Academic journal article Yale Economic Review

MAINSTREAMING INCREASING RETURNS: Web 2.0, Copyright, & Intellectual Property Economics

Academic journal article Yale Economic Review

MAINSTREAMING INCREASING RETURNS: Web 2.0, Copyright, & Intellectual Property Economics

Article excerpt

IN THE AGE OF Facebook and Flickr, in the global mushrooming of the Web 2.0 battlefield, the world has shifted from material, product-oriented businesses to intellectual capital industries. In contrast to the usual physical production process, this proliferation of expansive social and economic platforms is characterized by a unique "networking effect": namely, as the size of the user base grows, the utility of such technological networks rises, not falls. So-called "increasing returns" products do not behave according to classical economic precepts on either the supply or demand side.

On the demand side, increasing returns goods differ from traditional market goods in terms of their social value. For traditional goods, an increase in supply decreases the utility of the good. An increase in the supply of diamonds, for example, decreases the perceived value of each diamond airead}· in the marketplace. Goods that express increasing returns, however, gain in value as the supply of the good rises. For instance, one fax machine has ver}' little value, but as more and more fax machines are produced, the value of each fax machine in the marketplace increases because each fax machine becomes more useful.

On the supply side, products with increasing returns also behave differently than traditional goods. Conventional product-based processes are subject to the law of diminishing marginal returns. That is, for each additional unit of input, one receives less and less additional output with all other factors held constant. According to diminishing returns theory, eventually it becomes impossible to continually decrease the average cost of production no matter how large the scale of the enterprise. While early increases in production run size lead to falling average costs through a variety of factor inputs (e.g.: higher bargaining power over inputs, learning curve efficiencies, etc.) at some point producers run into administrative and communicative problems that effectively stymie further increases in production efficiency.

However, in an information economy - one where the primary output is an intangible idea, design, service or website, not a physical product - industries that experience increasing returns occur regularly. This dvnamic causes those who have an advantage to get even further ahead because declining average costs and/or increases in perceived value amplify the benefits of scale; success is, in essence, self-reinforcing. The marginal cost of production for information goods is often negligible: the first cop}· of Microsoft Windows costs millions of dollars, but the second costs only a few cents. Those companies that obtain a lead, irrespective of the cause, can more easily become a staple in the marketplace and eventually become the technological standard.

Until very recently, goods have almost exclusively been physical and trade has been rooted in productive competition. Trade was either based on the harvesting of raw materials - coffee, cotton, and coal - or on the marketing and circulation of finished goods - cars, clocks, and crayons. With rare exceptions, no one company could dominate the marketplace because that given company faced decreasing returns to scale, and the price was forced down to the average cost of production for all firms. Even if only a select few companies dominated the market, these companies inevitably ran into barriers such as limited demand or limited access to resources when they sought to expand. Diminishing returns existed in some form, and the marketplace for material goods could be considered more or less perfecdy competitive as a whole.

And yet, the rise of the intellectual property and the services-based economy has generated a new species of increasing returns businesses that leverage the network effect. Many electronic devices, operating systems, and software applications have become standard platforms that mature in benefit as they achieve scale.

For example, in the well-known Betamax-VHS videotape format war, VHS took the initial lead, as it was easily available to rent in popular chains like Radio Rentals and DER while Betamax was confined to upscale providers. …

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