The paper notes the role that information economics played in stimulating / stories/reports/baker-jayadev-stiglitz-innovation-ip-developmentpdf. PDF | In this chapter we outline a novel theory of the consumer market, Whereas mainstream economics bypasses the information problem in its supply-. This overview document of Applied. Information Economics is targeted toward executives who make decisions about approving IT projects. The issues covered .
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When George Stigler published “The Economics of Information” in this journal a little over 50 years ago (), he was justified in his complaints about the. The economics of information has constituted a revolution in economics, information), firms strive to increase their market power and to. “There is no doubt about it: we are living in the Information Age,” Hal Varian, That is why economists have intensely studied the market, the very mech-.
At that time, it became more open to rigorous thinking and made increased use of mathematics, which helped support efforts to have it accepted as a science and as a separate discipline outside of political science and other social sciences. It enquires how he gets his income and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the study of man. This is because war has as the goal winning it as a sought after end , generates both cost and benefits; and, resources human life and other costs are used to attain the goal. If the war is not winnable or if the expected costs outweigh the benefits, the deciding actors assuming they are rational may never go to war a decision but rather explore other alternatives. We cannot define economics as the science that studies wealth, war, crime, education, and any other field economic analysis can be applied to; but, as the science that studies a particular common aspect of each of those subjects they all use scarce resources to attain a sought after end.
Dramatic as those operating changes have been, a more profound transformation of the business landscape lies ahead. Executives—and not just those in high-tech or information companies—will be forced to rethink the strategic fundamentals of their businesses. Over the next decade, the new economics of information will precipitate changes in the structure of entire industries and in the ways companies compete.
Early signs of this change are not hard to find. CD-ROMs came from nowhere and devastated the printed encyclopedia business as we traditionally understand it. How was that possible? This is a spectacular, if small, example of the way information technologies and new competition can disrupt the conventional value proposition of an established business. Imagine what the people at Britannica thought was happening. Microsoft merely spruced up that content with public-domain illustrations and movie clips.
It was a toy. Parents had been downloading Britannica less for its intellectual content than out of a desire to do the right thing for their children. And along with the computer come a dozen CD-ROMs, one of which happens to be—as far as the customer is concerned—a more-or-less perfect substitute for the Britannica.
Revenues continued to decline. The best salespeople left. Under new management, the company is now trying to rebuild the business around the Internet. Britannica is in an information business. Many businesses fit that description, among them automobiles, insurance, real estate, and travel. Every Business Is an Information Business In many industries not widely considered information businesses, information actually represents a large percentage of the cost structure.
More fundamentally, information is the glue that holds together the structure of all businesses. But the value chain also includes all the information that flows within a company and between a company and its suppliers, its distributors, and its existing or potential customers. Supplier relationships, brand identity, process coordination, customer loyalty, employee loyalty, and switching costs all depend on various kinds of information.
When managers talk about the value of customer relationships, for example, what they really mean is the proprietary information that they have about their customers and that their customers have about the company and its products.
Brands, after all, are nothing but the information—real or imagined, intellectual or emotional—that consumers have in their heads about a product. And the tools used to build brands—advertising, promotion, and even shelf space—are themselves information or ways of delivering information. Similarly, information defines supplier relationships.
Having a relationship means that two companies have established certain channels of communication built around personal acquaintance, mutual understanding, shared standards, electronic data interchange EDI systems, or synchronized production systems.
In any downloader-seller relationship, information can determine the relative bargaining power of the players. Auto dealers, for example, know the best local prices for a given model. Customers—unless they invest a lot of time shopping around—generally do not. Not only does information define and constrain the relationship among the various players in a value chain, but in many businesses it also forms the basis for competitive advantage—even when the cost of that information is trivial and the product or service is thoroughly physical.
To cite some of the best-known examples, American Airlines for a long time used its control of the SABRE reservation system to achieve higher levels of capacity utilization than its competitors. Wal-Mart has exploited its EDI links with suppliers to increase its inventory turns dramatically.
