Economics has been in the news. Since the start of the recession, many people have been introduced to Hayes’ and Keynes’ conflicting theories and economic literacy is improving. This is a good thing, but as the rest of the world, economics itself is being disrupted by Digital. These are the economics of Digital:
Digital threatens economic rent
According to Google, economic rent is the extra amount earned by a resource (e.g. land, capital, or labour) by virtue of its present use. Digital disrupts rent because it tends to create more value for customers than it does for your organisation, making the extra amount earned tend to zero very quickly.
Digital makes unbundling your product easy, allowing customers to buy only those elements they want or need, and pay for them only when they want it, such as in PAYG insurance.
Digital destroys many intermediary propositions. There is no need for a big box store 30 minutes away when I can have anything I want delivered in under 24 hours. Some intermediaries thrive – such as price comparison sites – but even those propositions drive the destruction of rent values, pushing margin down to 0: first for market participants who want to appear high on the list, then for marketplaces themselves as new entrants lower participation costs.
Digital drives the marginal cost to 0, as Digital products can be infinitely replicated at no cost. This favours only the largest players and puts enormous downward pressure on price, hence the prevalence of free products and service.
As a result, customers benefit and companies find it difficult to win and make money. There are some winners: those that can scale globally and create the best customer experience at the lowest marginal cost. When market prices tend to 0, successful players have found ways to generate revenues elsewhere. The first generation of services was advertisement-supported, shifting the creation of value and introducing the idea of monetising attention or eyeballs. Customers have started to reject adverts and advertisers are querying the value of their investment. Therefore, the model is evolving into one based on data collection, analysis and processing, with the intent to create value for all parties and generating income.
Digital favours Winner Takes All economies
I have written about Winner Takes All before. When scale and network effects dominate a market, all value rises to the top in a strange, frictionless manner.
Traditional markets allow for many players, as the limitations of the physical world play their role. For example: it is impossible to build an infinite physical store, stocked with infinite fresh produce, infinitely close; therefore convenience stores find their niche to market a very limited range of undifferentiated, expensive food.
However, as business becomes Digital, those constraints no longer apply, and a single business can and will dominate. Convenience shopping is doomed – Amazon does it better.
A small number of technology-savvy winners will marshal huge volumes of customer data, drawn from their scale and network advantages. That triggers a virtuous cycle in which information helps identify what products to build and what new sectors to enter, leading to eventual domination and a de-facto monopoly.
Incumbents often procrastinate. They believe their market share will remain, their niches will not digitise or be taken by other players, and that it’s enough to compete with traditional rivals. They fail to disrupt from inside and digitising aggressively. They fail to survive.
First movers have a real advantage
When disruption comes to your industry, you’d think you have 2 ways to react: you could jump in and try to stay ahead, with the added cost and risk from learning as you go; or you could wait and see what the competition do, moving later but executing better.
While both these approaches may have been reasonable in the past, wait and see is no longer an option in the Digital world. The lack of friction sets first movers well on the way to a winner take all position, while low rent levels make it difficult for execution efficiencies to make a real difference in the market. When your competitor’s product is free, how much cheaper can yours be?
First movers develop a learning advantage, what Eric Ries calls Innovation Accounting in The Lean Startup. They test and learn, prototype and refine. They then scale successful experiments into platforms, at a pace that far outstrips that of organizations in wait-and-see mode. They will eventually find a great new business model, but the real value of moving early is to develop the ability to test, learn, prototype and scale at Digital speed. Early movers embed information, new ways of working and learnings across their business. They also benefit from word of mouth from early adopters and undivided attention by influencers and the media.
Do you understand the economics of Digital?
The economics of the Digital world is very different to that which most top managers grew up with and understand. Take the time to really understand the new economic paradigm of no rent and winner takes all. The survival of your organisation depends on it.