"The New Economics of Media"
The New Economics of Media Micromedia, Connected Consumption, and the Snowball Effect Umair Haque http://www.bubblegeneration.com Spring 2005 Media 1.0: Mass Media Mass Media Value Chain Publishi Infra Producti ng/ Distribut Attentio structur Retail on Marketi ion n e ng • 6 primary value activities – Infrastructure • Technology – Content • Creativity – Marketing • What media is bought and sold – Distribution • Transport & logistics – Retail • Where and when media is consumed – Attention • Why is attention part of the value chain? • Most media markets are 2-sided markets: they coordinate consumption by advertisers and audiences • Attention is how we will refer to this coordination process Two Sided Markets Production Supply Demand Advertiser Media Audience Demand Supply Attention Supply coordinates demand on both sides of a two-sided market and sets equilibrium prices. Unlike in other markets, in the media marketplace, attention is a critical part of the value chain, because it is demanded by advertisers and supplied by consumers. On the other side of the two-side market, production is demanded by consumers and supplied (funded) by advertisers. Media Orthodoxy • The Media Industry’s First Law: attention is scarce – Is this accurate? • Attention has always been getting absolutely scarcer as media grows • But… – We’re interested in • relative scarcity along the value chain • marginal scarcity at large scale – Relative and marginal scarcity are what count economically… • …because they define the structure, dynamics and expected value of differing strategies in the media industry • Is attention scarce? – Relatively… • …and at the margin? – It’s about to be • But it hasn’t always been… Media Heresy • In fact… – Attention has remained relatively abundant for many years • What!? How can we prove this? • By asking how great the risk of losing audience actually is – The real problem facing the media industry • A zero-sum game: media’s grown quantitatively and qualitatively, but attention hasn’t • Attention’s about to become relatively scarce (fast) – Let’s begin by rewinding • And examining a non-networked world of pure mass media • In order to understand how attention abundance has shaped industry dynamics… • …and led to the creation of core competences and strategies which become core rigidities and errors in a Media 2.0 world Attention Abundance • Attention is directly unobservable… – …and traditional share-based metrics shed no light on relative abundance • But indirectly… – The industry’s actions reveal abundant attention • Following deregulation, network TV ad time per hour increased exponentially from 6:48 in 1982 to 12:04 in 2001 • Similar figures for radio, newspapers and magazines (if we count ‘special supplements’ and advertorials)… • While production investment has increased linearly – Increasing ad time is equivalent to investing in attention • Because ad time is simply a marketing cost borne by players on the other side of the 2-sided market • The distinction between ad time and marketing cost is a figment of accounting – unimportant economically Attention Abundance • What does hypergrowth of ad time tell us? – If attention was scarce, increasing ad time would be a dominated strategy • …Because marginal revenues from advertising would be less than marginal costs of viewers lost to rivals… • …And so returns to investing in attention (increasing ad time) would be dominated by investing in production (higher quality programming) or infrastructure (creating a technological cost advantage) – In fact, attention has been relatively abundant at the margin • Intuition: buying attention via ads is cheaper than attracting it via quality content • Proposition can only hold if attention isn’t scarce, since attention scarcity would increase marginal cost of lost viewers, offsetting marginal revenues from advertising Mass Media Resource Dynamics • In a mass media world… – Downstream resources are scarce... • Distribution scarcity (Transport/inventory/broadcasting costs) • Retail scarcity (Spectrum scarcity, limited shelf/screen space) • Production scarcity (Infrastructure and human capital costs) – …and upstream resources are abundant • Attention isn’t scarce relative to other resources – Attention scarcity isn’t a driver of value creation, because barriers to media consumption are high – Limited supply of cinemas, radio stations, newspapers, tv channels, etc… • Implication: – Quality does not efficiently drive popularity… – …Because attention is cheaper than costly production, distribution, ideas, editing, finishing, etc… Mass Media Industry Structure • Abundance is no surprise, given industry structure – Mass media businesses are cash cows… • …at least in a Media 1.0 world • Ask Warren Buffett (whose fav investment was local papers) – …because high entry barriers artificially or naturally limit rivalry • Broadcast media spectrum scarcity: auctions impose huge entry costs • Print media natural monopoly dynamics: average cost falls in circulation – So mass media players gain strong first-mover advantages • Which they use to acquire, pre-empt, or bankrupt competitors – Supply remains limited on both sides of the 2-sided market • For advertisers, prices rise: media inflation… • …Whose revenues are often used to drop prices on the other side of the market, and subsidize audience growth – Attention remains relatively abundant • Because total supply never grows… Mass Media Value Equation • Mass media value capture is a function of… – Distribution and retail scarcity – Whoever controls these scarce resources… • Can exert market power along the value chain – …increase share and control how value is captured – Retailers and marketers achieve control via consolidation: acquisitions, partnerships, & alliances which realize economies of scale and scope in marketing • Retail & marketing control how value is captured – By leveraging marketing economies of scale and scope to control downstream resources, they can exert market power along the value chain – Canonical examples: vertically integrated Hollywood Studio System, major labels, broadcast networks 1950-1990 Quality Doesn’t Scale • The problem is… – At large scale, marketers and retailers have little incentive to invest in quality • Since production costs don’t realize scale and scope economies, but marketing and retail costs do – Production costs grow in output because risk accelerates – Example: films & records going ‘over budget’ – Marketing costs decrease in output because risk decelerates • Returns dominated by production scarcity, not attention scarcity – Highest returns to player who can most efficiently allocate scarce production resources – What’s the profit-maximizing strategy? • Invest in attention, don’t invest in production – Unintended consequences: • Quality drives popularity inefficiently – Because attention isn’t scarce, but production is Marketing Cost Explosion Hollywood Nominal and Real Marketing Costs, 1981-2004 45 Real marketing expenditure has quadrupled, while real 40 production expenditure has only doubled: firms have 35 cumulatively invested twice as 30 much in attention as production. Since this strategy has persisted 25 Nominal for 25 years, investing in 20 Real attention must realize superior returns to investing in 15 production. 