recover the fixed costs.
That doesn’t mean any company is automatically successful in doing it, but it will be possible.
I offer the following (silly) business proposition: if you pay me $100 billion, I will irrevocably transfer the full rights to the Beatle’s “Let it Be” to the public domain. Anyone and everyone can do what ever they want with it. Your fixed costs are $100 billion. How do you make your $100 billion back?
That’s a bad example, because you have set a made up price. Part of the deal here is that it’s in the creators best interest to minimize the fixed costs as well, using means of production that decrease their upfront costs.
So, your example is meaningless, because it doesn’t cost $100 billion to create a song.
quality can compete with free
Bottled Water, Anti-Virus programs, Firewall programs, condoms, Television programs, Internet, Operating Systems. These are just a few quick things that compete with free, and not only compete, but are million and billion dollar industries.
Any company can easily compete with free, if they make a quality product that people want to buy.
The problem is the music industry is to lazy to make a quality product and so they want to just sue every one who doesn’t want to pay for a crap product. Just fade away into nothing music labels, you are no longer needed. I think it’s been long enough that you’ve thrived leeching off the hard work and talent of musicians.
scarcity
“Matt, I agree with you 100% on the Club Goods, and I believe that is an appropriate model for thinking about digital goods with MC=0. However, my understanding was that this whole thought exercise was about removing scarcity. Adding exclusivity adds scarcity, which truly changes the game.”
Ah, true. So, to kind of restate, the current situation is that of a club good, however, the proper state for these goods, arguably, is that of public goods. Because there is little technical reason why these couldn’t be public goods as for digital goods there’s no inherent consumption cost for the producer, and exclusivity is artificially induced by copyright, and since the good essentially has an AC or MC=0 (MC is just the first derivative of AC, so it doesn’t matter which you talk about), there is still theoretically a $0 cost for digital good. Since MC=0 removes price differentiation (not that price differentiation has ever exists with music), profits should be derived from a secondary market of added value.
This is really the essence of why the copyright was created. Because past content creators realized that books and music were as good as public goods, but inducing an amount of exclusivity for a time period has the potential to encourage creators to create. However, we’ve become so accustomed to copyright that it now seems the proper state of such goods instead of their natural state as being a public good. There are of course other way to induce exclusivity such as with added value of an exclude able good, so really, copyright isn’t needed except for an easy way into business.
Real-life experience
I have a degree in economics and own an on-line publishing company, so I can put a real-life spin onMike’s argument, as that’s how I run my business. I incur a fixed cost to develop market research reports which I then sell off my website. Essentially my marginal costs are close to zero. Not really, because I have variable costs such as rent, bandwidth, etc… But effectively, given the volume we sell. I price my reports based on what my competitors are charging for similar offerings, past experience, and what customers are willing to pay. Essentially all my reports cost the same to produce, but they are all priced differently. If one doesn’t sell at the inital price, I keep lowering it until it does sell. To get a high price for my reports, I have to add value. I pick markets that others have ignored which gives me exclusivity. I target the format of my reports to meet the needs of my target customer.
markets exist with value
“So the critical point here is that the market exists only if…”
Markets exist where there is value, but no one acknowledges those markets until a profit is made. For instance, the OLPC market is there. Poorer countries will derive value from laptops, but no one has yet to find a way to make money off of that market. Negroponte will hopefully both establish the market through a cheaper and more affordable laptop for those countries, but also play a charitable role in doing so. There is a market for charitability, but few acknowledge it because most charities are either a lose or neutral based on costs. Still, I wouldn’t say there isn’t a market there because there is value. It just has yet to become massively profitable.
Re: markets exist with value
My apologies, I may be using the wrong terminology. I was using the term ‘market’ to imply that someone will produce goods and exchange will occur. So I would argue in the OLPC market, there is value, but there is no ‘market’ as i am using it because the costs to create a ‘market’ are higher then the ‘value.’ Not sure what the right term would be there.
I also agree things like altruism change the way you think about these things, or any kind of non-rational actor. Sometimes I wish I had gone into behavioral economics!
Re: Re: markets exist with value
I see, and get where you’re coming from. I might have been a little picky anyway. I’d like to add that even though we’re talking about goods that have MC=0 and possibly giving these “primary” goods away for free, then deriving a profit from another related area, doesn’t mean you can’t get paid for the first. There are authors and musicians who give all of their creations away for free, but if you like, you can “donate” or pay for a copy after the fact. From the few sources I’ve read about doing this, they’ve found that either the return per song is higher than if they listed on iTunes, or the population of fans grows enough that even marginal returns increases profits more than if the content had been locked down.
It’s self advertisement really. Instead of putting up an ad from Dove soap where you make money by sending them traffic by basically telling your customers that, “hey, support this content by buying Dove soap. If you want more of my stuff, then buy Dove.” Instead, you say, “hey, support this content by paying for this content. If you like it and want more, then give me some money. If I don’t get enough, then there won’t be more.” I think too many people fear the lost of control and fear losing out on the perceived value of non-tangible items.
price driven towards MC
“But regardless, there seems to be some confusion with MC and Price…”
It’s not so much that price will be zero with an MC=0, but that with competitive pressures, the market will drive the price toward MC, which is theoretically 0 for digital goods. So, unless you do what you’ve done in your publishing business by adding exclusivity of added value, there argument that copyright should supply the full added value is ludicrous (IMO), which is really what these articles by Mike have been getting at in a way.
Some clarifications
Hey,
First of all, the reasona movie sells for less than $0 is not that it adds “value”. Value is encompassed inthe price itself- when you say that something costs $0, you are saying it’s value is $0.
What’s really the key here is that movies will never be perfectly competitive. The reality is that movies aren’t perfect substitutes for one another. This is because, if I wanted to see Will Ferrel make an idiopt of himself in Talldega Nights, I’d have to buy THAT movie from one studio and ONE studio only- so in essesnce, it’s a monopoly. Or at least, monopolistic competition.
So that’s a bad example.
In addition, remember that marginal cost includes the salaries of everyone who works for a company- so everyone gets paid, has jobs, and makes money. The COMPANY turns no net profit.
In addition, remember that marginal cost also has the component of opportunity cost in it. If you don’t keep this in mind, you’ll make the mistake of thinking that actual proft goes to $0- it doesn’t. What goes to zero is the profit above and beyond opportuinty costs. Otherwise, everyone would leave a $0 profit industry for more profitable ones. Things should move to an equilibrium…
And even at that, all this is highly theoretical, and can’t really be applied in real life.
Moreover, I think those who support anti-trust legislation know this all too well- they just think that it would be better for people to pay a little extra to spur competition than be driven out by a competitor who is able to offer basement prices.
Re: Some clarifications
I’m sorry to say this, but I think almost everything you said has something wrong with it.
“when you say that something costs $0, you are saying it’s value is $0.”
No, when you say something cost $0 it means that it costs $0. There could very well be great value derived from that such as with air or water. What does air cost? $0, but what value does it have to you, infinite value. Prices will be above $0 because those things have value to you above $0, and you can’t get that thing anywhere else for even if the cost itself is $0. Price is the representation of the value, not the cost, so you could price something below the cost, like an XBOX 360, and still find profit in that industry from other value offerings.
“What’s really the key here is that movies will never be perfectly competitive. The reality is that movies aren’t perfect substitutes for one another.”
Just because there aren’t any perfectly competitive markets doesn’t mean that the academic argument doesn’t have any application. Also, you’re miss using the perfect substitute concept. Computer games are perfect substitutes for movies, and any other entertainment options as well. Movies could be thought of as substitute for other movies, but that’s too small of a scale. If you want a Will Ferrel movie, then yes, you can only get a Will Ferrel movie from certain places, but that says nothing about other substitute industries. You’re not properly defining what industry movies are in. They’re not in the movie business, they’re in the entertainment business, which has plenty of perfect substitutes.
“marginal cost includes the salaries of everyone who works for a company…In addition, remember that marginal cost also has the component of opportunity cost in it.”
Marginal cost is the derivative of (changing of) total cost / quantity. If quantity approaches infinity such as is theoretically possible with digital goods, then MC approaches 0, or for all intents and purpose, MC=0. So, no matter the actual total cost, there can still be a MC of 0 from the change in cost of producing another good decreases. Also, opportunity cost is not a part of the MC calculation. Indirectly, it could be in considered, but there is no component of MC that includes opportunity cost.
“If you don’t keep this in mind, you’ll make the mistake of thinking that actual proft goes to $0- it doesn’t.”
No. The mistake is that profits have no direct relation to costs. Ideally, you want price to exceed cost deriving profit, but there is no guarantee of this situation. Companies go out of business because of this. People leave $0 profit industries because you can’t make a profit, but that doesn’t mean people leave MC=0 industries.
“And even at that, all this is highly theoretical, and can’t really be applied in real life.”
This is very theoretical, but logically plausible. Take Steve’s real life example of his own publishing company. Theory successfully applied to life. QED, stay in school.
“I think those who support anti-trust legislation know this all too well- they just think that it would be better for people to pay a little extra to spur competition than be driven out by a competitor who is able to offer basement prices.”
Anti-trust has nothing to do with being driven out of business by price competition. Anti-trust legislation is about creating fair markets where there may be a market failure. Anti-trusts don’t force people to pay more, they penalize companies for creating, inducing, or exploiting failures in markets, which is anti-competitive, but none of that has any direct consequence to this discussion.
The primary market seems to be a blind spot here
Why do I get the strange feeling that everyone apart from me has discounted the primary market for digital art into a nonentity?
If you can sell a $100m movie for $150m then that sounds like a viable market to me.
Why is everyone focusing upon whether it’s possible to give the $100m movie away for nothing and attempt to make $150m in the secondary market by adding value to copies?
This is like a drug company publishing the formula to a drug they just spent $100m developing – without patent – and then attempting to recoup this money by supplying pills in mahogany boxes at $10 each, in the face of competitors who provide them in shrinkwrap @ $1 each.
Somehow, I think the drug company should attempt to sell their formula to a goodly sized population of folk who fancy they could do with it today, or possibly tomorrow.
The other way of looking at it is that the folk who fancy they could do with a drug today, or possibly tomorrow, club together to put a bounty on the release of the formula to such a drug. Drug companies then compete to win this bounty.
Re: The primary market seems to be a blind spot he
Crosbie,
We’re not ignoring it all. Those are two cases — but they’re quite related.
One is that you get people who value the product to pay for its creation, on the assumption they’ll get more valuable out of it after it’s created. That’s absolutely a viable model, and I did in fact discuss it above when Jamil brought up the bridge analogy.
The second is that once the product is created, there are additional secondary markets that make it valuable.
What the first case is saying is that you get someone to pay for the creation, and the second one is saying that whoever is creating the original is effectively “paying” for that creation because they recognize the secondary market is valuable enough to make it worthwhile.
So it’s really no different. In your example, where people band together to pay for the formula to a drug, what they’re really saying is that they recognize the secondary market (the benefits of the drug) are worth the cost of developing the primary market.
There’s always value to someone — and there are many different models for capturing it.
Here’s a piece on a related topic you may want to read. It comes from the viewpoint of a software developer thinking about how to price his product, and is very well written:
http://www.joelonsoftware.com/articles/CamelsandRubberDuckies.html
Not exacly accurate...
“…in a competitive market, the price of a good is always going to get pushed towards its marginal cost” is not the complete picture of the price of goods. It is also a maxim that the price of goods will always rise to the extent the market will accept. Almost everyone agrees that producers are entitled to a profit for the goods that they produce, and that this profit is the incentive that encourage further production. What almost no one can agree on is the amount or percentage of cost that is acceptable for profit. It is within this grey area that prices fluctuate and competition takes place. Every once in a while someone will come up with a new idea that allows costs to be lowered and skews the market until competitors find a way to also use the new idea. Under cutting the price, that is selling a product for equal to or less than it costs to produce that product, is not competition, it is manipulation.
“If the market is perfectly competitive, then eventually I’m going to be forced to sell those cars at $20,000 — leaving no profit.” No you won’t, if my remembrance of history is accurate. What you will be forced to sell your car at is $20,000 + X where X is the amount of profit the market finds acceptable. I cannot recall a single instance of a producer surviving in a marketplace where they sold items at cost, and continued to sell those items at cost after they had driven all other competition out of the market by doing so. This statement ignores the very large Human trait of wanting more then we had before.
“The makers of automobiles keep trying to adjust and differentiate their cars through real and perceived benefits (such as brand) — and that lets them add value in a way that they can make money and not have to worry about having products priced at marginal cost.” I agree with this, but would like to point out that when this happens they are no longer competing on the product that has reached “marginal cost”, but rather are now competing on the “added value”. In other words, when a product has reached its marginal cost in the marketplace then all competition on that product stops. Let us take an example where an item has reached its fixed marginal cost, Oxygen. It is amply abundant and free for every one to use; it cannot be owned as there is no way to distinguish one atom or one volume of it from any other, at least so far. So how does any one make money from selling Oxygen? They don’t; they make money selling containment, transportation, compression, purity, etc. The same holds true for water; Dasani does not compete with free.
Competition can only happen in a marketplace where prices can fluctuate. When a product reaches fixed market cost, regardless if it is the marginal cost, then competition stops and producers of that item are forced to find other products where the market allows greater than marginal cost in order to compete. Often these products are based on perception of value rather than actual value, such as having a certification as opposed to not having a certification in the case with used cars or legal opposed to illegal as in the case of music.
Re: Not exacly accurate...
Almost everyone agrees that producers are entitled to a profit for the goods that they produce
Who is this “almost everyone?” It’s no one I know. No one is *entitled* to profit. You are only entitled to try to sell a product at whatever price you can. If I make a crappy product no one wants, then I’m not going to be able to profit from it. No one is “entitled” to profits.
What almost no one can agree on is the amount or percentage of cost that is acceptable for profit.
Can you point me to a serious discussion of this in economics? No one argues over that. The market sets the price. If you can’t profit at that price you go out of business or you figure out a way to meet the market price (either by decreasing your cost of production, or adding additional value to make people willing to pay more).
if my remembrance of history is accurate. What you will be forced to sell your car at is $20,000 + X where X is the amount of profit the market finds acceptable.
Nope. You are missing the point entirely. There is no magic variable “X”. The only way there is an “X” is if you add value to make people believe that it’s worth paying more than the marginal cost because there’s no direct substitute.
I cannot recall a single instance of a producer surviving in a marketplace where they sold items at cost,
I thought I explained this pretty clearly in the post, but perhaps not. Of course no one sells products at cost. That’s because they’re constantly differentiating so that they can sell it above cost. That’s the whole point of the post.
I agree with this, but would like to point out that when this happens they are no longer competing on the product that has reached “marginal cost”, but rather are now competing on the “added value”. In other words, when a product has reached its marginal cost in the marketplace then all competition on that product stops.
This is so wrong I’m not even sure where to begin. Please recognize that cost and added value are two sides of the same coin. A lower cost is simply one type of “added value”. If you can’t lower the cost any more then you just find different added values — but it doesn’t change (or stop!) competition at all.
