The New Economics of MediaMicromedia, Connected Consumption, and the Snowball Effect

Umair Haque http://www.bubblegeneration.com Spring 2005

Media 1.0: Mass Media

Mass Media Value ChainInfra structure Production Publishing/ Marketing Distribution Retail Attention

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 MarketsProduction Supply Demand

Advertiser

Media

Audience

Demand Attention

Supply

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 Industrys First Law: attention is scarce Is this accurate? Attention has always been getting absolutely scarcer as media grows But

Were 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?

Its about to be But it hasnt 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: medias grown quantitatively and qualitatively, but attention hasnt Attentions about to become relatively scarce (fast)

Lets 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 industrys 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 isnt 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 isnt scarce relative to other resources Attention scarcity isnt 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 Doesnt Scale The problem is At large scale, marketers and retailers have little incentive to invest in quality Since production costs dont 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

Whats the profit-maximizing strategy? Invest in attention, dont invest in production

Unintended consequences: Quality drives popularity inefficiently Because attention isnt scarce, but production is

Marketing Cost ExplosionHollywood Nominal and Real Marketing Costs, 1981-2004 Real marketing expenditure has quadrupled, while real production expenditure has only doubled: firms have cumulatively invested twice as much in attention as production. Since this strategy has persisted for 25 years, investing in attention must realize superior returns to investing in production. Why is this strategy dominant? In a mass media world, producers realize marketing economies of scale and scope, and production diseconomies of scale and scope:

45 40 35 30 25 20 15 10 5 01 3 85 7 9 1 93 5 7 9 01 19 8 19 8 19 8 19 8 19 9 19 9 19 9 19 9 19 19 20 20 03

Nominal Real

Popularity and QualityQuality drives popularity hyperefficiently

Popularity

Media 1.0

QualityQuality drives popularity inefficiently

The Blockbuster Effect

The Blockbuster Effect: Downstream Scarcity & Strategy Whats 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 EffectConsumer goods tie-ins

Value

Motion picture revenues TV & Cable syndication Demand

OutputDVD, VHS

Cinema

The Blockbuster Effect Example: Jurassic ParkMerchandising: $50m

Value

Revenues Syndication: $50m Demand

OutputVideo: $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 Prisoners 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 erosioneverywhere!

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 ScaleProduction CostProduction is cheaper than attention Media 1.0

Production and attention are equally costly

Attention CostAttention is cheaper than production

Attention & Production Costs in RivalryProduction CostProduction is cheaper than attention Media 1.0

Production and attention are equally costly

Attention CostMarketing cost wars make attention increasingly relatively costly

Attention & Production CostsAt high levels of output, investing in attention is profit-maximizing

Value

Attention costs Production costs

And investing in production is dominated

OutputWhy 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 arent realized because of high costs of contractual completeness, which makes risk increase in output, and high technology costs.

Attention & Production CostsValueAt low levels of output, investing in attention is dominated Attention costs Production costs

OutputWhy do some media firms invest in production, and others in attention? Because the scale at which they operate dictates different profit-maximizing decisions about which inputs to invest in. And investing in production is profit-maximizing

Attention & Production CostsValueProduction is more expensive than attention: invest in attention Attention costs Production costs

Marginal cost of production exceeds marginal cost of attention

OutputMedia firms producing at different scales will choose different inputs. Small scale producers will invest in production, and large-scale producers will invest in attention. Hollywood vs Cannes Attention is more expensive than production: invest in production

Media 1.0 Total Cost FunctionThe shapes of the attention and production cost curves

Value

Cost of all inputs

create an S-shaped total cost function

OutputThe 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 QualityMarketing wars increase the cost of attention

Value

Attention costs Production costs

..Since production costs dont decline, production investment declines: fewer production inputs are used at equilibrium price

OutputMarketing spirals act as an entry barrier. They raise attention costs, while Marketer economies of scale and realizes marketing and retailer consolidationscope are still realized proportionally (the economies of scope and scale in flattening of the green curve). The result is a shakeout and increased industry marketing. because returns or scope concentration, Production scale to attention remain high only for large-scale players. Quality erodes as realized. investment is traded for marketing economies arent production investment.

