Economics of IT .docx - Economics of IT I Economics of...

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Economics of IT I. Economics of Digital Goods Properties of digital goods 1. Can be easily replicated 2. Can be easily distributed 3. Have an unusual cost structure High cost of producing the first copy low or 0 costs of producing the second, third … (low variable costs) creation costs are sunk (and not easily recoverable) no capacity-based limitations on production digital goods are costly to produce but cheap to reproduce ! Recap: Basic economics: 1. Consumers Consumers prefer more to less (higher quality, higher quantity, better ‘fit’), and are willing to pay more for more For a given product, consumers prefer lower prices Different consumers like different things Some consumers are systematically willing to pay more than others (the ‘wealth effect’) 2. Producers Profits = Revenues – Costs; Revenues = S(price X quantity) Producers prefer higher profits Higher profits require higher revenues and/or lower costs A producer with lower costs can charge the same (or lower) prices for the same product and still make higher profits A producer who sells ‘better’ products can charge a higher price and still sell the same quantity Ex = Britannica v. Encarta - Britannica: 200 years, $2,000 for a printed set - 1992: Microsoft purchased Funk & Wagnalls to make Encarta - Britannica response : Online subscription at $2,000 per year Sales dropped 50% between 1990 and 1996 Online subscription at $120 CD for $200, after1996 $70-$125, now: $50 Sunk costs by first-mover competitors drive price to marginal costs of making additional copy must “uncommoditize” product (dominance; differentiation)
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So how it does it look now? Microsoft shut down Encarta web site on October31, 2009. “The category of traditional encyclopaedias and reference material has changed" "People today seek and consume information in considerably different ways than in years past” Simply could not compete with Wikipedia (1.27% share of Jan visits vs. 97%)! Market structures for digital goods “Commodity” goods (perfect competition) not viable Threat of sequential price cutting (example: CD telephone books) Inevitability of marginal cost pricing when many firms sell very similar digital goods Viable market structures : Dominant firm with economies of scale Differentiated products: Many firms, each producing a differentiated variety of the product The two generic strategies revisited Cost leadership How does one become a cost leader when variable costs are zero? o As quantity sold goes up, average costs go down o Sell and resell as many versions as you can (examples?) o Drive others out of the market Cannot make product price cheaper so minimize average cost (how many units are you selling) à Economies of scale allows to compete with rivals à cut prices Reduce cost by selling more !
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