Competition can only happen in a marketplace where prices can fluctuate. When a product reaches fixed market cost, regardless if it is the marginal cost, then competition stops and producers of that item are forced to find other products where the market allows greater than marginal cost in order to compete.
Amazingly, for all of the incorrect statements you make above, on this one, you are exactly correct. That’s the whole point of this series. You compete with free by recognizing the larger market you are competing in and then offer additional products that have a higher than zero marginal cost and use the zero marginal costs goods to promote it.
So, despite you’re disagreeing with me and getting a bunch of the basic points wrong, the final point agrees with exactly what I wrote. Not quite sure how that happened.
Art can be bought because people want it - not jus
Re: Art can be bought because people want it - not
“This is an obscure hypothetical created because people see no primary market.”
No this is not hypothetical. The RIAA/MPAA are complaining about piracy and people downloading free digital copies instead of buying from them. They’re going to Congress and the Senate asking for more laws to protect their business model that isn’t doing a great job competing in the digital market where the customer knows that making digital copies essentially costs nothing, yet they still have to pay $10 for an album or lesser quality than a CD with DRM that doesn’t allow them fair use rights. Point out the hypothetical part in this real situation where multi-million dollar industries are pushing for new laws simply because they can’t figure out a more profitable business model.
No is arguing that the market for art is going away. Art exists as a primary market of original creation because there is scarcity for original creation. And even in the copy market there are tons of stores that sell reprints of art for hundreds of dollars. No one is saying this should go away. What has been argued is that in the face of these RIAA and MPAA tactics, they need to realize that the theoretical cost of their product is moving towards $0 (this is the whole MC=0 discussion that has been repeated to death almost). So, what should they do when they’re creating essentially commodity goods that cost almost nothing? How do they realistically expect to make a profit from that because customers aren’t stupid, and they realize that grabbing a free copy is getting easier by the day? The companies need to add value to their commodity, and we’ve seen this from other industries before such as with special packaging, or physical copies (like books), or special added features. Artists won’t go out of business, and no one has said that either, but the distributors of that creation are selling us expensive crap. We know it. They know it, but instead they’re trying to legislate that we have to pay them what they want instead of what the market is driving them towards. There’s nothing hypothetical about that.
Re: Re: Art can be bought because people want it -
Additionally, it has been noted that you can still make a profit off the original free digital copies. Plenty of musicians and authors and video makers give away their products free, and then ask for money afterwards if you’re satisfied. They in turn make more money per copy then they would having locked down, and only sold first. Is this the only option? No, but it is one that’s been working for some. And that’s reality.
Re: Art can be bought because people want it - not
This is an obscure hypothetical created because people see no primary market.
It’s not hypothetical at all. It’s the world we live in.
You cannot hope to require that all digital works are only remunerated by the secondary market.
Sure you can. It’s what’s happening today.
Who pays for movies today? The audience.
Who will pay for movies tomorrow? The audience.
This is wrong. What the audience is paying for today is the *experience* and *entertainment* of watching a movie. It already is a secondary market to the movie itself… The industry doesn’t realize it, but they’ve always been selling the secondary product, not the primary one.
marginal costs
I think that what the RIIA and associated agencies are trying to do with the lawsuits is to increase the marginal costs of downloading movies or songs.
The cost of a possible lawsuit gets added into the price of downloading a song and pushes it higher. Also the shutting down of popular sites like Napster increase the cost of finding music and reduce the probability of finding it.
I am sure that you will agree that the cost of downloading a song or a movie is higher now than it was a few years ago with Napster around.
Flawed comparaison
the big difference between the car maker and the digital (MPAA/RIAA) is that the car maker need to make a good product as peoples can return a car is they are not satisfy with it. Try get a refund on a movie ticket or a DVD once you have open it. And don’t give me the rental excuse, since when ypu pay to test drive a car? The reason behind the MPAA/RIAA sueing everybody is because they run the US justice system. the MPAA/RIAA are openly criminal organisation with is still been permited to operate. Force the big movies studio to offer a WARRENTY on they product and it will change everytinh
Re: Flawed comparaison
“Try get a refund on a movie ticket or a DVD once you have open it.”
When I had to buy crappy music or watch crappy movies before I know they were crappy (which I do less so today thinks to preview options), I got refunds all of the time. Plus, it isn’t really important that the comparison be perfect, and I don’t get why people continue pointing out the differences. Do yall not have imaginations? Is it really that big of a stretch to see the similarities within the differences. They’re different products, different industries, so they’ll obviously have differences, but we can still derives similar concepts from similar, but not exactly equal situations. That isn’t exactly college level material. It’s more like elementary grade shit, but I guess the discussion of MC and such is throwing people off?
Music is like diamonds
We’ve had a lot of example industries come up in comparison, but I think the diamond industry is a great comparison. There is a cartel of diamond companies that control the distribution of diamonds. They understand that price is driven towards MC of their good (as part of the MC equation is the quantity of goods sold), so they limit the number of new diamonds released onto the market each year. This, along with some smart branding/advertising, helps keep the price of a fat diamond really high. This is what the RIAA/MPAA is trying to do except that their good is nearing a time when distribution is free and unlimited. Yes, it still costs more to extract the diamonds or make the music, but that’s really a sunk cost and one that gets cheaper every day.
So, the cost of distributing the good is primary concern, and since there is a physical good in the diamond industry, they can artificially manipulate supply. The other difference diamonds have from music or movies is that when one is consumed or bought by another person, then different person has fewer choices of diamonds. So, how do you compare the diamond market to digital goods where consumption is non-rivalrous? Think of diamonds from the perspective of the quartz industry. How many people would pay thousands of dollars for quartz today? No one because you can walk down to your local park and practically pick one up for free, so people might still like quartz, but no one is willing to pay for it because they know it costs almost nothing.
What should diamonds do then? Well, since diamonds are really really hard, they can sell them for another added value property. Of course they don’t sell as high in that case, so they’d prefer to sell for pleasure like music. Still, if the supply was not controlled as it was and was more like the digital content industry, then they’d be forced by the market to look for other ways to make money from diamonds beyond their shininess (which is what has happened with quartz as it’s used as an industrial good now instead of in jewelry which it once was). The same is true for digital music and movies except that the industry is fighting rather hard to keep this market inevitability from happening.
We differ
Mike, we differ.
Art is valued precisely because of the experience and/or entertainment it can create.
A digital copy is not valued, unless the recipient does not have one and cannot easily obtain one.
An environment or medium that enhances the quality of the art (its experience and entertainment) is valued for the value it adds to the art at the time the art is appreciated, e.g. a cinema.
You can put the cost of a copy at zero, and make the value added to it a lot or a little, but what you can’t do is argue away the cost and value of the art.
Art is work.
Work is money.
The cost can be absorbed into a promotional overhead to some extent, but not indefinitely.
An artist (or film studio) cannot live on goodwill alone.
At some point the audience and artist have to do a deal: art for money, money for art.
Re: We differ
An artist (or film studio) cannot live on goodwill alone.
Have I EVER suggested they live on goodwill alone? Not even close! I’ve been saying they can make a lot more money by simply recognizing the economic reality they face — and that’s using the content that has a zero marginal cost as a promotional vehicle for those things (such as the experience) that don’t have a zero marginal cost.
At some point the audience and artist have to do a deal: art for money, money for art.
This is not true at all. If the art can be used to make something else a lot more valuable, and that art can be copied at zero marginal cost, it’s actually inefficient for it to work the way you describe.
Someone has to pay for it
It’s all very well being able to take some art that happens to be lying around and at $0 MC use it to make something else more valuable.
However, whoever created that art needs a return on their investment – beyond the warm feeling of knowing just how many value-adders can make a living from it.
You do not give a $100m movie away for warm feelings.
A studio makes a $100m movie at around $150m because there are around 150 million punters who’d be happy to pay the STUDIO a dollar each to have it made.
The studio doesn’t make the movie and give it away, simply because it can join the massed army of value-adders each adding $2 value to a $1 cost-added copy. That is hoping to out compete the market by having the edge of audience goodwill.
90% of punters are not going to refuse to purchase their hotel’s value-added copy in preference for the genuine studio copy – if the latter isn’t available.
Why the hell do you think copyright was so appealing to printers?
Goodwill isn’t enough.
You need a contract – a voluntary contract – not a tax.
We’ll give you $150m if you produce our movie.
We’ll produce your movie if you give us $150m.
That is how you make movies.
Not: We’re giving a $100m movie away because we reckon that in a couple of years we can add enough value to copies that we can easily collect $150m.
Tell you what. Sell someone else’s movie and end up making $150m instead of $50m.
You are telling me that the $100m is the differential value accruiing from goodwill.
There is a case for giving your work away, but this is promotion. It is not something you can do forever.
I grant you that the artist can command a premium on their sale price (on their copies), but this is inconsequential if they command 1% of the market in terms of volume.
However, goodwill isn’t far off patronage. Audiences are prepared to subscribe to artists in order to procure further works. It is possible that people will seek out an artist’s more expensive value-added copies precisely in order to perform such a subscription. However, I’d suggest it was better to make this explicit, e.g. “I will pay you $X for your next work”.
Re: Someone has to pay for it
Crosbie,
You seem to be missing the point entirely.
The whole point (please go back and read the earlier posts) is that you simply cannot expect to make up the money in the primary market because of the basic economics of content, but that doesn’t mean you can’t make it up with the secondary market — and, in fact, that’s really what the industry has been doing all along.
Your claim that they need to make it up in the primary market is bogus. It’s simply not true. It’s never been true and it will never be true.
Again: the movie industry never made money selling movies. They made money selling an experience — and that experience was made worthwhile by having movies be a part of that experience.
It has nothing to do with goodwill. It has to do with providing a *scarce* resource that is inevitably tied to the non-scarce one, and charging for it.
I don’t see why you keep claiming it’s goodwill. It has NOTHING to do with goodwill. It has to do with building a market for scarce products that people will buy and using non-scarce products as promotions for that scarce market. It’s exactly how it’s always worked, but it’s now changing to a much larger scale. That’s got nothing to do with goodwill and everything to do with how basic markets work.
Excellent post!
Mike, it’s almost like you spent a long time constructing your posts in this series. They’re all wrapped up in a bundle that delivers learning, clarification on the issue, and usually realistic examples to describe your points.
This post is gold, definitely one I’ll be explaining to my Economics prof after class.
Art was financed by monopoly
The movie industry has made sufficient money to finance the production cost of the movie because of its monopoly on copies.
If you remove that monopoly, there may be a good degree of inertia in the market used to paying for copies (iTunes) rather than manufacturing their own (file-sharing), and also a degree of goodwill that biases an audience toward patronising the original artist (Jamendo).
But the fact is, without a monopoly, the only thing that has anyone coming back to the producer rather than anyone else who can add value to copies is goodwill. You can’t discount this very significant aspect, and say that it’s worth the producer’s while producing new art at great expense simply to increase the size of the product portfolio for them and everyone else in the ‘copy+added value’ market.
The only solution to this free-rider problem is collective action.
Let’s imagine that copyright disappeared tomorrow, but that movies were so esoteric that the only people who could easily duplicate them were movie studios. Those studios would either all grind to a halt, collectively agree to share funding for all movies, or collectively agree not to copy each others’ movies.
If everyone can easily duplicate movies, then either the industry stops making new movies, audiences collectively fund the movies they want, or a law is passed that prohibits anyone making their own copies.
Value-adders may be able to survive on the markup they add with value to a copy, but then they need 100% of that profit – there’ll be precious little left from that profit to spare on funding a new movie – unless they’d claimed 1.5 billion copy sales all to themselves – which is getting on for a de facto monopoly all by itself.
Re: Art was financed by monopoly
If you remove that monopoly, there may be a good degree of inertia in the market used to paying for copies (iTunes) rather than manufacturing their own (file-sharing), and also a degree of goodwill that biases an audience toward patronising the original artist (Jamendo).
It’s a lot more than “goodwill.” And, I’m sorry that you seem unable to think up other business models — but there are plenty. I’ve tried to highlight a few here and I’ll continue doing so, but it’s got a lot more to do with giving people what they want, and not just “goodwill.”
If you stop thinking of the movies themselves as a product and part of a bundle of goods and services that represent a saleable product, you discover that it’s not so easy for everyone to just copy….
Re: Art was financed by monopoly
I agree.
Laws prohibiting copies is what we have now.
Abandoning those copyright laws would lead to the situation Crosbie Fitch described with no real advantage for the producer over all the free-riders.
A possible way for “audiences [to] collectively fund the movies they want” would be a content flat rate.
This idea is from 2004 and it got very silent about it again.
Too bad, I still think it’s the only way out of the ‘war on filesharing’ that’s both acceptable for producers and customers..
Sufficient Business Models
Mike, I’m interested in your business model, because I can’t see how it can be viable – and yet you can.
What I’m skeptical of is that there is any incentive for someone in the secondary market (adding value to free copies) to independently invest in the production of a new work of art (costing $100m) and give this away without attempting to sell it in the primary market (sale of original art).
If you’re guaranteed sale of 100m items (of something else like soft drinks, airline tickets, etc.), then you may more easily countenance procuring a $100m movie to add value. But, then this is the primary market internalised – you’re not adding value to copies, you’re creating art to add value to products.
And don’t forget, anyone else can include the same movie on their own product – without having the $100m overhead.
For example, in 2020 when copyright has been abolished, Coke pays $100m for the production of Star Wars 7 in order to affix a micro-HDDVD to the top of their cans, and Pepsi says “Ta very much” and slaps a copy on their cans too. People only veer towards Coke over Pepsi because of goodwill to the company that actually funded the movie.
The free copy is irrelevant because in a market where copies are free Coke might as well not affix copies, and neither need anyone else. All that needs to be known is that Coke philanthropically paid for the movie’s production, and this may improve customer relations. In other words, is a $100m movie worth more in terms of increased sales/brand loyalty?
Re: Sufficient Business Models
And don’t forget, anyone else can include the same movie on their own product – without having the $100m overhead.
That’s where you go wrong. You are assuming that the secondary product that they’re selling is easily copied. The trick here is to find secondary products that are *not* so easily copied. So, with your movie example, you can’t just copy the actors. So why not use them in your marketing. Appearances by the actors are important. Or if it’s a sponsorship deal, have the actors or actresses do special promos for that brand. If Coke paid for the movie, Pepsi can’t copy that.
Better yet, tie it to other things. Go see the movie and get a discount coupon on the DVD — which will include behind the scenes footage that Pepsi doesn’t have access to. Or perhaps it includes a discount ticket to the next movie that Coke produces. Or the next movie with those actors. Or it offers you a bit part in one of those movies.
There are tons of things you can put in place that set the incentives in a way that are not easily copied.
Pushback
Mike,
———————–
I said, “You are saying a private entity can ALWAYS create that initial product, and then make enough to recover the fixed cost.”
Mike said, “Not quite. If there is the demand, there will be a way to recover the fixed costs. You are misinterpreting what I said (and it might be my fault for the way I stated it). But, if there is real demand for the product, there will be a way to recover the fixed costs.”
—————————–
This is where I don’t feel convinced — so you are saying if there is demand for a product, a private entity can ALWAYS create that initial product, and then make enough to recover the fixed cost and still make money (assuming they execute well).