Popularity and QualityQuality drives popularity hyperefficiently

Popularity

Media 1.0

QualityMarketing cost spirals mean quality erodes as relative investment in production declines, and becomes even less correlated with popularity

Summary: Mass Media Value DynamicsIn a non-networked media world, retail & marketing capture the most value. Producers and distributors remain fragmented because production returns dont scale: they dont realize significant economies of scale or scope by consolidating.Attention

Attention

Attention

Infra structure

Production

Distribution

Marketing

Retail

Attention

Marketing and retail returns do scale: by consolidating, retailers and marketers exert power over downstream resources by realizing economies of scale and scope in marketing and retailing, and power over upstream resources by limiting media supply (and consumption choices).

Attention

Attention

Attention

Summary: Mass Media Value DynamicsBlockbuster strategies emerge due to the natural economics of mass media: production is costlier than attention, so the dominant strategy is to invest in attention (marketing cost wars), and economize on production (quality erosion). The 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.Infra structure Production Distribution Marketing Retail Attention

Attention

Attention

Attention

When attention is abundant and production, distribution, and retail are scarce, blockbusters achieve an efficient allocation of scarce production resources, by supplying media valued the most highly to the greatest number of consumers within each retail/distribution channel: mass media. The unintended consequence is that quality doesnt drive popularity.

Attention

Attention

Attention

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?

Lets 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 arent 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 dont 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 dont 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? Its 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 ScaleProduction CostProduction is cheaper than attention Media 1.0 Media 2.0 Production and attention are equally costly

Attention CostAttention is cheaper than production

Attention & Production CostsAt high levels of output, investing in production is profit-maximizing

Value

Attention costs Production costs

And investing in attention is dominated

OutputValue 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 HyperdeflationConsumer goods tie-ins

Value

Mass media revenues TV & Cable syndication Hyperdeflated revenues

OutputDVD, 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 dont 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 & DemandPriceInelastic demand Demand Supply

QuantityAnd inelastic supply mean media spending stays stable as % of GDP

Understanding Media 2.0 DemandPriceDemand Supply

QuantityThe Long Tail: cheap information shifts demand outwards by the value of distribution and search costs saved

Understanding Media 1.0 SupplyPriceIndie record labels Pixar Clear Channel

Aggregate supply curve is inelastic

Quantitybecause ownership of scarce production, distribution, and retail resources creates increasingly inelastic firm supply curves

Understanding Media 1.0 SupplyPrice

Attention costs

Production costs

QuantityBecause attention costs are relatively low, returns to marketing are economical, and marketing wars occur production costs dominate attention costs, because content, production, and retail resources are scarce, and attention is abundant

Understanding Media 2.0 SupplyPricebloggers podcasters Pixar

Aggregate supply curve shifts outwards

QuantityMicromedia supply curves are more inelastic than traditional media, because of hyperspecialization. Exampe: bloggers

Understanding Media HyperdeflationPriceDemand Micromedia explodes media supply more than cheap information shifts demand outwards Supply

Quantityand the equilibrium price of media falls: media hyperdeflation

Understanding Media 2.0 Returns & ScarcityPriceMicromedia explodes media supply Production costs

Attention costs

Quantityattention costs dominate production costs, because technology ends production, distribution, and retail scarcity, and so attention becomes relatively scarce Marketing wars become uneconomical because returns to costly attention are low

Media 2.0 Models: Aggregators, Platforms, and Reconstructors

Understanding MicromediaMicromediaMicrochunk Microchunk Microchunk

BlogEntry Entry Entry

PlaylistTrack Track Track

PodcastSnippet 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 doesnt helpBloglines 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 dont 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 dont 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 qualityReconstructors 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 youll 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 PlatformsBlogEntry Entry Entry

Complements & Consumption InfoComment Comment Comment Link Citation Trackback

Understanding Smart AggregatorsBlogEntry Entry Complements & info

BlogEntry Entry Complements & info

BlogEntry Entry Complements & info

Smart Aggregator Selected MicromediaBlog Entry Complements & Info Blog Entry Complements & info

Understanding ReconstructorsBlogEntry Entry Consumption info

BlogEntry Entry Consumption info

BlogEntry Entry Consumption info

Reconstructor Personal CastEntry Entry Entry

Understanding The Media 2.0 EcosystemMicroplatform Blog Entry Blog Entry Blog Entry Comment Reconstructor Personal Cast Entry Entry Personal Cast Entry Entry Personal Cast Entry Entry Smart Aggregator Selected Micromedia Selected Micromedia Selected Micromedia Blog Entry Personal Cast Entry Blog Entry Blog Entry Comment

Media 2.0 Value ChainProduction

Micro platform

Production

Aggregation

Re construction

Attention

Production

5 primary value activities Micromedia platforms Technology

Reconstruction Personalization

Production Human capital

Attention

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 CreationUtilityAggregate utility Distribution of preferences has fat tails

A

B

C

D

E Preference ContinuumZs disutility increases in A-ness

Z

As disutility increases in Z-ness

Efficiently allocating attention becomes vital when attention is scarce. Maximizing value creation by matching content with preferences.

Maximizing Value CreationUtilityTotal value lost Total value created Blockbuster 1 captures half Blockbuster 2 captures half

A

B

C

D

E Preference Continuum

Z

Mass media producers dont 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 CreationUtilityTotal value created Snowball 1 captures niche Snowball 2 captures niche

A

B

C

D

E Preference Continuum

Z

Micromedia producers can efficiently target content to each niches 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 PlasticityUtilityTotal value created Snowball 1 captures niche Snowball 2 captures niche

A

B

C

D

E Preference Continuum

Z

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 Isnt 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 didnt 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 its 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 goods 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 EffectConsumer goods tie-ins

Value

Motion picture revenues TV & Cable syndication Demand

OutputDVD, VHS

Cinema

Micromedia Returns: The Snowball EffectSyndicated by hi-traffic site

Value

Reviewed by hi-visibility pub

Micromedia revenues Demand

OutputAggregated by aggregator Published personally

Snowball Example: BlogSyndicated by Yahoo News

Value

Syndicated by Slashdot

Micromedia revenues Demand

OutputSyndicated by link aggregator Published on personal blog

Snowball Example: PodcastReviewed by the NYT

Value

Syndicated by BoingBoing

Micromedia revenues Demand

OutputAggregated 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, its popularity in the niche will grow as its 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 QualityQuality drives popularity hyperefficiently

Popularity

Firm coordination costs Media 1.0 Media 2.0

QualityQuality 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 MarginMicromedia realizes higher returns

Value

Firm coordination costs Micromedia returns Traditional media returns

Micromedia marginal return exceeds traditional media return

OutputTraditional media realizes higher returns

PP is a More Efficient Producer

Snowball Strategy Whether youre 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 theyve produced goods for decades AKA Incumbent inertia a lot of them wont survive

Jack and Hilary Dont use the property rights metaphor As an excuse for strategy

Heres 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 Its 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 TailA smaller number of blockbusters

Price

Demand Supply

QuantityAnd a growing number of snowballs Create new value, which raises 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 DJs everyones 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 its 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 theyll 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 theyre 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 dont get the RIAA to sue remixers and samplers

Smart Aggregation DJs leveraging label info to predict value of tracks maximizes value creation within the niche

Decentralized preference information Listeners vote with their feet Billboard doesnt tell them what to dance to

Connected consumption My value increases when you dance

Dominant product strategies: Openness, intelligence, decentralization, connectedness

An Instructive Case StudySupply 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 Distributed economies of scale Coordination economies Production economies of scale and scope... Openness Intelligence Decentralization Connectedness

Give rise to fundamentally new kinds of economies

which require radically different product strategies

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 The blockbuster effect

which is a total inversion of the dominant Media 1.0 strategy

Thank You