How the economy works…

Banking collapse

Embedded below is a great 30-minute video walking through the basics of how a capitalist economy works, how they can go wrong and what (ought to) work best to get them back on track, acknowledging that boom and bust cycles are somewhat inevitable…

[ba-youtubeflex videoid=”PHe0bXAIuk0″]

Virtual Goods and Viral Challenges

One of the current trends being debated on the Internet is the rise of the virtual economy – the trade of virtual goods that only exist online. And often only exist within a specific platform online. If the platform goes away, so do all the virtual goods. This leads many academics to ask why do people buy virtual goods? I assume they wonder why people buy tickets to the theatre or cinema too, since once you’ve attended and watched the performance, you have nothing left but the memory. The ticket doesn’t buy you anything physical that you can keep, other than a piece of paper with your seat number printed on it.

In December 2009, BBC News reported that the US virtual economy is predicted to be worth up to $5 Billion in the next 5 years, and that sales in Asia are already at the $5 billion mark and growing.  They are predominantly being driven by games played in online social networks, from massive multiplayer online games (MMOGs) such as World of Warcraft and 3D virtual worlds such as Second Life to web-based sites like Facebook.

One of the key traits of virtual goods at the moment is low cost – individual items usually cost pennies/cents to purchase. That might not sound like much of a business model. But people are far quicker to handover money for cheap goods than expensive ones. And thanks to social networks, virtual products can benefit from viral marketing, leading to 000,000’s if not millions of sales. Those numbers start to add up.

This all sounds wonderful for the business selling the product. However, we are beginning to see that viral growth can have a sting in the tail. As demonstrated last year in Second Life with the plight of the digital chicken:

The trouble with exponential growth is that it rarely persists. An exponential curve will either flatten out or, as seems to happen more often, will plummet. It seems social networks are increasingly driving behaviour towards viral purchases. If you’re betting your business on viral sales, be careful with your forecasts and be prepared for the drop.

Hat to New World Notes for this case study and referencing the above video. His post covers the impact this trend and resulting revenue had on Second Life’s economy.

What we do on the Internet

Harvard Business School’s ‘Working Knowledge’ web site has an excellent article exploring how to quantify the economic impact of the Internet. You can read the article here.

One interesting snippet included in the article is a TNS study reporting on the leading activities of Internet users:

As noted in the article, the majority of activities are funded by advertising one way or another. We don’t pay to use a search engine or read the news (yet – certain news moguls would like to change that…)

I was surprised to see price comparison sites featuring so high up. But what is interesting is that the only two activities not dependent on advertising or affiliate marketing to fund their Internet business models are online banking and paying bills online. Note that number 5 is visiting a brand or product web site, not necessarily buying anything whilst you’re there. How news thinks it can achieve what only banks and utility services have achieved on a mainstream scale is anyone’s guess. Whilst ‘Lookup news’ will likely remain near the top, what form of news could change entirely.

On a related note, Gerry McGovern has an excellent article talking about the differences between Google and Yahoo. Specifically, how Yahoo switched its focus to advertisers whilst Google remains focused on the end-user despite both having the same revenue goals. Proof is in the pudding, as Google continues to rise and Yahoo continues to fall. If they want to make money on the Internet, maybe those news moguls should take a leaf out of Google’s book instead of wanting to torch it.

References:

Microsoft vs Google in the Search Wars

Stop the clocks, blogging has recommenced 🙂

Couple of cheat posts coming up, starting with this one, which are really reproductions of comments I’ve left on other posts but with added juice.

Henry Blodget posted the following article on Silicon Valley Insider: It’s time for Microsoft to face the reality about Search and the Internet

It’s a great article and worth a read. Here’s the comment I left there:

I think people make a good point in highlighting that competition in search is a good thing for us as consumers. Just not sure it’s a good thing for Microsoft

Comparing with the likes of SQL and Exchange is comparing apples with pairs*, I always tell people to never underestimate just how hard MS will work to develop the winning product. But past successes have always been about bringing in a lower cost product with good enough features to compete against an expensive market leader (the business intelligence and systems management markets being two of the latest focus areas gaining ground in the enterprise software market).

Competing against ‘free’, a product used by one audience and paid for by another, is a completely different challenge and one that MS has yet to succeed in. Time will tell. But I doubt it will come from competing like for like. Google didn’t knock Alta Vista off the top by copying their business model. To take over a market means to do something different that weakens the incumbent players. Adding to the challenge is that ‘free’ or ‘freemium’ models have yet themselves to stand the test of time. Somebody somewhere always has to pay, one way or another. Making money from sales of a product or service still have far more long term potential than making money from people paying for the attention you’ve managed to capture.

And that all said, I still wouldn’t underestimate MS, Google isn’t the only one who can create ‘waves’** under cover

I suspect the ol’ Google vs Microsoft debate will rumble on for a few years yet. Steve Ballmer and quite a few influentials within Microsoft would like a big slice of the advertising market that is a fair bit bigger than the software market. But I’m still not confident that’s the right goal.

The argument goes that people are becoming used to not paying for online services. Yet Flickr has done quite well getting people on to premium accounts. Virtual worlds and multi-player online games like World of Warcraft also seem to find plenty of paying customers (I’m one of them, and a girl too – take note, Xbox team. I’m in that market that Nintendo noticed whilst considered a has-been at no.3 in the console market a few years ago). I’m also in that apparent small minority who pays for their music online. Amazon has done quite well just selling stuff that you go looking for rather than have thrown at you in a glitzy banner, eBay isn’t doing so bad either. None of them dependent on advertising revenue. The last two examples have both made money from closing the distance from customer to seller without advertising interrupting the process.

And who wants to be an advertising company anyway? Google succeeded ‘cos they managed to make the ads as unobtrusive as possible and came up with a great revenue concept (auction the search words) to get companies competing for what little ad space there is. Most people seem to dislike ads unless it is for the exact company they are looking for (I do a search for Hilton Hotels, I want the damn official web site, not a million travel web sites) or something completely original (that ends up in the ‘top 100 ads’ TV chart). Even worse are the fake web sites that get into search results only to present you with a page of even more ads than the search engine dared to show you.

Advertising is not a loved market. Microsoft is not a loved company. I don’t know if that’s the synergy they see but it’s not a great start. Without doing the research, I’m guessing the margins in advertising are not as healthy as software. And Google may be raking the cash in from ads but is pouring a fair chunk back out again, not least running the hardware to support YouTube.

What is right is the desire to create a new market. Monopolies (natural or otherwise) and market domination rarely last for very long… unless funded by government but let’s not go there today. Microsoft needs to keep testing new waters and best do it whilst there’s oodles of cash in the bank than start when it’s running out. And call me biased because I used to work there, but I still hope all this Google chatter is smoke and mirrors whilst they work on something worth paying for.

* Oh dear, didn’t notice I’d used pair instead of pear when posting the original comment, and you can’t go back and edit them. Oops.

** Google cleverly making waves (Techcrunch)

Delicious tags: Microsoft Google Business

Where is the value in paying for software

Two interesting articles that share a common theme – the expected value from buying software.

In The Future of Enterprise Software – I am so scared, I am so excited, Chris Balavessov writes about how Waste Management is suing SAP after purchasing a $100m system that failed to work as demonstrated. Apparently, SAP have already admitted the demonstration used to sell the software contained smoke-and-mirrors that were not part of what was being sold to Waste Management. It’s about time somebody questioned the value in some of these expensive deals. Countless organisations spend millions upon millions of dollars on ‘enterprise resource management’ and friends, only to still end up running the business out of spreadsheets. The closing comment from the article:

More so than ever, the time is coming for companies that build it right and do it right to prosper while the ones that exclusively focus on just selling it right and who-cares-what-happens-after-the-deal-closes to stare at a lacklustre or flat revenue curve. Because you really can’t fool all the people all the time.

Hear hear! Smoke-and-mirrors demonstrations wow customers into thinking certain aspects of technology are easier to set-up and use than they actually are. There is often little discussion about the hidden elements (often complex and often dependent on people and information) required to achieve what you see.

In an Interview with Donald Knuth, by Andrew Binstock, they discuss the benefits of open source programming. Whilst I don’t share Donald’s confidence about open source as a dominant business model in the future for writing software, I do agree with his take on how and when we will choose to pay for software:

I believe that open-source programs will begin to be completely dominant as the economy moves more and more from products towards services…Yet I think that a few programs, such as Adobe Photoshop, will always be superior… I’m quite willing to pay good money for really good software, if I believe that it has been produced by the best programmers

I think Apple’s iPhone is the latest example of when people will be more than happy to pay a premium for a product regardless of how cheap similar alternatives may be. Because Apple has established a brand and reputation around being ‘best of breed’ in terms of design and usability of their products. If you don’t want best-of-breed, then the preferred alternative usually sits at the opposite end of the scale – free products that deliver good-enough capabilities. To borrow a style from the old Creating Passionate Users blog, it’s the classic love/hate split where being in the middle = mediocrity = satisfying nobody and going nowhere.

Demand Curve

Regardless of cost, products need to either be very good or just good enough. People will happily jump from free to expensive (and vice versa) when the conditions are right. They rarely move linearly through the range of options. Expensive doesn’t guarantee being very good but we anticipate that cheaper means lower quality. Being average and cheap is not a successful strategy in a market where good enough is available for free. Ditto for being expensive and failing to deliver.

Technorati tag: Software Economics

What comes next?

If I had to attempt foresight, my guess is that the ultimate change this time around will be a shift from local to global politics. Whilst the Internet has created a flattened world in many respects, politics is still a local affair. But there are issues on everyone’s agenda that pay no respect to national borders  Read More