Information Economics

Some say the information revolution happened in the 1970s upon the advent of the personal computer, some say it happened in the 90s when the internet reached critical mass. These were incredibly important events in the history of humanity, but I claim the information revolution has seen only its beginnings.

Consider the case of the automobile. The transportation revolution did not happen overnight in 1897 when Rudolf Diesel built the first combustion engine. Instead, it happened gradually as the world was changed around the people as a result of this new technology. Oldsmobile and Ford refined the process of creating cars, and with that transformation came a new kind of economics based on the assembly line. The transportation revolution came to its apex upon the construction of the interstate highway system, upon which the choice of where a person lived and where he worked became decoupled.

We have seen the analog of the advent of the combustion engine and the beginning of Ford’s innovations. “The Information Superhighway” is superficially related to the creation of the highway system, but I think of that as an echo of the revolution of the highway system, not the revolution of the information age. We are at the creation of the assembly line, before it gained wide adoption. Google is Ford.

The reason is that the information age is about information, which is a totally different kind of beast than traditional commodities, around which our economy is based. As few as five years ago, businessmen tried to charge $50 for ready-made software sitting on a shelf as if it were a television or a bag of rice. But that is an ancient conception that completely fails to reflect the economics of what a software package is.

To see this issue clearly, we have to step back from our personal conceptions of money as a thing which allows us to live and operate in society, and think about it in terms of what it was when it was created: an abstraction for trade, which served to make society as a whole more efficient. Money is about allocating scarce resources to where they will most benefit society. It isn’t perfect at doing that job, but it is pretty damn good all things considered. It works way better than communism, which puts that allocation in the government’s hands.

Back to the television and the software package. A single television requires resources to produce. When you buy a television from the shelf, you are communicating “a television has value to me, please continue to allocate resources to produce televisions”. As society moves beyond the need for new televisions, people stop buying them, money (an abstraction for resources) stops flowing to the manufacturer of the televisions, and the company shrinks or dissolves so that those resources can be allocated somewhere where they can more benefit society.

Try to apply this story to software. Software costs resources to produce initially, but after it is on the shelf, all the resources it will ever consume have already been spent during its development, modulo its useless and wasteful packaging. Now there is a component of continuing to improve the software, but the cost of improving the software is not proportional to the number of users the way the cost of producing televisions is proportional to the number of people that want televisions. While treating software as a commodity does serve to compensate the creator for producing the software, when seen from the perspective of the economy as a whole rather than a single business, it makes no sense. The idea of commodity software is a misallocation resources.

Fortunately, the idea of commodity software is gradually fading away. We have mostly done away with the wasteful practice of putting software — essentially free to reproduce — into boxes, which have a cost to reproduce and are only advertisements until they are thrown away by the purchaser. But the model persists in the App Store, among other places. But note how the great Giants of the age are no longer using this model. Apple is profiting off of others using this model, but they are not using it directly. Google and Facebook will have nothing to do with it. Microsoft is dying a slow, painful death.

While there is a social realization that the old commodity model isn’t working anymore, it is not clear to me that anyone sees where it is headed. Google has hit a sweet spot where they can provide value to everyone without charging consumers any money — by collecting data about people, they make it easier for producers and consumers to connect when they stand to benefit from each other, and they found a nice place to skim compensation off of that arrangement. Google essentially has one very valuable product. Apple’s business model is basically that of a hardware company. But how does a typical software company work in the new age of information?

To explore this idea, I will take the vantage point of looking at society as a whole and follow the scent of efficient resource allocation. Resources are required to produce software in the first place: we need ideas, programmers, testers, and marketers. After the software has been conceived of, written, and tested — that is, at the point when the consumer uses the software — all the resources required for producing the software have already been expended. It is nonsense to charge people at this point; society would benefit more if you simply gave your software away, because the cost of doing so is (almost) zero. We need a way to pay for ideas, programmers, testers, and marketers. The resources required for providing a product are proportional to the difficulty of its creation, not the scale of its distribution.

I picture a combination of Kickstarter and an economic extension of UserVoice due to John De Goes. Allow people to pledge money for the improvement (or creation) of a product or feature, to be paid when that feature is usable. The features that are most valuable to people will have the most money pledged to them, providing incentive for the company to develop those features. We are now allocating resources where they need to be: in improving the product, rather than paying for the vacation of somebody who created valuable software in the past, somebody whose mind and expertise would be more beneficial to society developing or improving their product. This is just one idea, I’m certain there are other models that will accurately reflect information economics as well. In particular, this model compensates those who implement an idea, but not those who came up with the idea in the first place, which is a place for improvement.