I assume that you are really saying, if there is ENOUGH demand for the product. Which gets back to a point I was trying to make earlier. If the demand level is too small, there is no opportunity. Large enough there is. And a middle ground, where the demand level determines if a product needs monopoly rents to be profitable. When people say “how can i compete with zero” they are really asking, is the demand high enough that I can compete without some sort IP imposed monopoly?
I think you are also saying that the answer to that question is always yes, that you need to redefine (and enlarge) the ‘product.’ Then you can always get demand levels to cover the initial products and still make money.
If this was as common as you imply, why aren’t entrepreneurs buying out IP (a fixed cost), releasing them into the public domain (which is what people want and benefits society), and then recooping their costs and make a tidy profit on top of it as you say is always possible? I hope that wasn’t snide, but this is why I have a hard time buying that part of your premise.
Re: Pushback
If this was as common as you imply, why aren’t entrepreneurs buying out IP (a fixed cost), releasing them into the public domain (which is what people want and benefits society), and then recooping their costs and make a tidy profit on top of it as you say is always possible?
A few reasons. First, companies that own IP are overvaluing that IP, so that it’s much easier and cheaper to create your own new IP and do something with it. You’re much more likely to get a better ROI, since the costs of creation are a lot lower than the costs of obtaining the IP currently.
Second, not many entrepreneurs understand this new model yet.
Realworld Example
“So, your example is meaningless, because it doesn’t cost $100 billion to create a song.”
Okay, so my example had made up numbers. Let’s go with a real one. You just bought the entire Beatles collection, valued at $400MM.
(http://money.cnn.com/2005/05/05/news/newsmakers/jackson_loan/index.htm)
Per your argument, you have just released the collection into the public domain. How do you pay off the $400MM debt you have just incurred?
Mind you, being the free rider that I am, I (and hundreds of others) mirror what ever follow-on business you create, and charge less because we aren’t paying off the $400MM.
Re: Realworld Example
Per your argument, you have just released the collection into the public domain. How do you pay off the $400MM debt you have just incurred?
Again, as I describe in the comment above, that’s the wrong way of looking at it. If I’m an entrepreneur, that’s a bad investment. The Beatles collection is overvalued because it’s based on the current monopoly they’ve been granted. It’s a much better bet to find some new artist whose music I can produce and then work with business models based on that content.
Mind you, being the free rider that I am, I (and hundreds of others) mirror what ever follow-on business you create, and charge less because we aren’t paying off the $400MM.
Nope. That’s the point I keep trying to make that I’ve been unable to make clear to you and Crosbie. The trick is finding business models and follow-on businesses that AREN’T easily copied. With musicians, that’s easy: you use access to the musicians. No one can copy that. No one else can set up concerts. Or a fan club that offers access to the band.
Yes, the songs may be infinitely copyable, but the stuff that you use as your secondary product needs to be things that aren’t infinitely copyable at all. And then, if someone else (your freerider) starts promoting your band using your content, it only HELPS your secondary business model… You’ve basically flipped the problem on its head. Every time someone “pirates” your material, it only helps you make more money.
Re: Realworld Example
Per your argument, you have just released the collection into the public domain. How do you pay off the $400MM debt you have just incurred?
Again, as I describe in the comment above, that’s the wrong way of looking at it. If I’m an entrepreneur, that’s a bad investment. The Beatles collection is overvalued because it’s based on the current monopoly they’ve been granted. It’s a much better bet to find some new artist whose music I can produce and then work with business models based on that content.
Mind you, being the free rider that I am, I (and hundreds of others) mirror what ever follow-on business you create, and charge less because we aren’t paying off the $400MM.
Nope. That’s the point I keep trying to make that I’ve been unable to make clear to you and Crosbie. The trick is finding business models and follow-on businesses that AREN’T easily copied. With musicians, that’s easy: you use access to the musicians. No one can copy that. No one else can set up concerts. Or a fan club that offers access to the band.
Yes, the songs may be infinitely copyable, but the stuff that you use as your secondary product needs to be things that aren’t infinitely copyable at all. And then, if someone else (your freerider) starts promoting your band using your content, it only HELPS your secondary business model… You’ve basically flipped the problem on its head. Every time someone “pirates” your material, it only helps you make more money.
Goodwill
Mike, I’m not saying your model will never fly – I think it will (sometimes), but I still think it’s really one based on goodwill (free release of a public work for its promotional and goodwill benefit).
Goodwill:
However, this does appear to be very much a model for the well established publisher/producer/manufacturer (and artists who provide their services to them) with a budget for which $100m is a drop in the ocean. This is because it seems quite risky to invest in goodwill – what happens if you gave Waterworld away?
Or The Alamo?
Not only are you gambling on the art being good, but you’re also gambling on the art producing a commensurate return via goodwill.
There are still many artists, many filmmakers, who will want to produce art for a minority audience. There won’t be a corporate sugar-daddy for every taste. Sometimes the artist will need to go direct to their audience – and obtain funding in the primary market (risk free).
Look at http://www.sellaband.com. This publisher simply sits back and, at zero risk to themselves, waits for a band’s fans to provide the finance. That’s what you call ‘taking candy from a baby’.
Re: Goodwill
Crosbie,
Why do you insist that it’s goodwill despite my repeatedly pointing out that it has NOTHING to do with goodwill?
I’m not sure I understand your example with Waterworld or The Alamo. What point are you trying to make? It’s risky to make movies? Huh? That’s no different no matter what the business model used.
Finally, your example of sellaband actually SUPPORTS my position. Sellaband is a situation where you are paying someone to create something new (i.e., a scarce resource). In that case, the people paying are recognizing that they’ll get some value out of it (mostly personal enjoyment) and therefore it’s worth paying up front for the creation. That’s exactly the model I’m talking about. In some cases it will be people paying for personal enjoyment. In others it will be for some other benefit — but that benefit will come from the content being freely usable.
Your point supports mine and disagrees with your own statement, because Sellaband has nothing to do with Goodwill and everything to do with recognizing the real market and where non-scarce items meet scarce items.
Re: Goodwill
Crosbie,
I’m not sure I agree about it being only about goodwill. I think a good example is the articles about jokes and copyrights. Jokes are a perfect example of Mike’s point. A good joke is pretty much in the public domain, but it takes more then a joke to make it work. Timing, style, history, etc.
So a perfect example of Mike’s theory is Seinfield. He created many really funny jokes, that people (even non-comedians) repeated, yet he could sell out places with his standup, and create new shows using old and new jokes.
Marginal goodwill there (from creating the joke), public domain good with zero mc (the joke), all the value is invested in who seinfield really is, and that is created by new and old jokes, combined with inborn talent no one can replicate.
Re: Re: Joking aside
Jamil, a joke is unlikely to cost $100m.
If a joke writer would like to see a joke performed well and doesn’t mind only being known by comedians, perhaps they’ll feed a joke to a comedian for nothing in the hopes that if it works well they’ll be approached again for more (perhaps with a sweetener). And remember, ‘goodwill’ includes the value accruing from reputation.
Will a drugs company, that knows their manufacturing plant isn’t up to the job, spend $100m on R&D into a particular drug and publish it with a free license in the hope that should other drugs manufacturing companies make good profits from it, they’ll come back to them with $100m and another $50m advance for a new drug? Perhaps – if there are VCs with titanium testicles.
Obviously, us critics are focusing on the examples that are least favourable. So, perhaps we need some supporters who can come up with most favourable ones.
In what circumstances can a movie be produced for $100m, be published copyleft, and yet recoup costs + profit for the producer within 5 years?
Re: Re: Re: Joking aside
Jamil, a joke is unlikely to cost $100m.
Crosbie… this is the wrong question. I will explain why in a future post, but don’t want to give it all away here. The drug company example is a bad one. It’s a favorite one of people who support the current IP regime, but it can be taken apart with ease… It’s just that it’s a longer post I’m already working on, so don’t want to spill all the beans here…
In what circumstances can a movie be produced for $100m, be published copyleft, and yet recoup costs + profit for the producer within 5 years?
When it comes to movies, though, that’s a different story, and you’re asking the same question the dude from NBC Universal asked me last year when I presented on this topic. It’s the wrong question. The first question is why does it cost $100m to make that movie. In most cases it’s because they’re overpaying for actors.
Recent studies have shown that name brand actors cost a lot and tend to have a negative ROI. If movie makers spent less on actors they’d save a lot of money. Second, the technology to do special effects and whatnot keeps getting cheaper.
The first question shouldn’t be how do I recoup my $100 million, but why am I spending $100 million.
Second, though, there are TONS of ways to recoup that money. As I’ve been saying for years, movies are about the entertainment experience, so whoever makes the movie needs to focus on the experience (which is a scarce good). Get people to go to the theater where the experience is fun and enjoyable and they’ll pay to go.
You, then, respond by saying that anyone else can show the movie as well… but whoever makes the movie has some special advantages. They can give those who go to the “official” showings something extra. Maybe it’s access to cast members at a special party. Maybe it’s a discount on the DVD. Maybe it’s a DVD with special extra footage that they hand you on the way out. Maybe it’s access to the next film they produce. Maybe it’s a chance to be in the next movie they produce. Maybe it’s getting to vote on what’s involved in a sequel. And on and on and on and on. The idea is that you’re providing an overall entertainment experience — not just the movie. And there are ways to get people to pay for that which aren’t easily copied even if the movie itself is copyable.
But, NOT TAX! Please!
jschenk,
Art should be bought and sold in a free market, not considered such an indispensible element of human existence that it should be funded by tax, with the fund disbursed according to a proliferation census.
Taxes are an ancient revenue mechanism that applies in the case when the collective (the people) cannot act as one, but must assign a representative government to act on its behalf.
Today, the very mechanism that facilitates digital diffusion among citizens is the very same mechanism that facilitates collective action by an audience to fund the art it desires.
Replacing copyright by tax is just as much a destroyer of a free market for art as copyright is.
Moreover, the value of art is in the eye of the beholder. All art is not equally valuable, nor can its value be determined by how prevalently it manifests. It certainly cannot be appraised by central committee – unless you are of the soviet mindset.
Goodwill
Hmm. I actually suggested Sellaband as an exemplar for a business model that operates in the primary market, i.e. quite at odds with a secondary market based business model.
If direct audience-artist bargaining is what you’re supporting, well, ‘snap’. Join the club.
I got this strange idea you were proposing that the artist/producer gave the work away, and then crossed their fingers that the goodwill so engendered would recoup the production costs.
Perhaps you should come up with a hypothetical case study that demonstrates how your model operates?
Re: Goodwill
Hmm. I actually suggested Sellaband as an exemplar for a business model that operates in the primary market, i.e. quite at odds with a secondary market based business model.
That’s the thing — it’s not at all at odds with it.
Let me explain:
You want to build a market around scarce products with the idea of using non-scarce products to support them. A not-yet-created album or movie is absolutely a scarce product. So, you can absolutely sell that — which is what Sellaband does.
However, once the content is created you can’t expect to keep selling it directly, unless you bundle it (concerts, access, etc.). But, you can also then use it to convince more people to pony up even more money for the next album/set of songs/whatever. Because *that’s* scarce.
See? It still fits very much with the model I’m putting forth. You don’t sell the non-scarce goods. You just sell the scarce goods — but that includes creation of new works.
And it’s not a different situation at all. In the case of Sellaband, the “secondary” product is the ability to be a part of the band’s creation of a new album. That’s what’s being sold, and the enjoyment of being a part of that is worth it to the fans. So, you still very much have that secondary market.
I got this strange idea you were proposing that the artist/producer gave the work away, and then crossed their fingers that the goodwill so engendered would recoup the production costs.
Noooooooo. Not at all. That’s why I kept pointing out that goodwill has nothing to do with this. It’s all about coming up with a *complete* business model that looks at the overall market of what you’re doing, recognizing what’s scarce and what’s non-scarce and learning how to leverage the non-scarce to sell the scarce. It’s got NOTHING to do with goodwill. Nothing at all.
“The trick is finding business models and follow-on businesses that AREN’T easily copied.”
I agree with you 100% here, and have never disputed you on this one. Neither has Crosbie. The real area where we disagree is that there is ALWAYS a way to recoup your cost, which you have said several times.
As you said in your posting, there are times when the IP is overvalued at a point where you can’t make viable business model out of it. I am saying there are therefore times where the inherent cost of creating the IP puts it in that category, even if you have some secondary market advantage. However, with a primary market monopoly, the cost becomes viable. And there in lies the true meaning of the question, “Can I compete with zero?”
Where I have focused on the costs aspect of it, I believe Crosbie has focused on the other side, saying there are times where the nature of the product is such that the secondary market can not give anyone enough of an advantage to justify the costs of creating the primary market.
Neither of us are disputing that there are (many) situations where your model would work — and probably far more situation then people are willing to accept and explore. However, I think the issue both of us have is the statement that this is ALWAYS true.
Re: Re:
As you said in your posting, there are times when the IP is overvalued at a point where you can’t make viable business model out of it. I am saying there are therefore times where the inherent cost of creating the IP puts it in that category, even if you have some secondary market advantage. However, with a primary market monopoly, the cost becomes viable. And there in lies the true meaning of the question, “Can I compete with zero?”
No… that’s something different. The situation you came up with was one where the value placed on IP *already created* was high. That’s different than the cost of actually creating IP.
And my point is that, when it comes to content that people want (which is what people complain about when it comes to competing with free) there will always be business models that work while giving away the content as part of that business model. Always.
You’re focused too much on the value, rather than the cost of production. Crosbie is focused on the cost of production, but is confused because he’s worried about high costs making it prohibitive for creation.
I disagree. If the content is valued, there will be a business model for it… whether it’s something like Sellaband, or via sponsorships or through some other means. It may take some shifting of focus in how you view the market you’re dealing with, but it’s always there.
Where I have focused on the costs aspect of it, I believe Crosbie has focused on the other side, saying there are times where the nature of the product is such that the secondary market can not give anyone enough of an advantage to justify the costs of creating the primary market.
Again, part of the problem here is this focus on what’s a “primary” or “secondary” market… which is actually wrong. You should be looking at what the overall market is — what the total benefit is — and then separating out the components into what’s scarce and what’s not scarce. The overall profit that can be derived from selling the scarce goods will always outweigh the cost of developing the non-scarce goods. How do I know? Because the non-scarce goods help you grow the overall pie for the scarce goods, and make them more differentiated and more valuable.
Missing the point...
Crosbie, you seem to be missing a very important point of Mike’s whole series (I hope it’s safe to say that).
You say that the movie producers either stop making movies or they’ll collectively agree on ways to get funding. This is simply not true. If there’s a demand for movies, there will be suppliers who rise to the occasion to deliver because there’s potential for large profit involved.
Let’s say Movie Producer A decides to stop making movies because they can’t make any money using an out-dated business model. They decide to completely pull out of a huge market and stop making movies (this seems highly improbable to me). At this point, as long as there’s a demand for new movies, other companies use this as an opportunity to become a major player in the industry. They design new business models that make sense for the current/future situation and new movies WILL be created, because that demand is still there.