And Nike has masterfully employed advertising, endorsements, and the microsegmentation of its market to transform sneakers into high-priced fashion goods.
All three companies compete as much on information as they do on their physical product. In many ways, then, information and the mechanisms for delivering it stabilize corporate and industry structures and underlie competitive advantage. But the informational components of value are so deeply embedded in the physical value chain that, in some cases, we are just beginning to acknowledge their separate existence. When information is carried by things—by a salesperson or by a piece of direct mail, for example—it goes where the things go and no further.
It is constrained to follow the linear flow of the physical value chain. But once everyone is connected electronically, information can travel by itself. The traditional link between the flow of product-related information and the flow of the product itself, between the economics of information and the economics of things, can be broken. What is truly revolutionary about the explosion in connectivity is the possibility it offers to unbundle information from its physical carrier.
To the extent that information is embedded in physical modes of delivery, its economics are governed by a basic law: the trade-off between richness and reach. Reach simply means the number of people, at home or at work, exchanging information. Richness is defined by three aspects of the information itself. The first is bandwidth, or the amount of information that can be moved from sender to receiver in a given time.
Stock quotes are narrowband; a film is broadband. The second aspect is the degree to which the information can be customized. For example, an advertisement on television is far less customized than a personal sales pitch but reaches far more people. The third aspect is interactivity. Dialogue is possible for a small group, but to reach millions of people the message must be a monologue. In general, the communication of rich information has required proximity and dedicated channels whose costs or physical constraints have limited the size of the audience to which the information could be sent.
Conversely, the communication of information to a large audience has required compromises in bandwidth, customization, and interactivity. A company can embed its message in an advertisement, a piece of customized direct mail, or a personal sales pitch—alternatives increasing in richness but diminishing in reach. When companies conduct business with one another, the number of parties they deal with is inversely proportional to the richness of the information they need to exchange: Citibank can trade currencies with hundreds of other banks each minute because the data exchange requires little richness; conversely, Wal-Mart has narrowed its reach by moving to fewer and larger long-term supplier contracts to allow a richer coordination of marketing and logistical systems.
Within a corporation, traditional concepts of span of control and hierarchical reporting are predicated on the belief that communication cannot be rich and broad simultaneously. Jobs are structured to channel rich communication among a few people standing in a hierarchical relationship to one another upward or downward , and broader communication is effected through the indirect routes of the organizational pyramid.
Indeed, there is an entire economic theory pioneered by Ronald H. Coase and Oliver E. Williamson2 suggesting that the boundaries of the corporation are set by the economics of exchanging information: organizations enable the exchange of rich information among a narrow, internal group; markets enable the exchange of thinner information among a larger, external group.
The point at which one mode becomes less cost-effective than the other determines the boundaries of the corporation. The trade-off between richness and reach, then, not only governs the old economics of information but also is fundamental to a whole set of premises about how the business world works.
And it is precisely this trade-off that is now being blown up. The rapid emergence of universal technical standards for communication, allowing everybody to communicate with everybody else at essentially zero cost, is a sea change. And it is as much the agreement on standards as the technology itself that is making this change possible. Those emerging open standards and the explosion in the number of people and organizations connected by networks are freeing information from the channels that have been required to exchange it, making those channels unnecessary or uneconomical.
Although the standards may not be ideal for any individual application, users are finding that they are good enough for most purposes today. And they are improving exponentially. Over time, organizations and individuals will be able to extend their reach by many orders of magnitude, often with a negligible sacrifice of richness.
Where once a sales force, a system of branches, a printing press, a chain of stores, or a delivery fleet served as formidable barriers to entry because they took years and heavy investment to build, in this new world, they could suddenly become expensive liabilities. New competitors on the Internet will be able to come from nowhere to steal customers. Similarly, the replacement of expensive, proprietary, legacy systems with inexpensive, open extranets will make it easier and cheaper for companies to, for example, bid for supply contracts, join a virtual factory, or form a competing supply chain.