10 Why is this strategy dominant? 5 In a mass media world, 0 producers realize marketing economies of scale and scope, 81 83 85 87 89 91 93 95 97 99 01 03 and production diseconomies of 19 19 19 19 19 19 19 19 19 19 20 20 scale and scope: Popularity and Quality …Quality drives popularity hyperefficiently Media 1.0 Popularity Quality Quality drives popularity inefficiently The Blockbuster Effect The Blockbuster Effect: Downstream Scarcity & Strategy • What’s the dominant strategy in a world driven by downstream scarcity? – Reuse the same expensive content across as many media as you can… • And price discriminate while you do it – Film release windows: Cinema, DVD, Video, TV, Ads – …And across as many market spaces as you can • Via tie-ins, promotions, etc… – Think Star Wars: happy meal toys, action figures, books, posters, t-shirts, breakfast cereal – Aka: Blockbusters • Blockbusters are a strategy to maximize returns on content – By reusing and leveraging it to realize marketing economies • Most efficient allocation of scarce production resources Mass Media Returns: The Blockbuster Effect Consumer goods tie-ins Motion picture revenues Value TV & Cable syndication Demand Output DVD, VHS Cinema The Blockbuster Effect Example: Jurassic Park Merchandising: $50m Revenues Value Syndication: $50m Demand Output Video: $405m Box Office: $480m Blockbuster Economics • Blockbusters are a natural result of mass media economics • Downstream resources scarce, upstream resources abundant • Which is why we see this strategy emerge in all mass media – How do we maximize expected profits of costly production? • Diversify risk by expanding revenue streams across scarce retail and distribution channels (in audience segments) • Price discriminate by cost of retail and distribution channels relative to total segment value • Marketers and retailers realize scale and scope economies via these tactics… – By reusing and leveraging marketing assets across segments • …Which are implicit ways to allocate scarce production resources • …by buying attention, which is cheaper than attracting it via investing in quality – Since attention is relatively abundant The Problem with Blockbusters • Buying attention: marketing economies hit diminishing returns – Each segment is less and less valuable and saturated faster • But since attention is cheap… – Rivalry to economize on production and invest in attention creates marketing cost spirals • Marketing wars between blockbuster marketers, each of whom thinks attention will be cheap • Prisoner’s dilemma: each is better off marketing less • …Quality erodes – As marketing costs spiral and relative production costs shrink – Where have we seen this dynamic? • Hollywood marketing cost explosion, major label sales declines, magazine subscription erosion…everywhere! – These unintended consequences are costless as long as attention is cheap, since quality does not drive popularity – But what happens if attention becomes more expensive… • …and returns to marketing decline? Attention & Production Costs at Large Scale Production is cheaper than attention Media 1.0 Production Cost Production and attention are equally costly Attention Cost Attention is cheaper than production Attention & Production Costs in Rivalry Production is cheaper than attention Media 1.0 Production Cost Production and attention are equally costly Attention Cost Marketing cost wars make attention increasingly relatively costly Attention & Production Costs At high levels of output, investing in attention is profit-maximizing… Attention costs Value Production costs …And investing in production is dominated Output Why do attention and production costs scale differently? Marketing economies of scale and scope are the result of leveraging and reusing content across distribution and retail channels to achieve price discrimination and diversification of risk. Production scale or scope economies aren’t realized because of high costs of contractual completeness, which makes risk increase in output, and high technology costs. Attention & Production Costs At low levels of output, investing in attention is dominated… Attention costs Value Production costs Output Why do some media firms invest in …And investing in production production, and others in attention? is profit-maximizing Because the scale at which they operate dictates different profit-maximizing decisions about which inputs to invest in. Attention & Production Costs Production is more expensive than attention: invest in attention Attention costs Value Production costs Marginal cost of production exceeds marginal cost of attention Output Media firms producing at different scales Attention is more expensive will choose different inputs. Small scale than production: invest in producers will invest in production, and production large-scale producers will invest in attention. Hollywood vs Cannes… Media 1.0 Total Cost Function The shapes of the attention and production cost curves… Cost of all inputs Value …create an S-shaped total cost function Output The S-shaped total cost function means large-scale producers are naturally more efficient than small scale producers, because attention costs diminish due to marketing economies of scale of scope. Marketing Spirals Erode Quality Marketing wars increase the cost of attention… Attention costs Value Production costs ..Since production costs don’t decline, production investment declines: fewer production inputs are used at equilibrium price Output Marketing spirals act as an entry barrier. They raise attention costs, while marketing Marketer and retailer consolidation realizes economies of scale and scope are still realized proportionally (the flattening of the economies of scope and scale in marketing. green curve). The result is a shakeout and increased industry concentration, Production scale or scope economies aren’t because returns to attention remain high only for large-scale players. Quality erodes realized. as production investment is traded for marketing investment. Popularity and Quality …Quality drives popularity hyperefficiently Media 1.0 Popularity