On the flip-side, you say if they don’t stop making movies, they collectively agree on funding or whatever. Movie Producer A better not use their current business model or they’ll be replaced from a profit standpoint by someone else who actually understands the nature of today’s content economics. Simple really. They don’t catch on, they lose. Someone else wins.
So it really doesn’t matter if the industry stops making movies or does whatever it thinks will help them keep things the way they want them… what’s supposed to happen according to economics will happen no matter what, cuz that’s the way business works.
As far as your argument for goodwill goes, I’m not sure you’re even on the right track. I don’t think we’re talking too much about brand recognition and goodwill with this. It’s more on the reality that basic economics in certain industries are undergoing change; things are just different than they used to be. Content can be infinitely duplicated and the very basis on which these company’s business models was built has changed entirely. Now it’s time for the industry’s companies to stop dragging their feet and adapt to the change.
Let’s open up an online gambling site and start taking bets for how long it’ll be until the Big 4 in music ditch their old business models and realize that this is 2007 and there’s this thing called the Internet that makes many things abundant. Go all in with your money and receive double payout by betting on Universal going out of business before they change anything. Now this is good idea, someone better set a site up. But make sure you do it somewhere else besides the USA where horse racing is MUCH, MUCH different than betting on sports. Is horse racing a sport?
Or who’s up for a parody site mocking Universal? We can stress how important it is to include DRM on our CDs so that our customers are happy that they can only burn 3 copies of their CD. And we can even have a section dedicated to sucking up to the RIAA… how file-sharing must be stopped, how Limewire as a program is illegal, how to tell the public they can’t do something and then go ahead and do it yourself, a special section demonstrating how to create a double-standard… you know all that bull. Oh wait, we might wanna be careful with this though since we might get sent a DMCA take-down notice even though parody is legal. Still, we might get sued and then be another victim of extortion courtesy of the RIAA.
Confusion
When I said the Sellaband model was at odds with (my evidently wrong interpretation of) your secondary market based model, I didn’t mean it conflicted or couldn’t operate in tandem, I meant it was wholly different.
Sellaband is a zero risk model of collective/audience funding – even less risky than a copyright based model (where you produce the record and cross your fingers that it sells – irrespective of the notional monopoly on copies).
You have now clarified that you’re not proposing that your model involves producing a digital work at great expense and then simply giving it away – and hoping that goodwill in the market (and exclusive access to artists or other elements involved in the production) will add enough value to subsequent products that include or relate to the digital work, that this will recoup production costs.
* * *
I’m not quite ready to agree that movies cost too much to produce (or that actors get paid too much money).
I certainly agree that whilst there’s a demand for blockbuster movies, business models will be developed that enable the audiences that demand them to pay the producers to produce them (directors to direct them, actors to act in them, etc.). And in a free market (without copyright, compulsory licensing, or taxation).
I suspect the abolition of copyright is nigh, and have every conviction that expensive movies will not consequently become extinct and a historical blip of profligacy (like Apollo moon landings).
I’ve only been worried that you’ve been suggesting that artists should always give their work away and live off the resulting goodwill.
You’ve reassured me that this is a complete misunderstanding on my part.
I look forward to your further articles making things a lot easier to understand.
Another angle
I’m a programmer, not an economist, but I’m finding these posts extremely interesting Mike, so thanks for that. I state that as a caveat that I may be really really off base here, but…
Supposing a movie costs $100 million to produce, and the moviemaker can’t recover the cost via goodwill or whatever term you’d prefer to use to describe how things work in Mike’s model… maybe the movie shouldn’t be made. Mike’s model assumes perfect competitiveness – that is, beyond this single expensive movie, there are a lot of other movies that people are willing to pay the marginal cost to see. The Alamo may have failed to generate a profit, but I think it’s given that this only occurred because there was alternative entertainment that people preferred instead.
That is to say, there are two extremes: a near-perfect competitiveness where the market is flooded with goods of the same service and producers are attempting to recoup their costs with barely profitable prices (lack of scarcity) OR a market in which there is only one, or a few, goods, and then there is scarcity and Mike’s model’s unnecessary. (This second scenario doesn’t survive long, but it could exist is my point.) Either way, as a consumer, I’m entertained, and as a consumer, I’ll naturally prefer the first option, where I’m given more choice at a lower price.
What I’m taking away from this series is largely that a business model operating with (near-)zero scarcity is possible, and that as long as these models are possible, it is nonsensical for the government to interfere with protective legislations, because such legislation would only serve to restrict innovation. It’s up to the companies in the old scarcity model to adapt themselves to the new abudance environment, and as difficult as it may be, as evidenced by these discussions, it’s not even close to impossible.
After all, look at Google. Originating as yet another search engine in an overwhelmed search engine market and their net income for 2006 was over $3 billion. (Almost) Everything Google offers is free as well – talk about adding secondary value!
Mixed up
Romer doesn’t really prove that digital information is not a public good, he just fails to consider the possibility that it is and that it could or should be paid for in the way that public goods are normally paid for, i.e. by taxes.
For a detail analysis of this issue read my article Published Digital Information is a Public Good: The Case for Voted Compensation.
Not tax - collective patronage
Philip, tax is too broad a hammer.
We no longer need tax, because we have the Internet as an excellent mechanism for collecting revenue from a large number of fans. We don’t need a single central revenue collection service – certainly not for art.
Instead, let the fans voluntarily patronise their favoured artists – directly. Moreover, let the fans and the artist make their own bargain, set their own price and valuation for the art.
Just because art is a public good doesn’t mean that every single member of the public should pay for it. Only those that want it published need to pay for it.
Art is not a commodity – it is not consumed – its value is in the eye of the beholder.
My problem is semantical
“Art is not a commodity – it is not consumed – its value is in the eye of the beholder.”
Two points on this one as it is a common thread in posted replies here; Art IS consumed (synonym for used) both intellectually and emotionally but is not destroyed in its consumption. The value of EVERYTHING is in the eye of the beholder; art is just one example of this.
“Instead, let the fans voluntarily patronise their favoured artists – directly. Moreover, let the fans and the artist make their own bargain, set their own price and valuation for the art.”
You know, this kind of trading does still exist, and some consider it fun, but it is generally considered antiquated and inefficient. We use set prices for things so we don’t have to dicker over everything we buy, giving us more time to enjoy that which we are buying.
“…movies are about the entertainment experience, so whoever makes the movie needs to focus on the experience (which is a scarce good).”
Correct me if I am wrong but hasn’t this been done before and been abandoned? Can someone remind us all why the movie production houses of the past gave up on their bid to monopolize (in the control all aspects of a product, from production to consumption definition of monopoly) the movie going experience? Hmmm, could it be that:
4. In the evolving consumer advocate environment monopolies are bad, m’kay? Does anyone really think that Wal-Mart could add theaters to all its stores and leverage that into lower rates from movie distributors without severe public backlash?
3. Content producers have little leverage with content distributors. Pixar has little ability to influence Cinemark. What are they going to do? Tell Cinemark to improve its act or they won’t let them show Pixar pictures anymore?
2. Experience is a subjective thing; it will always be different for everyone. For instance, I don’t go to the theater for a social experience. I go for the sensation; the larger screen that engages more of my vision as well as the sound system that is allowed to be louder than what I could achieve at home.
1. Do we really want Corporate Police? Do we want established police forces parked in movie theaters in order to police social policies that might promote a better movie experience? Given that the vast majority of issues with movie going experience are social in nature how does a corporation correct or allow for correction of social problems?
Overall I have not seen the conclusion that one can’t compete at all when saying one can’t compete with free has been proven. You have agreed, or at least said I was correct when saying that competition occurs when a product is not free and stops when a product reaches free, and that “free” in this instance means a product’s price has reached marginal cost. If competition stops for products when they reach free then you cannot compete with free because competition has stopped.
I think a better title would be Saying you cannot compete USING Free is saying you cannot compete at all; which seems to be the point you are trying to make. One uses free items to enhance the ability to compete for items that are not free. This is a far cry from saying they cannot compete WITH free.
here's why you are wrong
Your car and movie examples are inapposite.
In the car industry, competitors also have to build a $100 million factory. Therefore, their car prices also factor in their fixed costs, and both you and they are competing to recoup fixed costs and make a profit.
In the movie industry, the “competition” (illegal distributors) doesn’t incur the $100 million fixed cost incurred by the movie producer. So the “competition” can price the movie at $0 and not suffer a loss, while the movie producer has to find a price that will enable him to both recoup the fixed costs and make a profit.
movie cost is inflated anyways in hollywood
the movies made for $100 million cost that much due to unions, star salaries, and a lot of other factors not related to the actual cost of making a movie. to make a hollywood type movie can be done much cheaper to a similar quality. so that figure is a bit of a red herring even if they do spend that much to make a lot of these movies.
You don’t own a business do you? Then you would realize that you can’t compete with free.
Incorrect statement
You say that if you can’t sell higher than marginal cost you will go out of business. That is incorrect since marginal cost includes opportunity costs, so there is “normal profit” associated with that. Not being able to sell above marginal cost means you will not earn *economic* profit. There is a difference.
Movies arn't free
This is a really flawed argument. Paying 100 million for a movie is not even in the same ballgame as paying for a factory to make cars. Making a movie means that most of your 100 million is now gone because it can only be used to make that one movie. The factory can be upgraded and re tooled so that it can make other vehicles. Plus, the fixed cost ARE a part of the cost of the goods. Markets adjust to that. I agree that when you stop innovating you will fail in the economy, but using as flawed argument as this to justify the point is fallacy. So, in conclusion, I agree with the value argument but not how it is explained.
I don’t like the “can’t compete with free” argument because it does not show how P2P filesharing truly relates to the artist and the industry. P2P users provide a valuable service to the artist: they distribute the artist’s work, increasing that artist’s popularity! This is the entire purpose for an artist to sign with a record label! This isn’t free, this is consumers spending a valuable, tangible service solely to make use of an intangible product!
Artists normally pay a recording company for this service – they turn over their rights to their own work, the recording company markets, distributes, and sells this work, paying itself first to recoup its real costs.
Artists don’t need to fear P2P. P2P increases the artist’s popularity, increases their potential ticket and merchandise revenues, while simultaneously decreasing their risk.
So how does an artist make any money? They leverage their popularity to sell tangible goods and services. With a record label, that means CDs, merchandise, and concert tickets (of which, the label collects a (large) portion of each) With P2P, that means merchandise and concert tickets, but P2P does not collect a tangible fee for its services.
P2P provides much the same services as record labels, but at a FAR lower cost.
The only downside is that the record labels have stigmatized P2P, and forced users to remain largely anonymous. Still, some P2P “labels” have popped up: Axxo, for instance. He’s become somewhat famous for high quality movie rips – when people want to see a new movie, they often search for axxo. If he did not need to fear record labels, he could offer a lot of additional services to artists and P2P users.
i laughed so much.... I almost died
“Saying You Can’t Compete With Free Is Saying You Can’t Compete Period”
Which is why increasing amounts of digital music using companies are going bust when they realise that can’t legally build a business without paying for the music they consume.
good.
If you don’t want to pay for it, don’t use it, don’t steal it.
It’s always quite amusing reading lawyers who gets paid huge amounts “per hour” on behalf of their mega corporations like google, talking about why other people/ artists/musicians/label’s should work for free;)
Really late
I think your title is misleading in that it seems to imply that music companies say they can compete. That is effectively wrong. IPR are a monopoly on a particular piece of music/movie/software etc… If you have IPR, you are not competing for that specific product. Now obviously, you are competing with other similar products, but
Another thing that people must realize is that the ability to live (ie: food, housing, etc…) are part of the fixed costs. You can’t live without food and such and that’s true for everyone, including competitors. So people can stay in business so long as those costs are covered as part of their fixed costs. Since everyone (including competitors) must cover them as well they won’t starve to sell for cheaper. This increases aggregate output which makes products cheaper for everyone. Increased aggregate output is good for everyone which means that everyone can afford more.
People will work until their marginal utility per dollar gets as low as the marginal utility per unit of leisure. So those who value money more than others and value leisure less will work more and produce more. Those who work more will make more but in a perfectly competitive market everyone makes more. So it’s not that people will be on the verge of starving just to produce more. The people who produce within a specific industry will be the people willing to get the least for the most output (compared to everyone else, getting the least is a relative term. When market conditions reach a point such that one can get paid more in another industry they will move there until everyone can get the same) but since everyone produces more in a perfectly competitive market everyone gets more (except for those who stand to gain, like a monopolist in a monopoly, in a distorted market).
So, if the marginal cost is 0, how do you finance the 100 millions cost of the film ?
other
cool site
Every Entrepreneur MUST Read This Post!
I believe the author is right on. If a start-up sucks it’s because of one of the following two reasons, worse, both:
a) Your product or service is not good enough
or
b) Your marketing sucks.
Its NOT all about PRICE - Price is way down the list - U dont know that ?
Mike you basing your assumptions on wrong facts, that is probably why you ommited any examples to support your claims.
Your first mistake is the assume, the value of something is based on the cost of it, and its scarcity. That price alone is the only motivation for competition.
What industries, have been forced by competition to sell their product at margin ?
Does Nike have lots of competition, massive pressure from competition in fact, yet Nike shoes are very expensive, and popular, and not scarce.
Clothes, same deal, huge competition and price is not the primary factor, and product is sold high above margin.
So competing itself means you may compete on quality, price, value, support, good will, social standing, availability, form, function, innovation, look, feel the list is endless.
Usually price is somewhere down the list of the most important thing when making a purchase, the first thing you decide is “is it going to do what I want it too”, do I trust the people I buy it from, will there be someone to call if something goes wrong, and so on.
May by price is a factor, but its NOT the primary factor, if it was everyone would only purchase the very cheapest of anything available, so it would be the cheapest car, cheapest house, computer, phone whatever.
But they dont, do they. You know people will buy the best they can afford, that does what they want.
Next to me here is my $2000 canon EOS 450D digital camera kit, I could have purchased a much cheaper camera, even a much more common camera, but price was not the deciding factor for my purchase, it was quality, functionality, support, and compatibility. Sure, I could have purchased a no name $50 digital camera, still takes pictures.
But it would be NOTHING like my EOS 450D.
For most purchases people make, its not price that determines their purchase, therefore its not price that companies compete on, its function, quality, support and so on.
And in the case of “file sharing” its what you are willing to pay for the legal copy of the movie, book and so on and the value is not in the price of the data, but the quality of the data (good movie or song).
People dont desire things that are cheap, they desire things that do what they want them to do, and that actually work, and has a quality and security of purchase from a known source (good will). (ie, i trust canon more than I trust ‘jo_backyard_reverseengineering.)
So your entire argument is based on a false premise, that markets are purly price driven, when clearly that is not the case, (and practically not the case).
It's not about price
Thanks Mike, I really did not know you could not compete with Quality, form, look, support, brand name, function, color, availability, smell, popularity, word of mouth, advertising, education, or necessity ?
so when I go and buy new tyres for my car, I only look for the very cheapest ones ?
When I shop for computers, or clothes, or shoes, or food, or cars, I search out for the absolute cheapest there is, (and the most common ofcourse), it does not matter that it does not quite do what I want, what the heck it was CHEAP.
