Chapter 3 How Information Market Place is Different?

In an information marketplace the commodity is information which is not consumed like any other goods. Furthermore, the information can be reproduced and distributed at almost no cost. Thus, the marginal cost of information is virtually zero.

Marginal cost measures the increase in total cost of production as a result of producing one more unit of output. It is the ratio of change in cost to change in output. Thus:

\[ MC = \frac{C_{2}-C_{1}}{Y_{2}-Y_{1}} = \frac{\Delta C}{\Delta Y} \]

where $MC$ is marginal Cost, $\Delta C$ is change in cost, $\Delta Y$ is change in output. In order to be profitable marginal cost must remain less than or equal to marginal revenue.

The next question that arises is if marginal cost is virtually zero then how come profits are not exorbitant (e.g., Amazon has barely made profits). To understand this lets define profit first.

Profit: Profit in economics is defined as the difference between the revenue a firm generates and the costs that it incurs. Thus:

\[ Profit = Revenue - Cost \]

Let’s break down this formula into minute details of significance:

\[ \pi = p \times (MKTSZ \times MKTSH) - [c \times (MKTSZ \times MKTSH) + FC] \]

where $\pi$ is Profit, $p$ is Unit Price, $MKTSZ$ is Market Size, $MKTSH$ is Market Share, $c$ is Unit Cost, and $FC$ is Fixed Cost.

Profits are not skyrocketing because $p$, $MKTSZ$, and $MKTSH$ are even shrinking for a firm. Firm has to remain very competitive and differentiate its product in order to maintain market size and market share and charge higher prices. Note, that the initial production cost of information goods are very high, however reproduction and copy of the same good become much cheaper. Therefore, it takes time to break-even the initial cost. Furthermore, due to virtually zero transportation cost the price of information goods tends to be lower.

A case of e-Commerce Industry. There are at least 1 million e-com sites serving consumers all over the world. Assuming the minimum revenues of US$ 100k per year and the number of meaningful e-com sites around the world to be about 100,000 we see that to serve 500 million people each e-com site is left with 5000 consumer per site. The question is, how sustainable that number is? The big players – Amazon in USA and Flipkart in India are able to sustain because they own massive consumer/market share. But there are just too many new e-com sites trying to capture a share of the e-com space that makes it harder to sustain in the long run.

Information as an economic good has some utility. However, due to uncertainty associated with it this utility always comes in the form of expectation and hence called expected utility². Information helps us in better decision making by reducing the uncertainty. Thus:

\[ Utility(I) = Expectation[\textrm{\emph{use of}} (I)] \]

Example: Sanna has invited Matti to dinner. Matti would like to bring a bottle of wine but doesn’t know what Sanna is cooking, fish (F) or meat (M). Matti prefers white wine (w) with fish and red wine (r) with meat. Matti derives the utility of 1 from bringing the right wine and -1 from bringing wrong wine. In the absence of any further information the odds of F or W are fifty-fifty respectively. The same is true for Matti choice of being right (Fw, Mr) or being wrong (Fr, Mw). Thus whatever Matti brings his expected utility is:

\[ U_{0} = (1/2)*(1) + (1/2)*(-1)=0 \]

Let’s assume Matti calls Sanna’s friend to find out whether she is a fish or a meat person. Matti thinks advice from Sanna’s friend would signal her choice with $3/4_{th}$ probability. Thus in this case Matti’s expected utility is:

\[ U_{s} = (3/4)*(1) + (1/4)*(-1)=0.5 \]

Thus, a piece of information make the difference in Matti’s utility by:

\[ \triangle{U} = U_{s}-U_{0} = 0.5 - 0 = 0.5 \]

In communication theory information is defined strictly in terms of probability of events. An event with high probability of occurrence has lower information content than an event with lower probability of occurrence.

Another definition of information is, essentially anything that can be digitized - encoded as a stream of bits - is information.

Some of the important features of information that makes it different from other economics goods are as follows:

Information is costly to product but cheap to reproduce.
Production of information has high fixed costs but low marginal costs.
Information goods are priced according to their value, not according to their production cost.
Information is an experience good whose value is known to consumers only after it is consumed.
A wealth of information created poverty of attention. Therefore, information search plays a critical role in attaining quality information.
In information economy firms need to focus not only on competitors but also on collaborators and complementors.
Apart from providing quality firms can maximize their profits from information goods by consumers and setting high .
Feedbacks are important mechanisms of growth of information goods.
Network effects or network externalities play a major role in feedback mechanism. \end{itemize}

Digital Strategies: Some of the important digital strategies that are important for sustaining long term growth are:

Differentiate your product.
Achieve cost leadership.
First mover has edge in this competitive environment.
Customization: Personalize your product and price.
Know your customer well.
Price your product creatively: High pricing, Low pricing (price penetration), Differential pricing.
- Personalized pricing: Sell to each user at a different price. (First Degree Price Discrimination)
- Offer a product line and let users choose the version of the product most appropriate for them. For example, such as quantity discounts for bulk purchases. (Second Degree Price Discrimination)
- Group pricing: Set different prices for different groups of consumers. For example, airline travelers can be subdivided into frequent flyers and casual flyers, and cinema goers can be grouped into adults and children. (Third Degree Price Discrimination)
Use promotion with a mix of traditional, new, and social media to reach your existing and potential customers.

This is a major concept in Economics of Uncertainty (Decision under Uncertainty.↩