Quality Marketing cost spirals mean quality erodes as relative investment in production declines, and becomes even less correlated with popularity Summary: Mass Media Value Dynamics Attentio n In a non-networked media world, retail & marketing capture the most value. Producers and distributors remain fragmented Attentio because production returns don’t scale: they don’t realize n significant economies of scale or scope by consolidating. Attentio n Infra Producti Distribut Marketi Attentio structur Retail on ion ng n e Attentio n Marketing and retail returns do scale: by consolidating, retailers and marketers exert power over downstream resources by realizing economies of scale and scope in Attentio n marketing and retailing, and power over upstream resources by limiting media supply (and consumption choices). Attentio n Summary: Mass Media Value Dynamics Blockbuster strategies emerge due to the natural economics of Attentio mass media: production is costlier than attention, so the n dominant strategy is to invest in attention (marketing cost wars), and economize on production (quality erosion). The Attentio n result is a smaller and smaller number of concentrated players, who are forced to invest more and more heavily in marketing as attention becomes scarcer. Attentio n Infra Producti Distribut Marketi Attentio structur Retail on ion ng n e When attention is abundant and production, distribution, and Attentio n retail are scarce, blockbusters achieve an efficient allocation of scarce production resources, by supplying media valued the Attentio most highly to the greatest number of consumers within each n retail/distribution channel: mass media. The unintended consequence is that quality doesn’t drive popularity. Attentio n Media 2.0: The Age of Plasticity The Age of Plasticity • Media 2.0 is plastic – …atomized media be reshaped, remixed, tweaked, cut, split… – …and aggregated, filtered, distributed, delivered, stored… – …almost any way/to any time/at any place consumers prefer • Plasticity makes Media 2.0 personal – No clear distinction between professional and amateur media… – …because all media can be unbundled/rebundled – The distinction shifts from professional/amateur to mass/personal – Media will be unbundled and rebundled at the personal (not mass) level • Beyond narrowcasting, nichecasting – personal control over the ‘cast • In an atomized environment, what becomes valuable? – What are the economic effects of plasticity? • Or: what does broadcatching really mean? – Let’s begin by understanding the economics of micromedia What is Micromedia? • Micromedia is… – Media that can be consumed in unbundled microchunks… • Microchunks of media unbundled from traditional media goods • Blogs vs newspaper articles • Tracks vs albums • Vlogs vs network news – ..and aggregated and reconstructed in hyperefficient ways • Blogs, vlogs, podcasts, mp3 tracks, RSS feeds • Micromedia can be unbundled and rebundled for consumers… – EG Blog entries can be aggregated and reconstructed by topic • …to create orders of magnitude more value than mass media – Micromedia explodes media supply • The total quantity of media goods explodes – …And atomizes it • The average size of media goods shrinks Micromedia Drivers • What drives the micromedia explosion? • And the shift from downstream to upstream scarcity? – Technology • Falling barriers to production – GarageBand • Unbundling: Falling barriers to distribution & retail – p2p, iTunes, BitTorrent, convergence of connectivity & platforms, micropayment • …And retail/distribution channel growth and fragmentation – Cinema vs VHS, DVD, VCD, MPEG – Regulation • Creative Commons • Fair Use (applicability grows in networked media) – Changing consumer preferences • The rise of connected consumption • The rise of peer production Media 2.0: The Long Tail • Micromedia disrupts the media landscape… – Upstream resources become scarce and downstream resources become abundant • Value capture is a function of attention scarcity • Retail and distribution are not drivers of value creation, because barriers to media consumption are low – Unlimited supply of tv channels, newspapers, radio stations, everything over IP, etc – Retail and distribution aren’t relatively scarce – Hypertargeted, microdifferentiated content is valuable – New market spaces emerge to control how value is captured • …which will be won by players who can realize economies of scale and scope in production or distribution (not marketing) to efficiently allocate scarce attention Media Hyperdeflation • What are the consequences of the micromedia explosion? • As micromedia explodes supply relative to demand, equilibrium prices fall – Production, distribution, and retail become relatively abundant… – …And attention becomes relatively scarce • Consumers can afford to consume greater quantities of smaller chunks of media – Assuming demand for media goods is relatively inelastic… • Or: falling prices don’t command proportionally more attention • Or: media spending/discretionary spending stays stable – As it has been for the last 20 years… • And assuming industry cost structures don’t adapt… – …Average returns fall • Where are we seeing the beginnings of media deflation? Everywhere • Falling ad revenues across mass media, falling circulation in newspapers, etc – Where does the value go? • It’s appropriated by consumers, who can consume more media more cheaply • Unintended consequences: this creates a further incentive for average quality to remain low Attention & Production Costs at Large Scale Production is cheaper than attention Media 1.0 Production Cost Media 2.0 Production and attention are equally costly Attention Cost Attention is cheaper than production Attention & Production Costs At high levels of output, investing in production is profit-maximizing… Attention costs Value Production costs …And investing in attention is dominated Output Value shift: in a Media 2.0 world, producers realize production economies of scale and scope in production, and marketing diseconomies of scale and scope. Attention becomes more expensive than production, because technology vaporizes production (distribution, and retail) costs, exploding media supply (relative to a mass media world, where media supply is fixed), which creates intense rivalry for attention. Strategy Decay: The Consequences of Hyperdeflation • What are the consequences of these economics? • Media 1.0 strategy decay… – The blockbuster and all other dominant Media 1.0 strategies fail in a Media 2.0 world • Why? – Blockbusters are a strategy to realize marketing scale & scope economies – Which is dominant because cheap attention makes marginal returns to marketing more attractive than marginal