When I go skydiving, I had to purchase a parachute, do you think I purchased the very cheapest one I could find ?
Could you possibly believe that there were other factors determining my purchase ? Way more important factors than price, or scarcity.
But if you want to go jumping out of an airplane at 20,000 feet with a el’cheapo cut price poor quality (BUT CHEAP) parachute GO FOR IT.. but for me, I would rather pay for something that actually works, and works WELL, your parachute failing, as you plummet to earth and 1000 feet every 5 seconds, and your chute does not open, you can think about all the money you saved for the final 10 seconds of your life.
May be you could spend the money you saved on an insurance policy, so someone else can value off your thrift.
Its NOT all about PRICE - Price is way down the list - U dont know that ?
Mike you basing your assumptions on wrong facts, that is probably why you ommited any examples to support your claims.
There are multiple examples in other posts on this subject, all fully supported. The assumptions are correct.
Your first mistake is the assume, the value of something is based on the cost of it, and its scarcity. That price alone is the only motivation for competition.
I make neither assumption. You have misread basic economics here. I never said the value is based on the cost or its scarcity. I said that price is driven to the intersection of supply and demand. That is basic economics.
I most certainly did not say price is the only motivation for competition. In fact, if you actually read the post you would notice I said exactly the opposite.
What industries, have been forced by competition to sell their product at margin ?
You miss the point, by a wide margin. Lots of industries would be forced to sell at marginal cost if they did not *keep innovating*. It is that innovation that gives them tiny fragments of competitive advantage, and it is in that advantage that they can charge a higher price.
But to claim that there are no industries where goods have been driven to marginal cost is to show ignorance of any commodities business.
Does Nike have lots of competition, massive pressure from competition in fact, yet Nike shoes are very expensive, and popular, and not scarce.
They are scarce. You are using a non-economic definition of scarce. A scarce good is simply a good that has a higher than $0 marginal cost. Thus, yes, sneakers are scarce.
And yes, Nike charges more than their marginal cost, because they are able to differentiate. Part of the differentiation is through smart branding — which creates a perceived benefit for which they can charge a premium.
Which is *my* point exactly. You compete on all sorts of things other than price.
So competing itself means you may compete on quality, price, value, support, good will, social standing, availability, form, function, innovation, look, feel the list is endless.
Exactly. That’s the point I’m making. Why are you saying I’m saying something different?
May by price is a factor, but its NOT the primary factor, if it was everyone would only purchase the very cheapest of anything available, so it would be the cheapest car, cheapest house, computer, phone whatever.
No one said they would purchase the cheapest thing. The point is *ALL OTHER THINGS BEING EQUAL* then you WILL look at price. Why you ignore that, I do not know.
But it would be NOTHING like my EOS 450D.
Right. Because Canon competed. You are making my point for me while arguing that you are saying something different.
For most purchases people make, its not price that determines their purchase, therefore its not price that companies compete on, its function, quality, support and so on.
Exactly. That’s my point.
And in the case of “file sharing” its what you are willing to pay for the legal copy of the movie, book and so on and the value is not in the price of the data, but the quality of the data (good movie or song).
But if all other things are equal… then what?
People dont desire things that are cheap, they desire things that do what they want them to do, and that actually work, and has a quality and security of purchase from a known source (good will). (ie, i trust canon more than I trust ‘jo_backyard_reverseengineering.)
Again, Darryl, that is exactly my point.
So your entire argument is based on a false premise
Except that you seem to agree with my point. You just don’t realize I was making the same point.
that markets are purly price driven
I’ve never said that. In fact I’ve said exactly the opposite in *this very post*.
"competition drives prices toward margin", where ?
in a competitive market, the price of a good is always going to get pushed towards its marginal cost.
That is the statement I was maily questioning, as you said its the basis of your argument.
I said Nike, as its a competative market, and costs are certainly not being pushed towards margin.
These products are not scarce, they are common and mass producted made at low cost, sold at high cost (margin).
What other industries ?
Fashion ? no again clothes are cheap to make but expensive to buy, and yes huge competition, and that market is not driven to margins!
lots of products and markets rely on products that cannot be made for any cheaper than a minimum cost, and there are some industries that rely on low margin high volume, and some that work on low volume and high market.
It’s not “supply and demand” is “supply and desire”, supply is not the issue, I can go to a shoe shop and I can choose from many manufacturers, manufacturing costs for the different branks will be much the same, but the markup or margins could be greatly different.
So I was questioning your statement that in a competative market price to tend or move toward the marginal production price, due to competition and availability.
If the price is high and the demand is high, the margin will be high. That means the opposite to your statement, that competition drives price to margin.
What examples of markets where this has occured, just say the markets, and I will do the research, but just saying “somewhere in MY past posts” is not good enough.
Just list your classic examples of markets where this has occured, I see (like me) your not afraid of typing.
Thank for your response.
Competition and "The Market"
I think the main error you make, is something you learn in any business management course, and again when you create your business plan.
Is that you compete with the entire market, there are no “markets”. I compete for consumers dollars, they can choose to spend it on my products, or a similar competing product, or they could spend it on gas for the car, or a night out to dinner.
Or a mortage, new car, boat, icecream for the kids, that is your competition, its market (the market) there is only one, in which customers can choose how to spend their discresionaly money.
And if your in the market it **is** competative, and you compete with everyone else in the market. This means that customers force value over price. If they think the value to them is more going out to dinner, that could prompt you to increase the value of your offering, that may be by lowing price, or increasing its quality, or functionality or many other things.
So a focus on cost, and cost above margin is not significant to the customer at all, as long as it was the required percieved value to the customer.
Otherwise, regardless of your product or cost or it, if its not considerd of value to the customer, they will spend their money on something else, and most probably in a different market segment.
i laughed so much.... I almost died
Wow. Wished I’d seen this one last year. Trolly don’t know the site at all, and should read the site. Just like the guy who said ‘you don’t own a business, do you?’ Just weird.
It's not about price
“Thanks Mike, I really did not know you could not compete with Quality, form, look, support, brand name, function, color, availability, smell, popularity, word of mouth, advertising, education, or necessity ?”
Thanks Mike, I didn’t bother to read your posts or your response, I just want to troll. -FTFY
“so when I go and buy new tyres for my car, I only look for the very cheapest ones ?
When I shop for computers, or clothes, or shoes, or food, or cars, I search out for the absolute cheapest there is, (and the most common ofcourse), it does not matter that it does not quite do what I want, what the heck it was CHEAP.
When I go skydiving, I had to purchase a parachute, do you think I purchased the very cheapest one I could find ?
Could you possibly believe that there were other factors determining my purchase ? Way more important factors than price, or scarcity.”
Do you always go looking for the cheapest? Or do you evaluate your needs versus what is available to you plus past experience PLUS advertising/word-of-mouth? You’re oversimplifying things without making any sense as to why.
“But if you want to go jumping out of an airplane at 20,000 feet with a el’cheapo cut price poor quality (BUT CHEAP) parachute GO FOR IT.. but for me, I would rather pay for something that actually works, and works WELL, your parachute failing, as you plummet to earth and 1000 feet every 5 seconds, and your chute does not open, you can think about all the money you saved for the final 10 seconds of your life.”
Nonsensical nonsense adding nothing to argument. AKA, Trolling.
“May be you could spend the money you saved on an insurance policy, so someone else can value off your thrift.”
Ditto. Trollish behaviour. Nothing about your post seems to be on topic with the article (part of a series you probably should actually read), and thus makes people question your ability to read and understand what was posted.
One can still make a profit from the original free digital copies. Many artists give away their products free, and ask money only after you are satisfied.
Agreed with the “If you say that you cannot compete with free, you cannot compete period!”
The fact is that people CAN compete with free. How? By realizing that our society is moving towards a system where ‘not-free but with benefits or security’ is what we are moving towards.
Such as I am more than willing to download the ‘real’ thing of something if it is priced right, has no DRM or other gotchas, AND is guaranteed to be free of nasty stuff like viruses and malware.
Small problem
“No matter how much they refine their manufacturing process, they can’t compete without breaking the law.”
Very well said. When publishers say they “Can’t compete with free”, they really mean that they can’t compete with people who are breaking the law to offer their products at $0 cost.
In that type of arena, where breaking the law is an option, typical economic models break down and marginal cost no longer means anything.
Small problem
I’m glad Masnick decided to put this up again.
He was completely schooled by this guy, and his rebuttal was fantasy- no examples, nothing based in reality whatsover.
Small problem
I’m glad Masnick decided to put this up again.
He was completely schooled by this guy, and his rebuttal was fantasy- no examples, nothing based in reality whatsover.
Not really
I disagree with the thinking “the price of a good is not what it is sold at, but what consumers are willing to pay for it”. I think the price of the good depends upon the supply and demand.
Google vs. Garmin et al.
What about competing with a company like Google that uses its core business (Search) to fund other products (like Google Maps, Google Maps for Navigation, etc.) and makes them available for free because it can translate that ubiquity into profits via its core business? In this case, isn’t the producer willing and able to sell goods at a direct loss? (As expected, shares of Garmin and others dropped significantly when Google announced their free product.) Is there another economic theory at work here?
This is a helpful counter to all the panic about free digital rights being the ruinationo of publishing.
Tara Maya
The Unfinished Song: Initiate (US)
Interesting point of view but...
Mike, I think I understand what you’re saying, but I think you’re missing two things:
1) When you sell something with marginal cost $20,000 for price $20,000 and make no profit, you had to spend $20,000 to do it, with no guarantee that you would ever sell it at all. This isn’t equivalent to giving away something that cost $0 because obviously there’s a difference between risking $20,000 and risking $0. Apples and cranberries aren’t the same just because they’re both red. I don’t think it makes sense to call two things equivalent just because the marginal costs compared with the profits are the same.
2) Most consumers would prefer to get something for free rather than paying for it. When business people say they can’t compete with free, I’m pretty sure that’s what they’re talking about. From a consumer’s perspective non-free vs free is the same as high cost vs low cost. They’re not equivalent and one is distinctly preferred.
Maybe I missed your point, because your analyses are generally right on and I don’t think you would gloss over these things.
Interesting point of view but...
As far as I personally understand it:
The $0 cost of distribution is not the risk. The risk is the initial investment (the fixed costs) that you then hope to make back another way. The car happens to have a cost of ?20,000 to make each new car, which you have to make back with profit to pay off both the fixed and marginal cost. In the film example, that cost to produce each new copy is effectively $0. Because of this you actually have an advantage over the car example, as now you can use this as part of a larger business model that doesn’t hinge on selling copies.
The perfectly competitive scenario is what drives this home.
That’s already been undermined by the fact your distribution (marginal) costs have gone to 0. In exactly the same way as a $20,000 to build car that is forced to sell at $20,000 makes 0 profit, file/s (the movie, music, etc.) that cost effectively $0 to copy and is forced to sell at $0 makes 0 profit. The situations end up the same in both instances, regardless of the price the consumer paid in either example. It simply doesn’t matter all that much that they didn’t pay outside of your own ability to adjust your business model.
Not really
Actually, movie theaters have raised their prices too much and are rapidly losing business. This is because they thinnk they’re a monopoly (one cineplex per town) but they’re not (there are plenty of alternatives to going out to the movies). Small theaters which offer lower prices and better concessions are surviving, but the cineplexes are in an interesting death spiral.
Just six words Mike needs to explain here.
From another thread, which you can search for keyed on those 6 words, but this IS the crucial point:
Mike says casually above, “My net outlay is $100 million.”
WAIT A SECOND. WHERE THE HELL DID YOU GET THAT $100M? No interest or other capital costs? It’s a crucial point and inquiring minds want to know.
Truth is, Mike simply conjures up that first $100M! — In comments above, he hopes to be able to explain how it can always be recovered, but never does, big surprise.
Yeah, priming the “model” with a $100M sort of makes your notions work, Mike. As in the old joke (so old that a million was big money): first, get a million dollars…
Too Bad Mike Flunked Econ 101
For a passing grade, explain what is wrong with Mike’s statement:
“To explain this, it helps to go back to your basic economics class and recognize that, in a competitive market, the price of a good is always going to get pushed towards its marginal cost. “
1. Mike is assuming a perfectly competitive market where all movies are the same. Mike is assuming that for one cent less, people will see Driving Miss Daisy instead of Die Hard. In the real world, the produces can say, I don’t care if Driving Miss Daisy is $8 or even free, you still have to pay $10 to see Die Hard, and people will see Die Hard.
2. Mike is mistaking marginal cost with marginal revenue. The producers of Die hard are not dumb enough (like Mike) to set their price at their marginal cost (of about zero for downloads). The producers of Die Hard will set their price to maximize their profits, which is far above zero and is where marginal revenue equals marginal cost. Mike is incorrectly assuming that marginal revenue equals price which is only true in a perfectly competitive where a firm has no pricing power. With some market power, lowering price not only costs the lower price on the last unit sold but a lower price on all units sold.
Too Bad Mike Flunked Econ 101
Too Bad Mike Flunked Econ 101
I didn’t actually, but I appreciate your concern.
1. Mike is assuming a perfectly competitive market where all movies are the same. Mike is assuming that for one cent less, people will see Driving Miss Daisy instead of Die Hard. In the real world, the produces can say, I don’t care if Driving Miss Daisy is $8 or even free, you still have to pay $10 to see Die Hard, and people will see Die Hard.
Not true at all. I am talking about the market for a single movie, not across movies. So the market for Driving Miss Daisy. That market is perfectly competitive because the product is the same.
Not sure why you bring in multiple movies, because I’m only talking about the market for a single product. Apologies if that wasn’t clear.
2. Mike is mistaking marginal cost with marginal revenue. The producers of Die hard are not dumb enough (like Mike) to set their price at their marginal cost (of about zero for downloads). The producers of Die Hard will set their price to maximize their profits, which is far above zero and is where marginal revenue equals marginal cost. Mike is incorrectly assuming that marginal revenue equals price which is only true in a perfectly competitive where a firm has no pricing power. With some market power, lowering price not only costs the lower price on the last unit sold but a lower price on all units sold.
No. I’m not actually. I am correctly using marginal cost. And I never said that producers would choose to set the price at marginal cost, I said that, within a competitive market, the *market* puts pressure to drive the price to marginal cost — which is a fundamental tenet of economics. It’s not up for debate.
And while you’re correct that the producer will always *try* to set the price at the point to maximize profit, you have (oddly) completely left the rest of the market out of the equation. I have not, which is why my statement was correct and yours is wrong.
I did not say “marginal cost equals price.” Please read the very statement you quoted. I said — accurately — that in a competitive market the price is *pushed* towards its marginal cost, and it is the market that does so.
As for your claims of market power, you’re correct if there is market power. The whole point of the discussion around file sharing however, is that said market power disappears and the market is, in fact, perfectly competitive.
Again, apologies if that was not clear.
But I will say that I was correct original, despite your snide assertion otherwise.
Too Bad Mike Flunked Econ 101
I have never heard that people copying and stealing your product/movie is part of the competitive market.
But if you want to eliminate all IP laws, then nobody will pay for the fixed costs of making movies or pay for research.
One maximizes profit at MARGINAL REVENUE = MARGINAL COST.