Inside large corporations, the emergence of universal, open standards for exchanging information over intranets fosters cross-functional teams and accelerates the demise of hierarchical structures and their proprietary information systems. The existence of channels creates hierarchy, both of choice people have to gather rich information in an order dictated by the structure of the channels and of power some people have better access to rich information than others do.
Hierarchy of choice is illustrated by the decision tree along which consumers are compelled to do their shopping in the physical world: they must choose a street, then a shop, then a department, then a shelf, then a product. They cannot select in any other sequence. They can return to the street and search along a different path, of course, but only by expending time and effort.
Hierarchical Decision Tree Hierarchy of power is illustrated by the traditional organization chart, in which senior executives have a wider span of knowledge than do their subordinates. Hierarchical Organization Hierarchy enables richness but constrains choice and creates asymmetries in information. The alternative to hierarchy is markets, which are symmetrical and open to the extent that they are perfect.
But traditional markets trade only in less rich information.
When the trade-off between richness and reach is eliminated, channels are no longer necessary: everyone communicates richly with everyone else on the basis of shared standards. This might be termed hyperarchy after the hyperlinks of the World Wide Web. Hyperarchy The World Wide Web is a hyperarchy. So are a deconstructed value chain within a business and a deconstructed supply chain within an industry. So are intranets. So are structures allowing fluid, team-based collaboration at work.
So, too, is the pattern of amorphous and permeable corporate boundaries characteristic of the companies in Silicon Valley. So, too, incidentally, are the architectures of object-oriented programming in software and of packet switching in telecommunications. Hyperarchy challenges all hierarchies, whether of logic or of power, with the possibility or the threat of random access and information symmetry. It challenges all markets with the possibility that far richer information can be exchanged than that involved in trading products and certificates of ownership.
When the principles of hyperarchy are thoroughly understood, they will provide a way to understand not only positioning strategies within businesses and industries but also more fundamental questions of corporate organization and identity.
The Deconstruction of the Value Chain The changing economics of information threaten to undermine established value chains in many sectors of the economy, requiring virtually every company to rethink its strategy—not incrementally, but fundamentally. What will be the point of having a supplier relationship with General Electric when it posts its downloading requirements on an Internet bulletin board and entertains bids from anybody inclined to respond?
What will happen to health care providers and insurers if a uniform electronic format for patient records eliminates a major barrier that today discourages patients from switching hospitals or doctors? Consider the future of newspapers, which like most businesses are built on a vertically integrated value chain. Journalists and advertisers supply copy, editors lay it out, presses create the physical product, and an elaborate distribution system delivers it to readers each morning.
Newspaper companies exist as intermediaries between the journalist and the reader because there are enormous economies of scale in printing and distribution.
But when high-resolution electronic tablets advance to the point where readers consider them a viable alternative to newsprint, those traditional economies of scale will become irrelevant. Editors—or even journalists—will be able to E-mail content directly to readers. Freed from the necessity of subscribing to entire physical newspapers, readers will be able to mix and match content from a virtually unlimited number of sources.
News could be downloaded daily from different electronic-news services. Movie reviews, recipes, and travel features could come just as easily from magazine or book publishers. Star columnists, cartoonists, or the U. Weather Service could send their work directly to subscribers. It does not follow that all readers will choose to unbundle all the current content of the physical newspaper, but the principal logic for that bundle—the economics of printing—will be gone.
This transformation is probably inevitable but distant. As newspaper executives correctly point out, the broadsheet is still an extraordinarily cheap and user-friendly way to distribute information.
Little electronic tablets are not going to replace it very soon. However, the timing of total deconstruction is not really the issue. Pieces of the newspaper can be unbundled today. Classified advertising is a natural on-line product. Think how much easier it would be to submit, pay for, update, search through, and respond to classified ads electronically. Newspaper companies have moved aggressively into the electronic-classifieds business.
They have exploited their advantage as makers of the original print marketplace to provide an integrated print and electronic offering that reaches the widest population of downloaders and sellers. The greater their share, by definition, the more attractive they will become to downloaders and sellers. Eventually, the newspapers will either lose business or more likely retain it by settling for much lower margins. Either way, the subsidy that supports the fixed costs of the print product will be gone.