returns to production – But blockbuster marketing costs increase in rivalry, because rivalry accelerates attention scarcity – Attention becomes more expensive than production, and returns to marketing erode – Implication: marketing costs for blockbusters will explode and returns will implode, as micromedia explodes media supply and accelerates rivalry The Blockbuster Effect & Media Hyperdeflation Consumer goods tie-ins Mass media revenues Value TV & Cable syndication Hyperdeflated revenues Output DVD, VHS Cinema Value Shift and Strategy Decay • More simply… • As competition explodes for attention from newer, cooler, hotter content, attention becomes relatively scarcer, so marginal marketing costs don’t diminish in scale, but begin to increase in scale instead • Or: price of media falls in a hyperdeflationary environment, which means costs must fall or margins must erode • Even more simply… • As attention becomes scarcer, it becomes more costly … • …and so economies of scale and scope in marketing erode because returns fall • …while production becomes more abundant and less costly, and so can realize greater returns • Value shift: • Media 2.0 dominant strategies are based on economies of scale and scope in production, distribution, and search • Which can realize superior returns to relatively abundant and cheap production resources by efficiently allocating scarce attention A Quick Review Media 1.0 Supply & Demand Inelastic demand… Demand Price Supply Quantity …And inelastic supply mean media spending stays stable as % of GDP Understanding Media 2.0 Demand Demand Price Supply Quantity The Long Tail: cheap information shifts demand outwards by the value of distribution and search costs saved Understanding Media 1.0 Supply Indie record labels Price Pixar Clear Channel Aggregate supply curve is inelastic… Quantity …because ownership of scarce production, distribution, and retail resources creates increasingly inelastic firm supply curves Understanding Media 1.0 Supply Price Attention costs Production costs Quantity Because attention costs are relatively low, returns to …production costs dominate attention costs, marketing are economical, because content, production, and retail and marketing wars occur resources are scarce, and attention is abundant Understanding Media 2.0 Supply bloggers podcasters Price Pixar Aggregate supply curve shifts outwards Quantity …Micromedia supply curves are more inelastic than traditional media, because of hyperspecialization. Exampe: bloggers Understanding Media Hyperdeflation Demand Price Micromedia explodes media supply more than cheap Supply information shifts demand outwards… Quantity …and the equilibrium price of media falls: media hyperdeflation Understanding Media 2.0 Returns & Scarcity Price Micromedia explodes media supply… Production costs Attention costs Quantity …attention costs dominate production costs, …Marketing wars because technology ends production, become uneconomical distribution, and retail scarcity, and so attention because returns to costly becomes relatively scarce… attention are low Media 2.0 Models: Aggregators, Platforms, and Reconstructors Understanding Micromedia Micromedia Microchunk Microchunk Microchunk Blog Entry Entry Entry Playlist Track Track Track Podcast Snippet Snippet Snippet New Market Spaces • Who fills the new market space… – …to efficiently allocate scarce attention resources? • Some old (failed) candidates – The Portal – Push (eg PointCast) – Interactive TV • Some new candidates: – The PVR and EPG – The Personal Server – The Feedreader • A jumble of models referred to as – The Aggregator • Two more are emerging: Micromedia Platforms and Reconstructors The Aggregator vs the Aggregator • What is aggregation? – ‘Rebundling of content from fragmented platforms & formats, repurposing, & delivery across new platforms & standards’ • Does this create value in terms of allocating scarce attention? – No! • Dumb aggregation is a value destroyer – The economics of dumb aggregation are about achieving market power via scale economies in syndication – …Scale economies in syndication will become less and less valuable • Due to open standards (eg: RSS, Ogg)… • Exploding the size of the mediaverse… • Massively raising search and transaction costs – How do I find cool new music? Google doesn’t help…Bloglines helps a lil bit – Value captured is a function of efficiently allocating scarce attention… • …dumb aggregation is inefficient at attention allocation Smart Aggregators • The Aggregator 2.0: – Allows consumers to navigate complex media landscapes by efficiently allocating scarce attention according to preferences and expectations • What does this mean? – Smart Aggregators • Leverage deep information about content to predict utility derived by consumers, slashing search and transaction costs of consumption • Examples – Collaborative filters – Recommendation & rating systems – Similarity & difference filters – Etc… – Smart aggregation is aggregation of content plus… • Aggregation of information, expectations, and preferences about content Smart Aggregators • Smart Aggregators don’t just rebundle content from diverse platforms & standards… • …They rebundle content, information about content and… – The network • EG i-Mode menu system (top ranked services move to top of menu) – The application • EG Bloglines, a9, Amazon – The device • EG iPod (with iTunes) – Rebundling of distribution with content aligned with consumer preferences and expectations, efficiently allocating scarce attention • Where will aggregators fail? – Where they don’t leverage info about content to slash search and transaction costs – Where they remain dumb 1.0 aggregators • Canonical example: MNO services • EG Vodafone Live! Micromedia Platforms • What are Micromedia platforms? – The microchunk itself becomes an open-access platform within the niche – An asset others can reuse to produce complementary goods • What kinds of complements can consumers produce? – Blogs, vlogs, podcasts – comments, links, tags – Tracks – playlists – Games – mods – Films – fan films (EG Star Wars) – In general… • the value of complements is bounded by costs of production and coordindation costs of collaboration • Micromedia Platforms – Enable a cost advantage in microdifferentiation – Leverage Peer Production to accurately microdifferentiate your good from other micromedia – Smart Aggregators are about quantity, Micromedia Platforms are about quality…Reconstructors are about both Reconstructors and Personal Media • The Reconstructor is the aggregator 3.0 – Makes media truly personal by leveraging plasticity • What do Reconstructors do? – Deconstruct micromedia by altering, remixing, and filtering microchunks… – …to reconstruct ‘casts of personal media • Unbundle microchunks from micromedia… – Blog entries from individual blogs, tracks from individual playlists • …and rebundle info about microchunks, microchunks, and distribution • EG Last.fm – Unbundles tracks from albums and playlists to reconstruct new playlists the collaborative filter predicts you’ll like • EG Technorati tag search – Reconstructs a result set of cross-media objects by tag • EG re:Blog – Unbundles blog entries from blogs to reconstruct cross-blog feeds by topic • Reconstructors will evolve naturally wherever media is plastic – Wherever microchunks can be unbundled from micromedia – Wherever contribution and aggregation of info about consumption is cheap Media 2.0 Market Dynamics • Smart Aggregators, Micromedia Platforms, and Reconstructors will consolidate horizontally and then fragment vertically – Consolidate across media • Horizontal consolidation realizes economies of scope – Fragment and specialize by industry or market space • Vertical consolidation realizes specialization gains • Their evolution will mirror search evolution – A dominant player horizontalizes… • EG Google moves across media (Web, Images, News, Blogs, Video)… – …and nimbler, more specialized competitors fragment the market vertically • EG Google challenged by Become (product reviews), Mobissimo (travel search), FindWhat (article search), Technorati (blog search) A Side Note on Broadcatching • Broadcatching… – ‘People will consume the media they like best’ • Of course they will – in a perfect world • In the real world… – there are search costs, transaction costs, coordination costs, etc • A simplistic model of a complex reality – Not a useful concept for strategists, because it ignores costs and benefits • Instead, think about the economics behind it – Smart Aggregators, Micromedia Platforms, and Reconstructors • Are ways to broadcatch economically • They operate at different levels… • …and have different dynamics… – (The key point) • …and realize different kinds of economies – Micromedia platforms exploit peer production: coordination economies – Smart Aggregators exploit cheap information: search economies – Reconstructors exploit open standards: distributed economies of scale Understanding Micromedia Platforms Blog Entry Entry Entry Complements & Consumption Info Comment Comment Comment Link Citation Trackback Understanding Smart Aggregators Blog Blog Blog Entry Entry Entry Entry Entry Entry Complements & info Complements & info Complements & info Smart Aggregator Selected Micromedia Blog Blog Entry Entry Complements & Info Complements & info Understanding Reconstructors Blog Blog Blog Entry Entry Entry Entry Entry Entry Consumption info Consumption info Consumption info Reconstructor Personal ‘Cast Entry Entry Entry Understanding The Media 2.0 Ecosystem Microplatform Blog Blog Blog Blog Entry Entry Entry Entry Comment Comment Reconstructor Personal Cast Personal Cast Personal Cast Entry Entry Entry Entry Entry Entry Smart Aggregator Selected Micromedia Selected Micromedia Selected Micromedia Blog Personal Cast Blog Entry Entry Entry Media 2.0 Value Chain Producti on Re Micro Producti Aggreg Attentio constru platform on ation n ction Producti on • 5 primary value activities – Micromedia platforms – Reconstruction • Technology • Personalization – Production – Attention • Human capital – Aggregation • Intelligent distribution Media 2.0 Strategy: Snowballs, Connected Consumption and Increasing Returns Hyperdeflation & Strategy • Does media hyperdeflation mean zero margins for content? – No! – Zero margins for average content • Single blogger, average film, single, or article • Strategy continuum: – Quantity: • Aggregate more content than competitors – Quality: • Microdifferentiate more narrowly than competitors • The point: – Dominant Media 2.0 strategies reverse the effects of hyperdeflation… • By limiting the expansion of supply faster than demand… • Or accelerating demand to catch up with supply – ….and leverage the natural economics of micromedia to create increasing returns to adoption Media 2.0 Strategy • How do dominant Media 2.0 strategies reverse the effects of hyperdeflation? – Production… • Leveraging relatively abundant production resources to cheaply produce microdifferentiated and hypertargeted content – Distribution… • Leveraging relatively abundant distribution resources to cheaply and intelligently distribute microdifferentiated content to niches – …And search economies • Using frictionless information-sharing mechanisms to cheaply reveal aggregate expectations, preferences, and satisfaction within the niche – In combination, these three mechanisms • Create more value than mass media can… • …And allocate scarce attention to it more efficiently than costly marketing or retail resources can – By maximizing aggregate utility derived from content – And slashing transaction and search costs of niche consumption Media 2.0 Value Creation • Why is efficient allocation of attention important? – Content is frictionlessly matched with highest value consumer preferences and expectations… – …Value creation is maximized • Maximizing value creation – Explodes demand or inflates value of supply – …reversing damaging hyperdeflation by raising equilibrium price • What bounds value creation? – Niche size • Because disutility increases in niche size – Search costs • Of finding goods within the niche – Transaction costs • Of consuming goods within the niche • How do you maximize value creation in the real world? – By leveraging connected consumption to slash search and transaction costs, and kickstart increasing returns – ..And leveraging media plasticity to reduce niche size Maximizing Value Creation Utility Aggregate utility Distribution of preferences has fat tails A B C D E Z Preference Continuum A’s disutility increases in Z-ness Z’s disutility increases in A-ness Efficiently allocating attention becomes vital when attention is scarce. Maximizing value creation by matching content with preferences. Maximizing Value Creation Total value lost Utility Total value created Blockbuster 1 captures half Blockbuster 2 captures half A B C D E Z Preference Continuum Mass media producers don’t realize production economies, but realize marketing economies. The dominant strategy is single products that satisfy the greatest number of people – blockbusters opposite the center. Since each niche values targeted content most, marginal disutility from mass consumption limits value creation – attention is inefficiently allocated. Maximizing Value Creation Utility Total value created Snowball 1 captures niche Snowball 2 captures niche A B C D E Z Preference Continuum Micromedia producers can efficiently target content