Observe how this new type of model has shifted the economic emphasis to one derivative higher. People are compensated for continuously improving their product and creating new products, rather than having one great idea and banking on it. This may frighten innovators: their great innovations now stand to make them less money; we now need to constantly work to create value instead of sitting atop a great idea allocating resources. But look at it from society’s perspective: we are coming up on an age of immense growth, in which every worker in the economy is seeking not just to continue the status quo, but to improve it! Everyone is an innovator or an enabler of an innovator. And this all comes from software being free to copy. When something is free to copy, everyone should have equal access to it. Any other way is short-changing society.

It’s time to stop clinging to software as if it is consumed when it is used. There is an economic boom waiting to happen, if we just let information resources flow the way they want to.

Another way to support the new economy is to Flattr this. ;-)

7 thoughts on “Information Economics

  1. I’m going to quibble (and it is just a quibble) with:

    Money is about allocating scarce resources to where they will most benefit society. It isn’t perfect at doing that job, but it is pretty damn good all things considered. It works way better than communism, which puts that allocation in the government’s hands.

    Markets are about allocating resources — and you could do that via barter, without money, but money makes the process more efficient in a way which is orthogonal to the market vs. communism efficiency improvement.

    I agree with your basic point. My employer sells our software on a “subscription for support and updates” basis. That is, once you pay the licence fee you can use the software forever, but to have access to support and new versions you need to pay a yearly fee (and the yearly fee is similar to the initial licence fee). Thus our incentive is to provide excellent support and new features, to persuade existing users to renew their support/upgrade licences. All our software is free to non profits and almost free for personal use — there’s no point in being a dog in the manger when you can identify a user who will benefit but can’t pay.

  2. Right on Luke! i’m digging what you buried in the yard! Also, i had a sneaking suspicion you were a good writer, but now i know for sure! Keep IT up! ;-)

  3. This is an interesting proposition for sure, but I can see some flaws:

    If this ‘fairness’ of valuing turns software into something where it’s essentially impossible to receive anything other than an hourly rare for working on it, won’t it simply drive even more smart people into non-productive industries which do retain the potential for disproportionate reward, e.g. banking, entertainment, etc.

    How would this actually come about? It’s one thing to talk about how short changing society – and god knows, society is being short changed by almost all industries. But what’s to stop people charging money for software by the copy? What would drive creators to adopt this new model that is to their own disadvantage, while the rest of society continues to try as hard as possible to take a larger slice of the pie?

  4. “When something is free to copy, everyone should have equal access to it”

    Let’s knock this up a knotch…

    Rather than speaking of the shrinkwrapped software itself, let’s talk about the company. The marginal cost of copying all of a software company’s products in their current state and then selling shrinkwrapped versions of them… is free. And you can race to the bottom and sell the software to anyone in the world for less than what a soda would cost them.

    So, while it may not be a step function, I think we’re already at what you describe.

    The thing that’s not free, as you point out, is the innovation. Buying my product isn’t just a monitary exchange, it’s, as you put it earlier, a vote for me. I get to set how much voting for me costs, and if you vote for me, then I’ll use that voting power to make more products. If I don’t use those votes to innovate, then shame on me and someone bigger and even less innovative will just copy my software, distribute it en masse, and get revenue by upselling complementary goods.

    The innovators themselves can’t so easily mass produced, though, and in this the artist economy is born.

    Bam.

  5. @”Interesting”, hmm, that is something to think about. The way I imagined it is that software becomes easy enough to create that anything someone sells by the copy can be replicated within a few months and given away for free. This is already happening to some extent with open source. It’s not yet a few months, it takes a few years and the open source software is slightly inferior but still gets the job done. But I feel like that gap is gradually closing. The goal of codecatalog.net is to enable this process (if it’s happening anyway, might as well be in the middle of it, right?).

    The movie and music industries have this problem too. They are solving it with theaters and concerts — unique experiences that cannot be copied. People are getting close to copying theaters with their home theaters. Copying concerts is still a ways off because of all the social energy. Software is already a fundamentally copyable experience.

    I just think the technology is outpacing the industry. Creation follows imagination by only a few months. Prices are dropping to the floor as an idea goes from new and exciting to taken for granted within a year. It’s awesome for society as a whole, but hard to know how to get compensated. There is an open source sweatshop competing with everyone for nothing.

    This segues nicely into Jude’s comment:

    @Jude, what is the marginal incentive people have to vote for you? I can pay several hundred dollars for MS Office, or $0 for a bootleg version (or OpenOffice). Even though I *do* value Microsoft’s technology, I can get the same outcome without paying anything. Microsoft deserves a vote for Office but didn’t get one.

  6. I picture a combination of Kickstarter and an economic extension of UserVoice due to John De Goes. Allow people to pledge money for the improvement (or creation) of a product or feature, to be paid when that feature is usable. The features that are most valuable to people will have the most money pledged to them, providing incentive for the company to develop those features.

    You are describing Threshold pledge system. As Kickstarter’s website does not mention its roots, I feel that I should do this.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s