Only in a perfectly competitive market where you are a price taker does price = marginal revenue = marginal cost.
Corn and other commodities are close to perfectly competitive markets. I can’t think of ONE IP market off the top of my head that any economist would model as competitive. Lady Gaga is not a substitute, much less a perfect substitute, for Sinatra.
Too Bad Mike Flunked Econ 101
Hilarious. I love the fact that I already explained that we were talking about the market for a single product… and your response is to once again pretend we’re not.
Too Bad Mike Flunked Econ 101
A “market” with a single product such as Die Hard with IP laws allowing only the copyright owner to sell in is known as a MONOPOLY, where the price never falls to marginal cost or zero.
If you are incorrectly calling pirates part of the market, it’s like saying GM can’t compete with car thieves.
It’s true that GM can’t compete with car thieves on price, but, the short story is that without the rule of law, there would be no cars to steal.
Too Bad Mike Flunked Econ 101
A “market” with a single product such as Die Hard with IP laws allowing only the copyright owner to sell in is known as a MONOPOLY, where the price never falls to marginal cost or zero
Really. Before dinging me on economics, it might help if you learned some.
A market with a single source is a monopoly. But a single product may not be, especially when there’s a secondary market.
I have no problem discussing the detailed economics, but your desire to slam me has only been demonstrating your ignorance of economics. Please stop that.
Too Bad Mike Flunked Econ 101
It’s not in Econ 101, so I’ll give you a break on it, but a LEGAL secondary market (GM’s used cars in the 50s or used DVD sales) does not change the MONOPOLY first sales where price never falls to marginal cost or free. Demand for new cars or new DVDs is only less because of legal resales.
You are saying that car thefts or movie thefts are a (legal?) secondary market? If you want to argue for no IP laws, be my guest, but try to do so without misusing every economics term in the book.
Too Bad Mike Flunked Econ 101
Debating with you is clearly pointless. The only one misusing legal terms is you. Infringement is not theft.
But it is also meaningless to this debate. I have no said that infringement is the secondary market. If you actually read the whole series of posts I’m talking about, I explicitly said I was discussing markets that had nothing to do with infringed content.
I am merely discussing the basic economics of content. Your inability to comprehend basic economics is not my problem, though I get the sense from your words that you are a biased party not here to understand, but here to try (and fail) to make me look bad.
You have failed, because you know that I actually have the economics correct. Debating with you further is a waste of time because you will continue to mislead.
If you want to have a serious discussion, I’m here for it. If not, then we’re done.
Too Bad Mike Flunked Econ 101
You don’t even have the Econ 101 knowledge to make a decent guess at my economics background.
I have taught Econ 101, Intermediate Econ, and graduate econ.
You are as wrong about me as your economics of content is wrong.
You must realizing that I am only reading you to see how pirates justify their theft and not to learn anything from you.
But to be fair, I will admit that you might have scrapped by and passed Econ 101 and I was exaggerating your failure for effect. If anything, you learned a few economics terms and hubris is leading you on a Greek tragedy.
Too Bad Mike Flunked Econ 101
I have taught Econ 101, Intermediate Econ, and graduate econ.
I fear for the students who learned from you.
You don’t know shit about economics from your comments here. And you know less about my economics education and lessons and I would suggest your refrain from making ad hom attacks on what you think I might have studied (and taught — because amusingly, you don’t even consider that I too may have taught economics).
Too Bad Mike Flunked Econ 101
Everyone who has googled you or read a one-paragraph bio of you knows you have a MBA. MBAs rarely teach economics courses, but I never made a claim that you never taught a course.
When you add MIGHT and MAY in front of teach, it sounds like BS from an MBA, which most MBAs are smart enough not to put in writing. Even Wikipedia does not allow statements with may or might.
If you have ever taught an economics course, and YouTube does not count, but I suppose high school or community college counts, I would suggest that you clearly say it or clearly say what and when you taught.
Padding your resume even if you put “might” or “may” in front of it will be considered fraud by many people.
A statement like, “I may/might have been on Seal Team Six,” technically is not a lie since I put MAY or MIGHT in it, but nobody would hire me if I made statements like that.
Too Bad Mike Flunked Econ 101
I didn’t say definitively because it’s meaningless. I’m just pointing out how ridiculous you look for assuming one thing.
What I taught, where and to whom is really meaningless in this discussion. This isn’t a pissing match appeal to authority. I’m just pointing out that you look silly when you make claims about me when you clearly have no idea what I’ve done.
You can’t respond to the fact that I got my economics right and you got it really, really wrong, so you go back to an appeal to authority, which is kinda funny for a “John Doe.”
I’m just saying it would be a mistake to assume the things you’ve assumed, and I find it funny that you have no argument so the best you can resort to is attacking something you know nothing about.
I have no fear that my economics credentials are solid. That this is the best you can do in attacking me is pretty funny.
A rational, educated person not blinded by ideology or hubris would check his economics with a third party.
It’s microeconomics, which has almost no wiggle room. It’s as clear as saying you added 2 and 2 wrong. On other subjects like politics or macroeconomics, you could argue both ways.
And if your criminal (thief/infringers) friends (you might want to question your life if your fans are all criminals) such as Anonymous decided to follow the rule of law and not retaliate against well all adults, people might post their real name.
Too Bad Mike Flunked Econ 101
Here is a link to an economics textbook that explains the difference between marginal revenue and marginal cost:
http://books.google.com/books?id=42mEopd5whUC&pg=PA178&dq=marginal+revenue&hl=en&ei=NDtQTvDTI8rb0QG8nvTIDQ&sa=X&oi=book_result&ct=result&resnum=1&ved=0CCoQ6AEwAA#v=onepage&q=marginal%20revenue&f=false
Unfortunately, you have also made a few other mistakes and may also need Intermediate Micro for your analysis.
Re:
A rational, educated person not blinded by ideology or hubris would check his economics with a third party.
The funny thing is that you keep making these assumptions. You assumed I failed economics. I did not. You assumed I must have “just scraped by” intro econ. You ignore the possibility (or the reality) that I took and taught economics at much higher levels.
And now you ignore the possibility that I checked my economics on these stories with others. I did. This whole series was checked with a bunch of economists, including one Nobel Prize winner (if you really are an economist, you’d know who this was) and one former economic advisor to a President of the United States.
They said I got it right. Why would I trust an anonymous “John Doe” over them?
It’s microeconomics, which has almost no wiggle room. It’s as clear as saying you added 2 and 2 wrong. On other subjects like politics or macroeconomics, you could argue both ways.
Indeed. We agree. Which is why I got it right.
And if your criminal (thief/infringers) friends (you might want to question your life if your fans are all criminals) such as Anonymous decided to follow the rule of law and not retaliate against well all adults, people might post their real name.
Not only do you make bad assumptions, you outright lie. I have regularly condemned Anonymous for its actions. They’re not “my friends” or “my fans.” And I put my name on.
You’re clearly a nobody wannabe who has never taught economics in his life. Otherwise you’d stand up for yourself. But you can’t, because you didn’t. That much is clear.
Too Bad Mike Flunked Econ 101
Again you make fuzzy, BS, borderline-fraudulent, claims that you taught/may have “taught economics at much higher levels.” (such as on YouTube, lol)
Now are making an “appeal to authority” that a Nobel Price winner checked your work. I suppose you may have asked someone for a comment, but I doubt anyone would give you a good grade on this flawed paper. More likely as you repeatedly do with comments you don’t like, you go into denial and ignore anything you don’t like, and mistake any signs of encouragement, “it’s a good start” as evidence of your genius, and ignore suggestions.
I also doubt any busy Economics Nobel Prize winner would spend more than five or ten minutes with anyone walking off the street. They usually don’t spend five or ten minutes with their own graduate students. So again like your hedged-claim that you, an MBA, taught economics “at a higher level,” just sounds like a claim too far. Of course you could be deluding yourself that a Nobel Prize winner spent some time on your paper. Your story would be more credible if you found some run-of-the-mill economics professor to check your work over the summer break, and you would get someone that might actually spend some time helping you.
I don’t mean to knock your school, but I can’t recall any econ Nobel Prize winners teaching there, not that I follow them, and they usually don’t like to teach MBA students or undergrads, preferring to teach the next generation of econ Ph.Ds.
And while only a small fraction of your readers are likely Anonymous members or hackers, I would guess that the large majority of your readers are copyright criminals who also have a great capacity for self-deception that they are not stealing the work of others.
Too Bad Mike Flunked Econ 101
“You’re clearly a nobody wannabe who has never taught economics in his life.”
You should not make statements that are too easy to prove wrong.
“You/Obama/Bush is a nobody” is an opinion that can’t be proven either way.
“You/Obama/Bush has never taught” is a fact that you are stupidly are guessing about with 100% foolish confidence “That much is clear.” You should at least hedge it by “I think you never taught.”
Too Bad Mike Flunked Econ 101
“You’re clearly a nobody wannabe who has never taught economics in his life.”
Also when you make factually incorrect statements that can be so easily proven wrong, people might offer to bet you money and take your money.
I’ll bet you $1,000 that I have taught economics.
But this does raise the question of is it ethical to take money, big money, from the not-so-bright, but it’s usually just $10 or $20 bar bets.
Looking forward to your slippery answer why you won’t put your money where your mouth is to make an “easy” $1,000. I better look up to see if bets are enforceable or legal. I am not sure it’s a bet if there is not an element of chance.
Of course you could say that I made a factually inaccurate statement about you failing econ 101, but I already admitted I was exaggerating for effect the same way people say Obama/Bushed failed Economics.
Too Bad Mike Flunked Econ 101
Again you make fuzzy, BS, borderline-fraudulent, claims that you taught/may have “taught economics at much higher levels.” (such as on YouTube, lol)
When did I claim to have taught economics on YouTube? I have never made that claim, only you have. I meant in a classroom at a university.
Now are making an “appeal to authority” that a Nobel Price winner checked your work
No. I am not making an appeal to an authority. I am not saying the economics are correct because of that. I am merely responding to your assumption that no one checked my work. You are wrong.
I suppose you may have asked someone for a comment, but I doubt anyone would give you a good grade on this flawed paper.
It wasn’t a “paper.” I ran this entire series by a number of economists I know. Certain corrections and changes were made based on their input, and all saw the final piece before it was published.
More likely as you repeatedly do with comments you don’t like, you go into denial and ignore anything you don’t like, and mistake any signs of encouragement, “it’s a good start” as evidence of your genius, and ignore suggestions
It’s pretty funny to keep watching you make really, really wrong assumptions. You really might want to stop doing that.
I also doubt any busy Economics Nobel Prize winner would spend more than five or ten minutes with anyone walking off the street. They usually don’t spend five or ten minutes with their own graduate students. So again like your hedged-claim that you, an MBA, taught economics “at a higher level,” just sounds like a claim too far. Of course you could be deluding yourself that a Nobel Prize winner spent some time on your paper. Your story would be more credible if you found some run-of-the-mill economics professor to check your work over the summer break, and you would get someone that might actually spend some time helping you.
I don’t mean to knock your school, but I can’t recall any econ Nobel Prize winners teaching there, not that I follow them, and they usually don’t like to teach MBA students or undergrads, preferring to teach the next generation of econ Ph.Ds.
Once again, bad assumptions on your part. I didn’t just “walk in off the street” and I never said that the Nobel Prize winner was from my alma mater. I’ve been writing/speaking/consulting on topics related to information economics for over a decade. Most people would recognize that during that time I’ve had opportunities to meet and become acquaintances and friends with numerous economists, including some who specialize in information economics.
And while only a small fraction of your readers are likely Anonymous members or hackers, I would guess that the large majority of your readers are copyright criminals who also have a great capacity for self-deception that they are not stealing the work of others
There you go again with bad assumptions. You really, really ought to look into your propensity to make really dumb assumptions.
Too Bad Mike Flunked Econ 101
You should not make statements that are too easy to prove wrong.
I find this hilarious given just how many comments of this nature you have made in this small thread alone.
Oh you make me laugh.
Too Bad Mike Flunked Econ 101
Also when you make factually incorrect statements that can be so easily proven wrong, people might offer to bet you money and take your money.
Wait. Let me get this straight. You make probably a dozen false assumptions about me, state them as fact, and then I make one single statement about you and you get your panties in a bunch and want me to pay $1,000?
You’re funny.
Loopy. But funny.
Okay. I’ll grant you that it’s entirely possible that you taught economics somewhere, though I stand by my position that I fear for your students if you did.
Anyway, you’re John Doe. You couldn’t prove you taught economics without proving who you are, and I thought you were afraid my “friends” in Anonymous would give you a beat down?
Of course you could say that I made a factually inaccurate statement about you failing econ 101, but I already admitted I was exaggerating for effect the same way people say Obama/Bushed failed Economics.
You made multiple factually incorrect statements about me. I make one (possibly) hyperbolic statement about you and you go whining like a little child and toss out a silly $1,000 bet?
Grow up you little child.
Too Bad Mike Flunked Econ 101
If you keep make “arguments such as:
“Grow up you little child.”
I would suggest you start blogging anonymously as John Doe.
Your commentary has never been that great, but you seem to be falling off the hinges. If the recession and advising companies to sell/compete with free, instead of price at marginal revenue has cut into your consulting business, there is always other honest work.
One can tell from your blog that you rarely listen and will likely go to your death like Gaddafi thinking you are correct, but my guess at where you went wrong is that you took ideas such as Chris Anderson’s Free, added bad economics, and took it too far.
Chris Anderson had a few interesting/wacky ideas on how to make money if you had to sell at free either because of piracy or just competition. You seem to be saying sell at free because of some incorrect economics analysis that since MC is zero, price should “be pushed to” zero, and sometimes bundle with another product if possible.
If it’s any consolation, you are providing a useful (and free) service to honest people, and I assume the MPAA, by providing a summary of the extremists.
And I am not a blogging expert, but I think, “don’t feed the trolls.” is blogging basics. If in your alternative reality, you think I am a troll (and know nothing about economics, lol), you should just shut up.
Too Bad Mike Flunked Econ 101
If you keep make “arguments such as:
“Grow up you little child.”
I would suggest you start blogging anonymously as John Doe.
Your commentary has never been that great, but you seem to be falling off the hinges. If the recession and advising companies to sell/compete with free, instead of price at marginal revenue has cut into your consulting business, there is always other honest work.
One can tell from your blog that you rarely listen and will likely go to your death like Gaddafi thinking you are correct, but my guess at where you went wrong is that you took ideas such as Chris Anderson’s Free, added bad economics, and took it too far.
Chris Anderson had a few interesting/wacky ideas on how to make money if you had to sell at free either because of piracy or just competition. You seem to be saying sell at free because of some incorrect economics analysis that since MC is zero, price should “be pushed to” zero, and sometimes bundle with another product if possible.
If it’s any consolation, you are providing a useful (and free) service to honest people, and I assume the MPAA, by providing a summary of the extremists.
And I am not a blogging expert, but I think, “don’t feed the trolls.” is blogging basics. If in your alternative reality, you think I am a troll (and know nothing about economics, lol), you should just shut up.