to each niche’s utility function by realizing production economies, which allow the cheap production of targeted content. The dominant strategy is a range of goods that satisfies niches with similar utility functions – snowballs within each niche. Since each niche values targeted content most, marginal disutility is minimized and value creation is maximized – attention is efficiently allocated. Value Creation and Plasticity Utility Total value created Snowball 1 captures niche Snowball 2 captures niche A B C D E Z Preference Continuum How small can your niches get? Niche size is a function of media plasticity – how costly it is to unbundle media elements. The more plastic media is, the less costly it is to build Smart Aggregators and Reconstructors to filter and remix it. For example, reconstructors for Hollywood flicks are costly, because unbundling them is difficult. What increases plasticity? Lightweight, open standards, like RSS; and modular architectures, like blog entries. Disconnected Consumption • Disconnected consumption – Media 1.0 goods are disconnected in consumption… – …centralized mechanisms inform expectations about utility derived from consumption • Your local paper reviews books, movies, music • Bestseller lists, Top 40 charts – Information distortion: these mechanisms are easily gamed • EG Top 40 charts gamed by radio payola • Bestseller lists gamed by publishers buying own books • True aggregate preferences are never revealed – Short term gains have long term costs • Value creation is minimized because attention allocation is inefficient • Consumer skepticism grows: search and transaction costs rise and expected utility falls Centralized & Decentralized Information • Centralized preference information – is uneconomical for micromedia • Siskel & Ebert can review 10,000 movies, but not 1,000,000 blogs • Search and transaction costs are too high • Micromedia goods require connected consumption… – For efficient attention allocation • …because it informs expectations economically – By decentralizing information transmission and processing – How? • Consumers can explicitly share expectations, preferences, and satisfaction… • …Or share complementary goods which implicitly reveal expectations, preferences, and satisfaction • Attention allocation is efficient because transparent info sharing removes information distortion • Decentralized trading of cheap information reveals most valued goods Connected Consumption • Connected consumption: your consumption is complementary to mine – Why? • Consumption externality: • When you consume micromedia, you reveal or contribute private info… • …which is valuable to me when aggregated and made public – How? • 2 mechanisms • By indirectly reducing my search and transaction costs: tags & playlists • By directly increasing my consumption gains: mods & complementary goods – Network FX: my marginal utility increases in number of connected consumers • Blog commenters, playlisters, tag contributors Connected Consumption • Isn’t a new thing – An emergent countercultural response to mass media homogeneity – Canonical example: Underground music, DJs, and the rise of club culture • DJ plays a selection of tracks • Audience reveals preferences, expectations, and satisfaction with their feet: private info is made public • Consumption externality: your dancing reduces my search and transaction costs • Tracks which maximize aggregate utility are efficiently revealed, and value creation is maximized… • …across multiple niches/different genres of club music • Music listeners are a connected network – DJs realized it, the music industry didn’t… • …Now, dance music is the fastest growing segment of the music industry and the segment which most regularly produces snowballs • We will return to this example later Connected Consumption & the Snowball Effect • Putting it all together: The Snowball Effect – Marginal utility can increase in consumption for a microchunk… • Under 2 conditions: • …as long as consumers can contribute information about it • …as long as it’s relative quality is high – …because of connected consumption • Smart aggregators reveal aggregate satisfaction in the niche • Your consumption has an externality: your private info is revealed… • …which helps me predict this good’s quality and slashes my search costs – EG Technorati Link Cosmos, Flickr/del.icio.us tags • …or Micromedia platforms allows consumers to add more complex info, like comments, reviews, karma, etc • You directly increase my consumption gains by producing & sharing complementary goods, whose value is internalized by the aggregator – EG Blogger & comments, games & mods, Winamp & playlists, RSS & shared subscriptions Mass Media Returns: The Blockbuster Effect Consumer goods tie-ins Motion picture revenues Value TV & Cable syndication Demand Output DVD, VHS Cinema Micromedia Returns: The Snowball Effect Syndicated by hi-traffic site Micromedia revenues Value Reviewed by hi-visibility pub Demand Output Aggregated by aggregator Published personally Snowball Example: Blog Syndicated by Yahoo News Micromedia revenues Value Syndicated by Slashdot Demand Output Syndicated by link aggregator Published on personal blog Snowball Example: Podcast Reviewed by the NYT Micromedia revenues Value Syndicated by BoingBoing Demand Output Aggregated by podcast aggregator Published on website Snowballs and Increasing Returns • The more a high-quality microchunk is consumed – the more value is added by consumers – …the more that microchunk is consumed • Because Smart aggregators collect and filter preference info… • …or Micromedia platforms allow complement production • Value snowballs via increasing returns to adoption – Positive feedback: if a product Is high-quality, it’s popularity in the niche will grow as it’s consumed – Quality drives popularity hyperefficiently – The downside • Decentralized info also allows transparency in quality • Aggregate satisfaction for microchunks is visible • Implication: only high quality microchunks can become snowballs – And… • Not all high quality microchunks will become snowballs • Snowballs are high quality microchunks that also maximize utility derived within the niche Popularity and Quality …Quality drives popularity hyperefficiently Firm coordination costs Popularity Media 1.0 Media 2.0 Quality Quality drives popularity inefficiently Snowball Economics • What does this mean? • Snowball economics – Niche demand curve for microchunks slopes upwards • Why? – The economics of connected consumption: Increasing returns to adoption – Quantity demanded increases in price • As a microgood is consumed more and more, consumption externalities add value by slashing search and transaction costs • …and/or complements add value by increasing consumption gains • …which raises the price to later adopters • Inversion of Media 1.0 price discrimination, where early adopters pay more • Example: Club music track… – Gets played at clubs, lounges, etc – Remixed, re-edited – Republished by major label Snowball Economics • The snowball effect means … – …successful aggregator or microdifferentiator micromedia models can realize higher returns than traditional media • Why? – Because snowballs create more total value… • Because micromedia are targeted to niches, and realize less disutility than mass media – And capture relatively more of value created • Because niches become winner-take-all markets… • …so margins explode: snowball prices rise in consumption, while costs remain constant… • This is a form of natural price discrimination which means micromedia producers can exert greater pricing power within niches – And is the inverse of Media 1.0 price discrimination, where prices fall in consumption Micromedia at the Margin Micromedia realizes higher returns Firm coordination costs Value Micromedia returns Traditional media returns Micromedia marginal return exceeds traditional media return Output Traditional media realizes higher returns PP is a More Efficient Producer Snowball Strategy • Whether you’re using Smart Aggregators or Micromedia Platforms to lay the infrastructure for snowballs… – The dominant Media 2.0 product strategy is the same: • Open up your goods – To let others add value and accelerate returns – the snowball effect – Extend openness as far as possible up and down your value chain – Give prosumers access to means of production for complementary goods • Comments are the most primitive example – Give prosumers access to preference and expectation info about your goods • Tags are the most primitive example – This is the polar opposite of Media 1.0 product strategies: – Protect your good with rigid IP to exclude non-payers from consumption • Without open access… – No decentralized info sharing, no connected consumption, no increasing returns, no snowball effect… – …supply explodes faster than demand, equilibrium price falls, margins erode Snowball Strategy and Property Rights • Media 1.0 strategy is built around exclusion – Media 1.0 goods are heavily protected • by all sorts of IPR… • …which function as effective barriers to imitation… • …because the opportunity cost is less than the monopoly right to benefit – IPR are not effective barriers to imitation in a Media 2.0 world • Even if they ‘work’ (ie, prevent ‘piracy’) • Because the opportunity cost is greater than the monopoly right to benefit – Why? – Rigid protection builds barriers to complementarity • It stops you from realizing new kinds of economies, which are the heart of dominant Media 2.0 strategies – Distributed economies of scale… – Economies of scale and scope in production… – Coordination economies… – All depend critically on complementarity between microchunks or microgoods Incumbent Inertia and RIP Media 1.0 • Media 2.0 strategy is built around inclusion – …failing to understand that long-term value creation depends critically on openness… – …and that Media 1.0 imitation barriers become Media 2.0 value traps… – …is going to be the single biggest cause of (fatal) strategic errors Media 1.0 firms make in transitioning to Media 2.0 – Because protectionism is such a deeply rooted part of how they’ve produced goods for decades – AKA Incumbent inertia – …a lot of them won’t survive Jack and Hilary • Don’t use the property rights metaphor – As an excuse for strategy • Here’s why: – The property rights metaphor • Only I have the right to use/benefit/exchange this piece of land – But what if you let others in… • …and they build you a house? – This is where the property rights metaphor ends up in a Media 2.0 world • This is what the economics of micromedia and peer production imply – The property rights metaphor itself is a block to thinking strategically about Media 2.0 economics Snowballs and Beyond the Long Tail • Remember… – the Long Tail not a profit function • It’s an outward shifting of the demand curve • Due to cheap search and an end to distribution scarcity • We are thinking about profit, not just demand • Snowballs are the Long Tail (and beyond) – Not every flick is a blockbuster… – …and not every micromedia good is a snowball – The Long Tail is a mix of the Media 1.0 and Media 2.0 demand curves • Beginnings of the micromedia explosion are shifting the tail of the media demand curve up… • …by changing its composition – Some blockbusters, some snowballs – The Long Tail is the beginning – not the end • At the limit, the Media 2.0 demand curve replaces blockbusters with snowballs • What does this look like? Beyond the Long Tail A smaller number of blockbusters… Demand Price Supply Quantity …And a growing number of …Create new value, which raises snowballs the equilibrium price of media, and also increase demand elasticity Snowball Effect Implications • Leveraging the snowball effect… – Maximizes value creation within the niche • The industry can hit a sweet spot: a sustained period of media inflation – Equilibrium price will rise even as supply explodes – Because demand increases within the niche • Media properties can become classic cash cows… – …like during the mass media golden age 1950-1980 • Eventually, imitation will erode margins – Two key implications: • First-mover advantage: snowball effect first-movers will realize a longer competitive advantage period of higher margins… • Lock out: late movers will be locked out of many niches due to increasing returns • The point: building a micromedia strategy now lays the groundwork for future competitive advantage The New Dynamics of Media • Industry dynamics will evolve through 2 stages – Shakeout • Media deflation as micromedia explodes media supply: shakeout for traditional media across value chain • Blockbuster driven players most threatened • This phase is under way – Majority of traditional media reporting declines in key growth & profitability metrics – Growth • Media inflation as new players leverage snowballs • Demand explodes due to increasing returns – A post-Long Tail world 3-5 years away – The point: • Those players that get shakeout strategies right will realize significant competitive advantages during growth stage – By possessing strong, relevant core competences Media 2.0 Strategy Building Blocks • How do you get shakeout strategy right? – Scale up new business models focused on investing in (not economizing on) production • Peer production models • Open access models • Sharing models – Scale down attention investment • Reduce dependence on blockbusters – Begin experimenting with