27 May 2008

Lock-in

Doc Searls talks about the familiar obsession of technology companies (in this case social-networking providers) for business models with lock-in, and strategies that "kill other companies"

Why do they do this? It's not because it's the only way to make money. Plenty of companies make money by supplying open, competitive markets in which consumers can easily choose one supplier over another.

But those companies don't make vast amounts of money - at least, not unless they are in vast markets. To make huge amounts of money without being the size of Mittal Steel or something, you have to have some degree of immunity from competition. This can come from network effects, patents, state regulation, or some combination.

I can't back this up right now, but I think that most of the private-sector business in the world - most of the salaries, most of the profits - come from socially useful work. But most of the biggest profits come from businesses which have found some way of locking out competition.

The kind of logic here is that behind every great fortune there is a great crime - if you define crime loosely enough to include practices that limit the choices of consumers. (And if you allow one or two exceptions, which are worth looking at in another post). It does not follow that behind every modest fortune there is a modest crime.

This has a huge effect on perception. When you look at the market from outside, the most visible practitioners are the most successful, who are largely those who have managed to extract some form of monopoly rent. And the size of those rents are so large that they do represent significant costs to society. But theyare the exception rather than the rule - the bulk of economic activity takes place in competitive markets by businesses without market power.

It was also one of the factors behind the original internet bubble. Investors were valuing business that used the internet, but were in fact normal businesses, by comparing them with the companies that made internet infrastructure, and therefore had lock-in because of network effects. Amazon is a large and profitable business, but it has little or no lock-in. Cisco, Sun, Intel collect monopoly rents resulting from the network effects of their installed bases. Therefore Amazon's operating profit is 5% of revenue, while Microsoft's is 35%

For the UK, statistics show 60% of business (by no. of employees or by turnover) is carried out by businesses with less than 500 employees - just some vague background to show that it's plausible that I'm talking about the real world.

No comments: