A Comparison Of Doing Business In The Digital vs. The Traditional Economy

Posted By Carlos Batista on May 18, 2017 in Business Topics, Online Business | 0 comments


Digital economy

 

Traditional Economy

 

In the traditional economy, there is a trade-off between the reach, richness and flexibility of communication. For example, if you want to transmit a message to many people in short period of time then advertising on television or radio may have been an appropriate policy, however the trade-off of high reach is low richness.

 

You don’t get very much detail from a minute advert on television or radio, usually I find that it just gets you thinking about the product, at most, there isn’t time to engage with the product on any significant level.

 

At the other end of the spectrum is one on one communication between the sales assistant on the shop floor and the consumer, but here again there is a trade-off between richness and reach i.e. high richness but low reach.

 

Digital Economy

 

However, the digital economy provides us with a platform for rich, unique and flexible communication with a very high reach potential, simultaneously. The challenge is for businesses to utilise this potential effectively take advantage of the economies of scale available.

 

Another, remarkable difference between the traditional economy and the digital economy is the idea of network effects. Here companies can take advantage of economies of scale.

 

The internet has increasing returns to scale, as the number of users increase the value of to each user increase. There is huge potential here for firms to increase the value of their products to consumers.

 

There is the potential for first-mover advantage, where if companies can take advantage of the network effects they can move down the learning/experience curve reducing the average costs of the product.

 

By reducing prices as average costs fall, firms can create barriers to entry, in a sense creating monopoly scenarios, but interestingly, monopoly scenarios where there is an increase in welfare to the consumer as well as to the producer.

 

Social Media Networks

 

Twitter is a perfect example of this, the combination of network effects and the learning curve results in a winner takes-all scenario, where markets work more effectively if one company controls the entire market.

 

A small number of social networking sites, Twitter, Facebook, LinkedIn, Instagram etc. have managed to lock-in to their consumer base and this has resulted in a tipping point where the competing company will experience a negative spiral as it loses customers and increases its average costs per unit.

 

One could further argue that it is economically inefficient to have more than one company compete in a marketplace for digital products, (we assume that there are large fixed costs that are sunk, but close to zero variable costs). Each competing firm would be adding to the total investment made in development costs of creating the product.

 

However, I believe that there needs only to be marginal product differentiation for firms to survive, the idea of two firms providing a service or goods that have close substitutability and yet are complementary at the same time.

 

This is the apple idea of small change. Garett Jones of George Mason University argues that so much of the production and innovation that goes on is by companies already in a line of work, deciding to just tweak slightly what they are doing to create a lot more value for people.

 

The iPad is a great example of this. Everybody made fun of it the day after it came out, “It’s just a huge iPhone.” But then upon reflection, a huge iPhone might be great. We all know the result today right.

 

Markets For Everyone

 

This is why Blogs, Twitter , LinkedIn, Instagram and Facebook are able to survive in the same ‘digital market’ and still take advantage of increasing returns to scale and first-mover advantage.

 

It is the small differences between the ‘products’ that allow providers of internet based services to stand alone, ‘niche based markets’. However, companies will never be able to take advantage of these network effects unless they can lock-in with their consumer base!

 

This is the fundamental message! Fortunately, the marketing lot are working hard at getting businesses to engage with their consumers ‘people to people’, so well done you lot!

 

Related to the idea of reach, richness and flexibility, and product differentiation is the theory of ‘The Long tail’. ‘The Long Tail’ refers to the statistical property that a larger share of population rests within the tail of a probability distribution than observed under a ‘normal’ or Gaussian distribution.

 

This has gained popularity recently as a retailing concept describing the niche strategy of selling many unique items in relatively small quantities. More than half of amazon.com sales come from book titles that are outside of the top 130,000, and thus books that would not be stocked in your traditional book store.

 

These sales are a result of the needs of a few. However, those few, aggregated across the entire internet, make a compelling business proposition. As you can see this relates well with our idea of small product differentiation.

 

Conclusion

 

My conclusion, if companies can engage with their consumers and thus take advantage of network effects and increasing returns to scale, then there are potential gains to be made for consumers and producers whilst minimizing the dead weight loss associated with traditional monopoly behavior.

 

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