snowball infrastructures • By generating connected consumption in your existing customer base • How??! – Divestment or refocusing of traditional media businesses… – …and acquisition or organic growth of new media businesses tightly targeting the above market spaces • That resemble Smart Aggregators, Microplatforms, or Reconstructors Media 2.0 Core Competences • What resource & competences will this investment create? – Economies of speed • Blockbusters are slow, because quantity of media is small; snowballs are fast, because quantity of media explodes – Production economies of scale and scope • Leveraging technology to open up access to the means of production – Connected prosumers • Network FX build the snowball effect – Personal media • Maximizes value creation and increases switching costs – Microquality • Quality in the niche becomes significantly more valuable than quality in the mass market The Three Sources of Media 2.0 Value • Revelation – Discovering which content is valuable • DJ’s – everyone’s John Peel – Publishing 2.0 • Aggregation – Centralizing and storing the huge amounts of microcontent… – Distribution 2.0 • Plasticity – Creating value by modularizing, standardizing, or extending content • So prosumers can remix, tweak, cut, merge, split it… • …or cheaply produce complementary goods – Infrastructure 2.0 • These 3 mechanisms allocate scarce attention efficiently – Scarce attention is the fundamental source of Media 2.0 value – Smart Aggregators do 1 and 2, Microplatforms do 3, Reconstructors do all 3 Media 2.0 Value Traps • The Media 2.0 demand curve – Is much less elastic than the Media 1.0 demand curve • Consumers are very price sensitive in a Media 2.0 world • Be careful of overloading consumers with ads • Aggregation – Is only a source of value on it’s own when you can erect barriers to imitation… – …which are tough to build as open standards replace more and more of the Media 1.0 infrastructure • Snowballs – Not every bit of microcontent is a snowball… – …and snowballs are not ‘microblockbusters’… – …because there are few Media 2.0 marketing scale or scope economies Media 2.0 Value Traps • Popularity – …is driven hyperefficiently by quality… • Not marketing – …high-quality content will realize increasing returns (fast) – Conversely, low-quality content will realize significantly poorer returns than in a Media 1.0 world • …because each niche is a winner-take-all market – Invest in production, not in attention • Protection – The micromedia explosion does not mean you should rigidly protect your goods – …instead, use leverage to make micromedia work for you… – …by opening up your goods to realize new economies An Instructive Case Study • House music, 1980 - 2005 – Micromedia explosion • Cheap production technology – Thrift store bought drum machines and synths • Open access distribution channels – Clubs, warehouse parties, etc – For 25 years, house music producers have released tracks using numbers of different aliases • Paradox: why use aliases if goal is to sell records? – Aliases are a kind of antibranding which raise mass market search costs • Strategy has persisted for a very long time – must lead to some kind of gains, otherwise would have been dominated • Explaining this helps us understand a radically different kind of media economics An Instructive Case Study • Why aliases? – Consumers are DJs – niche, not mass market – DJs are Smart Aggregators who arose because of a micromedia explosion and provide specialized knowledge about different genres to listeners – Successful producers release tracks under aliases on their own record labels: labels are important, individual tracks not – Why? • Labels are like tags – They lay the infrastructure for snowballs by allocating scarce attention according to expected utility • Just like tags lay the infrastructure than Smart Aggregators – …allowing DJs to cheaply find tracks they’ll probably like… – …and then play them, remix them, and sample them… – Increasing their attractiveness to other DJs and listeners • This should sound familiar… An Instructive Case Study • The snowball effect – Increasing returns to adoption within the niche – Demand for high-quality tracks increases in consumption – How? • Labels allocate scarce attention efficiently, maximizing value creation within the niche • Listeners vote with their feet – cheap information sharing about utility derived from track (and, by extension, label) • High quality tracks become Micromedia Platforms – Other producers add complements – remixes, edits, samples, etc • Value snowballs – The same dynamics as Media 2.0… • …but 20 years earlier • Smart Aggregators help listeners discover high-quality micromedia, whose returns can snowball, because they’re open platforms for others to produce complements to An Instructive Case Study • 4 crucial lessons, 1 point: • A radically different kind of media economics… – …Is responsible for the value creation (and capture) hypergrowth of House music • Open access product strategies – House producers don’t get the RIAA to sue remixers and samplers • Smart Aggregation – DJ’s leveraging label info to predict value of tracks maximizes value creation within the niche • Decentralized preference information – Listeners vote with their feet – Billboard doesn’t tell them what to dance to • Connected consumption – My value increases when you dance… • Dominant product strategies: • Openness, intelligence, decentralization, connectedness An Instructive Case Study Supply Demand Producer DJ Clubbers Demand Supply Some Recommendations • Get involved with at least one form of underground media – To understand the snowball effect – House music, outsider art, propaganda films • Get directly involved with at least one kind of connected consumption – Blogs, networked games, vlogs, podcasts • Know the difference between dumb and smart Media 2.0 models – MSO EPGs vs TiVo, iTunes vs Soulseek, MSN Spaces vs Bloglines • Really understand the Long Tail – A demand curve which shifts outwards due to cheap information and production… – …not a profit function Conclusion: Summary • The three sources of Media 2.0 value creation… – Revelation – Aggregation – Plasticity • …Give rise to fundamentally new kinds of economies… – Distributed economies of scale – Coordination economies – Production economies of scale and scope... • …which require radically different product strategies… – Openness – Intelligence – Decentralization – Connectedness • …in order to realize these economies and produce the dominant Media 2.0 strategy… – …The snowball effect – And realize increasing returns to adoption within the niche • …which is a total inversion of the dominant Media 1.0 strategy – The blockbuster effect Thank You