Too Bad Mike Flunked Econ 101
I would suggest you start blogging anonymously as John Doe.
Why? Because you don’t like the fact that I call you out when you make bad assumptions and act like a little child? I stand behind my words, unlike some people.
Your commentary has never been that great, but you seem to be falling off the hinges. If the recession and advising companies to sell/compete with free, instead of price at marginal revenue has cut into your consulting business, there is always other honest work.
Having our best year ever, thank you. Overwhelmed with folks asking us for help. We’re actually turning away business these days.
One can tell from your blog that you rarely listen and will likely go to your death like Gaddafi thinking you are correct, but my guess at where you went wrong is that you took ideas such as Chris Anderson’s Free, added bad economics, and took it too far.
You got things backwards. Take a look at who Chris thanked for the key ideas in the book. And trust me, Chris isn’t lacking for consulting work on this topic either.
You seem to be saying sell at free because of some incorrect economics analysis that since MC is zero, price should “be pushed to” zero, and sometimes bundle with another product if possible.
No. Not “should.” If you’re really an economist, you should damn well know that “should” has no place in economics. Should is a moral argument. Like you said earlier, we’re discussing 2+2.
If it’s any consolation, you are providing a useful (and free) service to honest people, and I assume the MPAA, by providing a summary of the extremists.
You make me laugh.
And I am not a blogging expert, but I think, “don’t feed the trolls.” is blogging basics. If in your alternative reality, you think I am a troll (and know nothing about economics, lol), you should just shut up
Responding to people like you is taking batting practice for the real games. You just tee ’em up, and I’ll keep hitting ’em out.
Too Bad Mike Flunked Econ 101
It’s IRONIC that someone who denies most feedback, not just my feedback, is running an “Insight Community” which sells feedback, but I guess you are just the middleman and don’t have to eat your own dog food.
Too Bad Mike Flunked Econ 101
With “friends” like Chris Anderson who needs enemies.
Chris Anderson quotes another poster on this blog who is twice as harsh as I am calling you a communist and a thief who justifies your thievery with economics.
You do realize Chris posted that comment to mock the commenter, right?
The most glowing acknowledgement to you was on the last page in the acknowledgments
In which he notes that I “inspired” the book. Chris and I also discussed the concept of the book at length. To argue that he disagrees with me is kind of funny.
Also, if things are going great, say something concrete like, “Sales have never been higher” because if just say something vague like “going great” people will assume you have no concrete good news to say and are full of it
Bizarre statement, since my exact quote was “Having our best year ever” which is concrete, and I did not say “going great.” In fact, just today we signed a new research deal that is one of the largest we’ve done, which guarantees that we’ll probably double our revenue this year. Life is good. Contrary to your false assumption.
Too Bad Mike Flunked Econ 101
It’s IRONIC that someone who denies most feedback, not just my feedback, is running an “Insight Community” which sells feedback, but I guess you are just the middleman and don’t have to eat your own dog food.
You really are the master of bad assumptions aren’t you.
Hell, I even told you that I took feedback from actual economists. I take tons of feedback. Yours is simply ridiculous.
Don’t confuse the fact that I think your “feedback” is from a position of near total ignorance, with the idea that I don’t take feedback. Taking feedback does not mean agreeing with some idiot. I take feedback from people who actually make valid points.
“Chris Anderson quotes another poster on this blog who is twice as harsh as I am calling you a communist and a thief who justifies your thievery with economics.”
“You do realize Chris posted that comment to mock the commenter, right?”
I have no idea what was in Chris Anderson’s mind, but you think you know what is in his mind.
I don’t know and sort of doubt Chris Anderson screwed you over on purpose, but if someone wanted to screw you over without leaving fingerprints, quoting someone else (Mr Doe says Obama is a socialist, I didn’t say it) is the basic way to do it.
Perhaps you unknowingly called Chris Anderson or one of his friends an “idiot” and “ridiculous” and you ended up with the fingerprintless knife in your back?
Balance & Endless Competition
Competition is necessary to keep market balanced. The weakest must leave, the strongest have to ‘fight’ between them. Each of us is a consumer. So the better quality of goods and services for cheaper price, the better for us all. When you can’t compete with price it is time to compete with quality of products or services.
Re:
I don’t know and sort of doubt Chris Anderson screwed you over on purpose, but if someone wanted to screw you over without leaving fingerprints, quoting someone else (Mr Doe says Obama is a socialist, I didn’t say it) is the basic way to do it.
Reading comprehension failure. You should try reading what’s actually said in that section.
Re:
“There are not good tools available (or executives aren’t using them well) to determine what the marginal cost is.”
The true marginal cost is quite obvious. It’s the minimal cost per song for storing the master, plus the bandwidth for transferring the data. Anyone with access to information from any large datacentre will be able to give the true marginal costs of transferring digital music.
“Your choices are Apple, ‘piracy’, or some other much smaller competitor that has to base their price negotiation with record labels on what Apple has been able to do.”
Not really, especially for Americans who are allowed to buy from Amazon and many others. US listeners are actually spoiled for choice. But, any problem here is a problem with the licensing, nothing to do with the true cost of supplying the music. It’s totally artificial.
Too Bad Mike Flunked Econ 101
ME: “Also, if things are going great, say something concrete like, “Sales have never been higher” because if just say something vague like “going great” people will assume you have no concrete good news to say and are full of it
MIKE” Bizarre statement, since my exact quote was “Having our best year ever” which is concrete, and I did not say “going great.”
If you really took feedback instead of just insulting people, next time if you want people not to think you are a BS artist, you should say “Sales and profits have never been higher” if you honestly can.
When sales and profits have not been higher, people say BS thing like you said “Having our best year ever” which could mean we had the most time off to lay in the park.
I am starting to think in addition to not doing well in economics, you did not do so well in business courses either
Too Bad Mike Flunked Econ 101
If you really took feedback instead of just insulting people, next time if you want people not to think you are a BS artist, you should say “Sales and profits have never been higher” if you honestly can.
Having our best year ever means exactly that. But if you wish to be pedantic and annoying, fine: “Sales and profits have never been higher.” In fact, since I wrote that last message, I can point out that Q4 will be, without a doubt, our best quarter ever in sales and profit, based on what’s already booked (and we still have another month to go…).
I am starting to think in addition to not doing well in economics, you did not do so well in business courses either
You can think whatever you want. You’d be dead wrong. I graduated at the very top of my class. Thanks.
You can't Compete with free
Of course you can, and this is what the content insudtries fail to see.
They need to learn the lesson of Linux. Linux based operating Systems are Free as in free beer (as well as Free as in Freedom), yet both microsoft and Apple compete very successfully with them. How many people use a Linux based operating system on their computers? Certainly not enough to affect Microsoft’s profits, ot Apple’s.
Then there is the lesson of Red Hat, which the content industries also fail to learn from. Red Hat is a Billion dollar company giving away an Operating System, and making money on the value add, the service contracts and other perceived extra value.
Red Hat makes these profits in spite of direct competion from free versions of their Linux Based Operating System, noteably Scientific Linux and CentOS, both of which use the Freely available code base that Red Hat makes available under the terms of a Free Software license (as they are required to by the terms of that Software license which is attached to the source code base they build Red Hat Enterprise Linux from). Yet in spite of the fact that they have competition from Free, they continue to make a profit and grow.
Hotel Commissions
Interesting article .. being in the travel industry it made me think how one could bring hotel commissions to zero and still add value.
Yes, too bad no one could compete with ‘Free’ radio or ‘Free’ broadcast TV.
Imagine if they could have… we might have had a service for the TV with hundreds of channels!!
Small problem
So, if a law exists, it is automatically good and should be followed? Even after the evidence of RAMPANT corruption that controls our political process?
You’re saying that people should follow the law. The law that media distribution companies have paid for, so they could maintain their control over the market. Do you not see the problem with that train of thought?
Not a valid argument
This isn’t a valid argument because the model for digital goods cannot be used as the same model for tangible goods.
Digital goods can be copied, duplicated, and distributed with no risk or cost from “competitors” (say, Icefilms or whatever). If both the illegitimate competitor’s product and the creator’s product is the same in the eyes of the market (and it appears to be trending that way with the rise of piracy) then the creator suddenly loses their rights to profit. Since, of course, the marginal price is zero.
That’s a fairly simplistic analogy, isn’t it? The differentiated (competitive) value here is the movie, itself. To use your analogy, the car manufacturers are continually seeking ways to differentiate with new features that make their product unique in a field of automobiles. If any new feature could be instantly be added to a given vehicle at no cost, what would be the point in producing a new model? In the final analysis – you are an idiot.
Then.. why is their competition between broadcast radio stations?
They are free to the consumer, no?
A lot of people still prefer to buy the “original” ones, not the pirated copies.
The cost of becoming a competitor isn't zero
It does cost something to build a factory. Potential competitors and those who fund them know this and won’t enter a market if they can’t earn back their initial investment plus a profit that offsets the risks involved.
Experenced Pirate..
I am a very experienced pirate with access to anything I could want though around 40 private trackers and other methods. This article in several aspects made perfect sense to me. I will spend the little money I have seeing a movie in the theater for multiple reasons. Mainly it would be for the huge screen, awesome sound, great popcorn I gladly overpay for, etc. I could watch a TS, SCR, etc at home, but if I know I am going to like the movie I MUCH rather see it in a theater. With music I have my favorite bands, I much rather have a physical copy with the paper inserts with all the art, lyrics etc. The music industry lost me though when I wanted my favorite bands CD and it was on the internet ready for download but it would not be in stores for months.. (the band leaked it themselves)
Honestly the best strategy is to be free to your consumers then you can compete on things besides price.
“Free” Radio drove the record industry – pretty much from the beginning. Why do they think ‘free’ won’t work anyway?
Hasn’t radio proven it will?
How else will people hear the music? I’m not just paying for something I’ve never heard – forget that.
Somehow the business model will have to incorporate ‘free’ media on the web, at least to a degree. Just as it had to ‘endure’ radio. If not for that ‘free’ Radio, I bet **exponentially** less music would have been sold over the history of media.
Compete with Free and WIN
For more literature on this topic I suggest you read this, it is from one of my favorite bloggers, Frank Addante. http://www.founderblog.com/2012/05/23/you-can-compete-with-free-and-win/
Oversimplification or misconception?
I know this is over five years old now, but it’s still showing up at the top of google searches so I want to address something I think is very misleading, and I am not sure if it’s due to a misconception on your part, or just that you simplified some concepts to fit into the blog package.
The first is when you say that “the price of a good is always going to get pushed towards its marginal cost.” That’s actually not true, unless marginal cost is constant. You seem to imply that later on, with your $20,000 car example, but marginal cost tends to change with each additional product (which is why it’s called marginal). In fact, it will be strictly non-decreasing after a point.
So, in a perfectly competitive market, the firm maximizes profit when they produce at the point where their marginal cost is equal to the price, meaning they keep producing and their marginal cost keeps going up until it meets the market price. So it’s in fact the opposite of what you claim: Marginal cost is “driven up to” (or rather, “selected to be equal to”) the price.
This is what defines the supply curve.
So when you try to address the issue of people tending “to look at it and say that if price equals marginal cost, then no one would ever produce anything,” what they really don’t see is that, since marginal cost is strictly non-decreasing, the price has been above marginal cost for each good produced up to that point. If the sum of the difference ends up being greater than your fixed costs, you turn a profit. It has very little to do with any value the consumer puts on the product, because that only affects the demand curve, which affects the market price, which affects the quantity produced. But marginal cost will always, in a perfectly competitive market, end up being equal to the price offered for the good.
Now, the market price is based on the total of all of the supply curves in a market, which are all based on that marginal cost, and so in a way price is influenced by what the marginal cost is. But that’s when looking at a market, not an individual firm. So, your conclusion about the price being pushed down to 0 is correct. You just make some mistakes in explanation on the way.
Nominal versus real profits
Price moves to where marginal cost equals marginal benefit on the last unit sold, including opportunity cost. If the movie costs 100 million to make, then the interest that money could have generated in a “risk free” investment has to be added to the zero nominal marginal cost. Assuming the return on investment is 5%, the revenue generated by the sale of the movie will generate 105 million in revenue, because that is the marginal cost for someone to provide the movie for someone to watch. It isn’t zero, because that is a distribution cost that adds to the marginal cost, not replaces marginal cost.
Classic Mikeness! COMMENTERS BEWARE!
Read from #131 (mine, brief) and then go on to those from #132 where Mike appears to debate, but when you contradict Mike, he soon says that you’re ignorant and it’s futile to debate you. That’s his consistent pattern. — He gave up on me after doing the same, and I’ve seen it several times. Mike can’t debate, especially when so trivially wrong as I and #132 point out.
Now, admittedly I and others are a trifle rude. (Seems necessary to be to argue…) It’s an unavoidable mistake as Mike jumps on it to claim you’re totally unreasonable and there’s no point to debate.
I’m surprised this topic is still semi-active (long after my 2011 comment), but if you think this is a forum for debate, you’re quite mistaken: it’s a walled garden for fanboy-trolls, all following this arrogant and ignorant frat boy who has no real world experience. — Saying that $100 million movies are priced without regard to “sunk (or fixed) costs”! Sheesh! He just conjures widgets up out of nowhere to make his notions work! Elsewhere I’ve told him that kids running a lemonade stand know better economics.
Mike actually has no ideas of his own. Just try asking what his position on copyright is: it’s “broken”, that’s all anyone has ever gotten…
The only real fun here is to snipe at Mike and his childish notions, because he SO deserves it.
Classic Mikeness! COMMENTERS BEWARE!
Blue, interesting to see you come back and try again. But, anyway, just to respond to your consistently clueless point, I’ll highlight yet again how you are wrong:
This isn’t debatable. You are wrong. Go to your local movie theater and check the prices. The movies that were made for $200 million have tickets priced the same as those made for $25 million. The cost to make the movie does not factor into the pricing of the ticket. For example, I just looked up my local theater, and I see Elysium and The World’s End are both playing. Elysium cost $120 million to make. World’s End had a budget of $20 million.
And yet… shockingly, ticket prices for each movie is identical.
Believe what you want, but pricing is driven by *marginal* cost, not by fixed costs.
Contrary to your total misreading of what I’ve written (and basic economics), I have never said that fixed costs *don’t matter*. Just that they *don’t matter for pricing*. They matter for the *investment decision* by the producers, in determining if they can recoup that investment at the price that people will pay. The fixed costs definitely do matter for that part, but not for pricing.
This has been explained to you over and over and over again for years. Why do you continue to not get it and to pollute the comments with ridiculous statements?
Enough people visited here to censor me? Or was it Mike hisself?
We’ll see if happens again! Evidence says was Mike, as he makes a RARE reply to me — that I’ll get to.
@ 182. This comment has been flagged by the community. Click here to show it
identicon
out_of_the_blue, Aug 28th, 2013 @ 9:57am
Classic Mikeness! COMMENTERS BEWARE!
Read from #131 (mine, brief) and then go on to those from #132 where Mike appears to debate, but when you contradict Mike, he soon says that you’re ignorant and it’s futile to debate you. That’s his consistent pattern. — He gave up on me after doing the same, and I’ve seen it several times. Mike can’t debate, especially when so trivially wrong as I and #132 point out.