So newspapers will cut content or raise prices for readers and advertisers, accelerating their defection. That, in turn, will create opportunities for another focused competitor to pick off a different part of the value chain. Thus the greatest vulnerability for newspapers is not the total substitution of a new business model but a steady erosion through a sequence of partial substitutions that will make the current business model unsustainable.
Retail banking is ripe for a similar upheaval. The current business model depends on a vertically integrated value chain through which multiple products are originated, packaged, sold, and cross-sold through proprietary distribution channels.
The high costs of distribution drive economies of utilization and scale and thus govern strategy in retail banking as it works today.
Home electronic banking looks at first glance like another, but cheaper, distribution channel. Many banks see it that way, hoping that its widespread adoption might enable them to scale down their higher-cost physical channels. Some banks are even offering proprietary software and electronic transactions for free. But something much deeper has happened than the emergence of a new distribution channel.
Customers now can access information and make transactions in a variety of new ways. Such a system lets customers pay bills, make transfers, receive electronic statements, and seamlessly integrate account data into their personal financial plans. In addition, almost all financial institutions supply information at their Web sites, which anybody on-line can access using a browser.
No single software program can achieve both richness and reach, yet. Web browsers do much less but reach the entire universe of financial institutions. However, the software vendors and switch providers have the resources, and ultimately will be motivated, to form alliances with financial institutions to eliminate this artificial trade-off.
Bridges between financial management software and the Web, combined with advances in reliability, security, digital signatures, and legally binding electronic contracts, will enable financial Web sites to provide the full range of banking services.
If that happens, the trade-off between richness and reach will be broken. Customers will be able to contact any financial institution for any kind of service or information. They will be able to maintain a balance sheet on their desktop, drawing on data from multiple institutions. They will be able to compare alternative product offerings and to sweep funds automatically between accounts at different institutions.
Bulletin boards or auctioning software will allow customers to announce their product requirements and accept bids. Chat rooms will permit customers to share information with each other or get advice from experts. The sheer breadth of choice available to potential customers will create the need for third parties to play the role of navigator or facilitating agent. For example, some companies will have an incentive to create or simply make available databases on interest rates, risk ratings, and service histories.
Others will create insurance and mortgage calculators or intelligent-agent software that can search for and evaluate products. Still other companies will authenticate the identity of counterparties or serve as guarantors of performance, confidentiality, or creditworthiness. But soon, through Internet technologies, customers will have direct access to product providers.
As choices proliferate, totally new businesses will arise to help customers navigate through the expanded range of banking options. Cross-selling will become more difficult. Competitive advantage will be determined product by product, and therefore providers with broad product lines will lose ground to focused specialists.
In this new world, distribution will be done by the phone company, statements by financial management software, facilitation by different kinds of agent software, and origination by any number of different kinds of product specialists.
The integrated value chain of retail banking will have been deconstructed. Deconstructed but not destroyed. All the old functions will still be performed, as well as some new ones. Banks will not become obsolete, but their current business definition will—specifically, the concept that a bank is an integrated business where multiple products are originated, packaged, sold, and cross-sold through proprietary distribution channels. Retail banks will not become obsolete, but their current business definition will.
Many bankers—like encyclopedia executives—deny all this. They argue that most customers do not have personal computers and that many who do are not choosing to use them for banking. They point out that people worry about the security of on-line transactions and that consumers trust banks more than they trust software companies.
All true. However, on-line technology is advancing inexorably. Market research suggests that Quicken users are more likely to be loyal to their software than to their banks. In one study, half of them said that if they were changing banks anyway, they would require their new bank to support the software—that is, allow them to transact their business on-line using Quicken.
Refusal to support Quicken or provide an acceptable alternative could undermine the entire value of a franchise within just a few years. The deconstruction of the value chain in banking is not unprecedented.
Fifteen years ago, corporate banking was a spread business—that is, banks made money by charging a higher interest rate for loans than they paid for deposits. Their business model required them to form deep relationships with their corporate customers so that they could pump their own products through that distribution system.
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