Friday, July 30, 2010

Why Information Is Not Free: The Myth of Frictionless Capitalism...

Information is the lifeblood of markets - knowing what is available, where it's available, and who wants it are crucial. Internet talking-heads have long insisted that, in the Digital Age, information wants to be free. But is this really the case?

In his book, Reinventing the Bazaar: A Natural History of Markets, John McMillan argues that, in fact, it is not case.

When we think of internet economics from a consumer-driven perspective, we think of comparison shopping. The search costs involved in finding the best price for a specific item have been greatly reduced by people's new ability to simply Google that item and see, within a matter of seconds, which seller is offering it at the lowest price. It's not rocket science to see how the balance of bargaining power has shifted to consumers.

And from the sellers' perspective, using information to match demand and serve the demand also creates positive economic externalities. This is what Bill Gates has referred to as "friction-free capitalism".

This all sounds logical in theory, however the results haven't always panned out as expected.

While it's true that the ease of comparison shopping on the internet has brought a perceptible lowering of prices, as economic theory predicts, it has failed to eliminate the dispersion of prices. What this means is that the same book might cost $19.99 on Amazon, but &16.99 on Barnes & Noble.com, and $12.99 on Books.com. In fact, if you perform a comparison shop on almost any item, it's striking how different prices on the same item remain despite the sellers' knowledge that many consumers comparison shop so easily on the Web. According to one study, the typical price dispersion was 37% for books and 25% for CDs. For books, there is actually more price variation among internet retailers than among bricks-and-mortar retailers.

Thus, the ready availability of "free" price information has not driven prices of identical items into alignment. This is something of a puzzle. McMillan says this can possibly be explained by 1) the laziness of shoppers to search for the lowest price, 2) the reliability of the seller, and 3) trust in the proprietor's judgment. Basically, the shopper is not simply buying a book, but a package of services of which the book itself is only a part. "Apparently, homogeneous items often are not actually homogeneous: it matters where you buy them".

This hardly paints a picture of frictionless capitalism. There are still clear search and transaction costs involved in the functioning of even the most modern digital markets, and that's a point worth remembering to those who tend to oversimplify E-business models.

What Stewart Brand once said still holds true... "Information wants to be free. Information also wants to be expensive. [It] wants to be free because it has become so cheap to distribute, copy, and recombine - too cheap to meter. It wants to be expensive because it can be immeasurably valuable to the recipient".
  

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