Now, admittedly I and others are a trifle rude. (Seems necessary to be to argue…) It’s an unavoidable mistake as Mike jumps on it to claim you’re totally unreasonable and there’s no point to debate.
I’m surprised this topic is still semi-active (long after my 2011 comment), but if you think this is a forum for debate, you’re quite mistaken: it’s a walled garden for fanboy-trolls, all following this arrogant and ignorant frat boy who has no real world experience. — Saying that $100 million movies are priced without regard to “sunk (or fixed) costs”! Sheesh! He just conjures widgets up out of nowhere to make his notions work! Elsewhere I’ve told him that kids running a lemonade stand know better economics.
Mike actually has no ideas of his own. Just try asking what his position on copyright is: it’s “broken”, that’s all anyone has ever gotten…
The only real fun here is to snipe at Mike and his childish notions, because he SO deserves it.
Classic Mikeness! COMMENTERS BEWARE!
@ Mike: what you say up there is:
As I’ve said often, you put up a huge “IF” and re-inforce it last sentence. The market for movies is NOT competitive NOR have “sunk (or fixed) costs” already been recovered: that’s your totally artifical condition never found in reality, so NONE of what you wrote there holds true! OBVIOUSLY you cannot recoup the $100 million AT ALL! In practice, you can’t recoup a $100 million ten cents at a time, either: even if your “sunk (or fixed) costs” are zero, you just simply can’t get enough people to watch! And yet Mike holds this illustrates some great principle!
Visitors, read this again slowly; Mike sez: “My net outlay is $100 million. My profit is zero. Every new item I make brings back in cash exactly what it costs to make the copy — so the net result is the same. It’s no different that the good is priced at $0 or $20,000” — The KEY point is that Mike has already made the $100 million of “sunk (or fixed) costs” just VANISH so that he can focus on marginal costs! Nothing to do with price, he says, let alone needs to be recovered. Just read from #53.
Another key LIE is that Mike treats physical goods the same as digital distributed movies (his “infinite goods notion), as if the costs for those are at all comparable. Bear that in mind when reading, because Mike always squirms away when I’ve pointed out the misleading juxtaposition: his notions don’t apply to physical goods. (THOUGH, he’s tried telling me that because Wal-Mart gives away free manufacturer’s samples, it proves his notions apply to real goods too…)
Mike’s latest counter is trivially stupid in saying that all movie tickets are priced alike, when they’re not, even for initial showings, and further, MOST of the “box office” take AT a movie theater goes TO the theater itself, which pays a probably FIXED RENT for the movie TO its distributors.
Mike now sez: “The cost to make the movie does not factor into the pricing of the ticket.” — YES, that’s because theaters don’t just hand over ticket sales to distributors: theaters take a RISK on every movie and keep any excess (after their own “sunk (or fixed) costs”. That’s where the flexibility is.
AND then there’s the follow-on market, where one can rent the movie from local store or off Netflix. — Whether ticket prices at a theater are fixed is irrelevant!
You’ve only constructed another deliberately misleading example because leaves out key facts like where most of the ticket price goes.
I’m not the only making these objections, MIke. Anyone who troubles to read all here finds plenty of objections and NO answer from you except more hedging and assertions of authority. #53 begins a crucial weakness that you’ve let lay since Feb 16th, 2007, where you wrote:
SOON, Mike? IT’S BEEN SIX AND A HALF YEARS! You CANNOT patch up the MAJOR HOLES in your assertions!
[By the way, is it any wonder that I’m RUDE to Mike? He’s just dodged with more Classic Mikeness! I assume he didn’t expect me to check here again..]
Enough people visited here to censor me? Or was it Mike hisself?
I’m reminded that BY STRANGE COINCIDENCE, 5 or 6 September was when my posts began to be blocked! I found that changing the “email” address I used “fixed” the problem. Of course I’ve no proof to offer the hypothetical objective reader, but the proximity in time to Mike being vexed enough here on the 4th to post at me — that’s about a once-per-year event — is evidence enough for me personally.
Enough people visited here to censor me? Or was it Mike hisself?
“Evidence”
Citation needed, and a word from Inigo Montoya probably wouldn’t go amiss…
Get help, you paranoid narcissistic loon.
re: Mixed up
Mike writes:
“The point is that there is still demand to get across the river, right? Therefore, it is in someone’s best interest to build that bridge — but they need to realize that they won’t profit directly from the bridge, but from additional services. And, even if others can take a lane for free and copy, the originator can still do quite well just by being the first and having the associated brand.”
Then a bunch of well-armed guys show up and take over the operation, taking all the revenue for themselves. Then another bunch sets up a roadblock at the other end and impose a toll of their own, and the span of the bridge turns into a free-fire zone and the situation becomes indistinguishable from Somalia. What’s to stop this? Don’t say the law, imposing an artificial concept of ownership on the situation…
Time is of the Essence
Mike, you chide your opponents (real or imagined) for not giving time its due, but you are yourself lax in this regard.
The price of goods are generally pushed towards the marginal cost, but rarely do they immediately reach that value, and it is in the area under the curve that ‘monopolistic competition’ works. It is an unstated assumption in your own description of the concept, with its ‘fleeting competitive advantage’.
Furthermore, you are right to point out that it is this way in every competitive market. It is this way for Honda and Toyota, and that is a good thing for society.
These are competitive enterprises by your own definition, but if there were some circumstance that forced their prices to immediately fall to the marginal cost for anything they did (every now and then, some misguided government enacts a law with this effect in some market segment), then in practice, they couldn’t even operate, making the question of whether they could compete moot.
Time and rates of change are relevant factors, and so there are circumstances involving prices at marginal cost where companies that are otherwise competitive could not compete. Consequently, the premise stated in the title of this article is false.
This doesn’t settle the broader issues of competitiveness and public policy, but it takes this particular argument out of play.
Mike is cool
out_of_the_blue and darryl just hate, hate, hate it when due process is enforced.
logic slightly flawed
I think your logic is slightly flawed. There is a difference with $0.
When something is free, there is no barrier or risk at all in acquiring that product or service. If there is a cost for a product, then I have an incentive to perform a more careful comparison to get the best product/service for the money spent.
If I am evaluating two products, one costs $20, and one costs $25. If the high priced product has superior features and better fits the business need, it is likely that someone will purchase that product.
Now, if I am evaluating two products, one is free, and one costs $5. If the $5 has superior features, and better satisfies the business need – BUT – the free product can also do the same job – it may be a bit more clunky, etc. I think most people will opt for the free product.
It may be a psychological effect – but it is real – and vendors have to deal with this reality.
Like all economic dilettantes (i.e., those whose command of economics does not include having graduated summa cum laude in the discipline at an institution in the top 1% globally), the author of this piece makes the first-year-undergraduate error of failing to differentiate between accounting and economic profit.
That is, failing to understand that marginal cost includes a normal rate of return on capital.
So while ‘sunk costs are sunk’, required rate of return times the dollar value invested in the capital stock is part of the ZPP (zero-pure-profits) condition that characterises competitive markets. The author writes as if people who pour money into productive processes just think “Oh, that toll-road we built? Yeah, all that money’s gone now… our marginal cost pricing algorithm should only include maintenance costs’n’shit”.
That small piece of typically-journalistic inaccuracy aside, I am on the author’s side here.
People who are bleating about things like copyright infringement need to understand that the marginal cost of production of a digital copy of a movie, is as near to zero as makes no odds.
The viewing experience of a digital copy does not include THX (or $8 popcorn or pre-movie ads), and is identifiably a different product to paying $20 for a seat in a movie theatre. (Also, I guess that watching something in one’s own home affords the opportunity for watching things in the nude, and a quick one off the wrist should the material warrant it… neither are things that you ought to do in a theatre)
They also need to bear in mind that rates of return on production of movies etc include a significant political premium, due to the the current monopoly-IP framework (whereby the output of some industries is protected against competition, due to bribes-paid, or possession of footage-of-politicians-in-underage-hooker-orgies).
As Cory Doctorow has quipped: if your business model involves trying to make a monopoly profit on a good or service that is made out of bits, you’re making a mistake as stupid as building a house on the side of an active volcano.
Here endeth the lesson: the economic way of thinking is best left to people who maintained an interest in it long after the maths got too hard for you.
We're now entering into a new era that may turn all this on its head.
It’s now 2016 and the fundamentals behind this article’s argument are changing significantly. We’re approaching the age of frugality-driven “performance over flash.” People are seeing through the scams that plague the concept of “value adding.”
“The answer is that they already do — even if they don’t realize it. Why do movies still cost more than $0? Because there’s additional value bundled with the movie itself. People don’t buy “a movie.” They buy the experience of going to the theater. People like to go out to the movies. They like the experience. Or people buy the convenience of a DVD (which is another feature bundled with the movie). They like to buy DVDs (or rent them) in order to get the more convenient delivery mechanism and the extra features that come with DVDs. In other words, they like the differentiated value they can get from bundled goods and services that helps justify a price that’s more than $0. Just as people are willing to pay more than the marginal cost (in some cases a lot more) to get that car they want, they’re willing to pay more for a bundled good or service with content — if only the makers of that content would realize it.”
Actually, the existence of movie piracy does signal a sea change in the conditions that support the assumption of “additional value”.
Take movies. More people do just “consume” a movie. In many cases people just go to the movie theater because that is where they will first get a chance to watch a movie. If they could watch it at home on Day 1, they would. This is why movie theaters fear the idea of simultaneous streaming and theatrical releases: they’d lose huge percentages of what few customers they still have.
Worse yet they’re also hobbled by a lack of convenience. Quite a few consumers out there would be happy to get download movie for free and pop their own popcorn for less money, get a $0.79 two liter bottle of soda compared to $3+ for a 32 ounce theater drink, sit in seats they trust to be clean, and where they can pause the movie to deal with a crying baby, answer their cell phone or go to the bathroom. So they’re not only vulnerable to being defeated by “free” but also by its faithful companion animal, “freedom.” See, putting a price on something also often comes with the right to control how it is consumed: this especially becomes obvious with non-scarce media goods.
But there is also a bigger picture. The no-frills market is growing in popularity with Millennials. Actually, it started with Gen-X’ers. And not just in America. See: Tata motors, Dollar Tree, and other ultra cheap no-frills market entities that are thriving. Then there’s Amazon which and ebay which are just happy to ditch the entire brick and mortar experience and send you a product, with zero frills, for barely above (or sometimes below) its production cost. The concept of adding value is irrelevant to an increasing number of people – the value is in the product doing what it says it does. This is why people generic medicines are increasingly popular and why name brands and no-name brands alike get more equally (but not totally equally yet) lauded or outright dragged in myriads of customer review sites because of their known performance. Also take note of the rise of lower-priced store-brand goods in supermarkets, and their increasing competitive standing against name brand equivalents.
Then take Linux. Microsoft, indeed, has done remarkably well in competing against free and open source Linux, but only in the desktop PC market. Linux has decimated (many times over, no less) Microsoft in the server market, and Microsoft’s presumed plan to make its Internet Explorer web browser a for-pay software like MS Office, was killed early by free software. Then there’s the mobile market, which is now dominated by iOS but also its competitor, Android, which is free. Admittedly the market for the hardware that uses Android has done well in defending itself against FREE: Samsung and its name brand competitors are going strong. (Let’s see how that goes, though, when 3D printing makes knockoffs far cheaper to produce.) In the operating system market, competing against free has quite often proven to be a disaster.
And, devastatingly, nowhere is this more obvious than in the world of employment. Cheap labor is winning out over expensive labor. Hence our astronomical manufacturing sector trade deficit. And even that is giving way to free-per-unit labor aka automation. Wait until people at home can 3D print cars (no doubt more than 50 years in the future) – it will devastate the most popular name brand manufacturers of the day. Free will cut deep into the profitability of non-free as 3D printing matures in efficiency and quality. Even clothing, which is remarkably resistant to “free”, will not be immune to 3D printing. 3D printing and open source designs will totally capsize (though not totally sink) the concept of adding extrinsic value to a product for the purpose of higher than marginal prices.
Make no mistake, adding perceived value to a product will always be profitable to some degree. Mostly the rich will cling to this concept as will those who wish to “keep up with the Joneses”. Then there’s the status-hungry kids who will want the “coolest” shoes, etc. But as they mature into working class adults, reality will force them to consider frugality and frugality favors free over value-added upselling. People are now increasingly skeptical of the value of brands. More people are aware of the psychological manipulations involved in consumer culture, more people are eco-conscious, and more people want their money to go further. The future calls for “adding value” to be defined as “product Y works better than product X and it costs less too”, not “your friends all love product X, you should, too!”
Not exacly accurate...
Benefacio is dancing around a point that you did get wrong, which is this: perfect competition doesn’t take you down to the marginal cost, because shareholders expect a profit. They vote for boards that intend to make a profit. That board hires executives who intend to make a profit, have a plan to do so, and are believably capable of executing the plan. Part of the plan is to price products at marginal cost + intended profit.
Competition only acts with downward pressure on the “intended profit” part of the equation insofar as one company’s intended profits are higher than another’s. Once pricing has reached the lowest profit intended by any company in competition, there is no player left who will unilaterally drop prices further. Think of it as a kind of natural collusion that requires no communication. All of the companies come to the same pricing conclusions because they are all subject to essentially the same pressures and reasons for existing.
This seems arbitrary to some people, even if they see it. It seems arbitrary to Benefacio: “What almost no one can agree on is the amount or percentage of cost that is acceptable for profit.” But it is not arbitrary at all. Companies/shareholders are driven to pursue a very specific profit margin: one that is as low as possible while being higher than that available to any other risk-adjusted activity for that company at that time.
The “as low as possible” part is because of competition. If competition isn’t perfect then they can get more, but competition is what usually caps it, wherever that happens. (Not always, of course. If there is no competition then profit margin is capped only by the value of the product to the consumer; the company can extract all but the last ounce of value from the transaction.) The “higher than other risk-adjusted activities” part is because otherwise the company/shareholders wouldn’t decide to do this business at all—they would do the thing with the higher risk-adjusted return.
You can see this latter force in operation all over the place—it is really just rational buying decisions on the part of investors. If GE wants to sell bonds, it has to pay more interest than T-bills. That’s because GE bonds are riskier. Who would buy them when T-bills were available at the same rate? No one. Similarly, why would anyone invest in a widget company that was only trying to produce 2% ROI? No one. That’s a worse risk-adjusted return than literally just about any other securitized offering. A company willing to price its products that way as a long-term plan would never even come into existence. A target of 6-12% ROI is the only reason to show up and build things (or to fund other people doing so) in the first place.
Now, I’m not sure this is really any kind of hole in your main points. The minimum profit margin for a company is really just a cost of doing business. My point is merely the academic one that it is a cost which cannot be competed away. Only margin in excess of risk-adjusted profitability necessities can be competed away.
Newspaper classifieds didn’t have much luck competing against free from Craigslist.
Re:
Ha ha ha ha
Really? You’re now trolling 12 year old articles with something you’ve had rebutted many times on threads from this year? Wow…
What’s sad is that you’re never making the point you think you are.