Ruthless Efficiencies

As readers of this site know, I strongly believe that we are now in the middle of a major overall shift in economic trend that hasn’t been seen since the introduction of the paper bill in late 1700s england. Seen under this lens, I’m starting to think that there may be some truths to the claims that some of the traditional industries are making that their business is getting hurt by new technology. Their business is getting hurt but it’s not because of any particular evil on the part of Internet companies. The truth is that the reason those industries are starting to suffer from the propagation of Internet technology is that their traditional business models were based on inneficiencies in the market.

The Music Industry

Take, for example, the music industry. Traditionally, the music industry has been based on aggregating multiple songs on a piece of media. Every few decades, they would benefit from the introduction of a new technology (for example, shifing from LPs to 8-tracks, then to cassette tapes, then to CDs) as people had to basically purchase the same good over and over again when they upgraded their equipment. Then came the concept of a digital track available via download. The music industry is trying to resist that change because the shift from selling pieces of plastic at a premium to buying individual tracks hurts them in two ways:

  • first, they now have to ensure that every track they sell has the potential of getting some buyers. Gone are the days of packaging some sub-standard product with some better products in order to average out the difference. Now, every track has to fend for itself.
  • Secondly, they can no longer rely on technology as a way to get sell the same track again and again to the same people.

So, of course, they are resisting the change. The issue they have with MP3s and downloadable music does not have to do with people sharing things illegally (as people have been sharing music illegally since the first days of recordable media) but rather because digital music has the potential of making their market a lot more efficient. Now that goods (in this case, songs) are parceled out in their most atomic way, there is no room for them to repackage them into something bigger that may be 10 percent good and 90 percent useless. Their approach to fighting things, of course, is to sue and attempt to create a new closed system through the use of digital rights management (DRM) in order to protect their advantage.

The advertising industry

Another industry getting hurt by the Internet is the advertising business. Traditional advertising business have been based on selling a general audiences to advertisers. The model, however, was based on the concept that some percentage of the audience would buy the product. What was always in question, though, was how much that number was. Then came the Internet with its easy to measure model. Ad banners were measurable but response rates were low. Then came google, with its rich contextual advertising model and its offer to charge advertisers only for the clicks they received. This started to change expectations as to what is now expected of advertising. As a result, advertisers are becoming more demanding of traditional media, requiring more information about the effectiveness of their purchase. Television, newspapers, radio are now considered less effective, because they can’t provide the rich tracking data that the internet does. The net result of this is that advertising is becoming more efficient. Along with that efficiency comes the fact that less dollars will be wasted and therefore less dollars will be spent. Because expectations have changed, advertising is suffering. Their model is evolving and they’re having difficulties adjusting.

The phone industry

The Internet is also starting to hurt the phone industry. The recent announcement by Gizmo that they would offer free calls is just another thing highlighting how the phone company model is broken: traditionally, phone calls have been very cheap to deliver (in an order of magnitude much lower than 1 cent) and phone companies have been charging a very large amount for those offerings. Voice over IP is undermining that, showing people that phone service can be very cheap. In the US, the telcos are trying to fight this by attempting to create a multi-tiered internet where such services would not go through. That model is doomed as mesh networks could undermine their ability to do so. Once again, efficiency is making a product much cheaper. At that point consumers win and the remaining players are making good money but are playing in a marketplace that is much smaller than it used to because inneficiencies have been worked out of the system.

Services

Service providers who do not need to have a foot in meatspace (accountants, lawyers, etc…) have the potential of being affected too. In “The World is Flat“, Friedman argues that this type of work is shifting overseas. He’s right and the long term trend has the potential of shaking up many services industry by providing those services at a much cheaper rate. Once again, the introduction of the internet and globalization is making a market more efficient (hence cheaper costs) but leaving behind a much smaller marketplace.

What to do?

When this stuff happens, the only thing you can do is figure out how to move upstream or change your business model. Large corporations are generally slow at making those types of evolutions but it’s a make or break scenario: adapt or die. The process can be painful: One of the first thing to do is figure out where your fat is and reduce it. This means getting rid of people who do not provide real value. The second part is figuring out which part of your business are highly efficient and invest in innovating with those companies. Ultimately, costs will continue dropping and survival will continue to be about increasing efficiency.

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