1. The New Economics of Media Micromedia, Connected Consumption, and the Snowball Effect Umair Haque http://www.bubblegeneration.com Spring 2005

2. Media 1.0: Mass Media

4. Two Sided Markets Media 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. Audience Advertiser Demand Supply Demand Supply Production Attention

13. Marketing Cost Explosion Hollywood 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:

14. Popularity and Quality Media 1.0 Quality Popularity … Quality drives popularity hyperefficiently Quality drives popularity inefficiently

15. The Blockbuster Effect

17. Mass Media Returns: The Blockbuster Effect Motion picture revenues Output Value Demand Cinema DVD, VHS Consumer goods tie-ins TV & Cable syndication

18. The Blockbuster Effect Example: Jurassic Park Revenues Output Value Demand Box Office: $480m Syndication: $50m Video: $405m Merchandising: $50m

21. Attention & Production Costs at Large Scale Media 1.0 Attention Cost Production Cost Production is cheaper than attention Production and attention are equally costly Attention is cheaper than production

22. Attention & Production Costs in Rivalry Media 1.0 Attention Cost Production Cost Production is cheaper than attention Production and attention are equally costly Marketing cost wars make attention increasingly relatively costly

23. Attention & Production Costs Attention costs Output Value Production costs At high levels of output, investing in attention is profit-maximizing… Why 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 aren’t realized because of high costs of contractual completeness, which makes risk increase in output, and high technology costs. … And investing in production is dominated

24. Attention & Production Costs Attention costs Output Value Production costs Why 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 At low levels of output, investing in attention is dominated…

25. Attention & Production Costs Attention costs Output Value Production costs Attention is more expensive than production: invest in production Production is more expensive than attention: invest in attention Media 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… Marginal cost of production exceeds marginal cost of attention

26. Media 1.0 Total Cost Function Cost of all inputs Output Value The shapes of the attention and production cost curves… The 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. … create an S-shaped total cost function

27. Marketing Spirals Erode Quality Attention costs Output Value Production costs Marketing wars increase the cost of attention… Marketer and retailer consolidation realizes economies of scope and scale in marketing. Production scale or scope economies aren’t realized. Marketing spirals act as an entry barrier. They raise attention costs, while marketing economies of scale and scope are still realized proportionally (the flattening of the green curve). The result is a shakeout and increased industry concentration, because returns to attention remain high only for large-scale players. Quality erodes as production investment is traded for marketing investment. ..Since production costs don’t decline, production investment declines: fewer production inputs are used at equilibrium price

28. Popularity and Quality Media 1.0 Quality Popularity … Quality drives popularity hyperefficiently Marketing cost spirals mean quality erodes as relative investment in production declines, and becomes even less correlated with popularity

29. Summary: Mass Media Value Dynamics In a non-networked media world, retail & marketing capture the most value. Producers and distributors remain fragmented because production returns don’t scale: they don’t realize significant economies of scale or scope by consolidating. 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). Production Distribution Marketing Attention Infra structure Retail Attention Attention Attention Attention Attention Attention

30. Summary: Mass Media Value Dynamics Production Distribution Marketing Attention Infra structure Retail Attention Attention Attention Attention Attention Attention Blockbuster 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. 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 doesn’t drive popularity.

31. Media 2.0: The Age of Plasticity

37. Attention & Production Costs at Large Scale Media 1.0 Attention Cost Production Cost Media 2.0 Production is cheaper than attention Production and attention are equally costly Attention is cheaper than production

38. Attention & Production Costs Attention costs Output Value Production costs At high levels of output, investing in production is profit-maximizing… Value 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. … And investing in attention is dominated

40. The Blockbuster Effect & Media Hyperdeflation Mass media revenues Output Value Hyperdeflated revenues Cinema TV & Cable syndication DVD, VHS Consumer goods tie-ins

42. A Quick Review

43. Media 1.0 Supply & Demand Demand Quantity Price Supply Inelastic demand… … And inelastic supply mean media spending stays stable as % of GDP

44. Understanding Media 2.0 Demand Demand Quantity Price Supply The Long Tail: cheap information shifts demand outwards by the value of distribution and search costs saved

45. Understanding Media 1.0 Supply Quantity Price Aggregate supply curve is inelastic… … because ownership of scarce production, distribution, and retail resources creates increasingly inelastic firm supply curves Clear Channel Indie record labels Pixar

46. Understanding Media 1.0 Supply Quantity Price … production costs dominate attention costs, because content, production, and retail resources are scarce, and attention is abundant Attention costs Production costs Because attention costs are relatively low, returns to marketing are economical, and marketing wars occur

47. Understanding Media 2.0 Supply Quantity Price … Micromedia supply curves are more inelastic than traditional media, because of hyperspecialization. Exampe: bloggers Pixar bloggers podcasters Aggregate supply curve shifts outwards

48. Understanding Media Hyperdeflation Demand Quantity Price Supply Micromedia explodes media supply more than cheap information shifts demand outwards… … and the equilibrium price of media falls: media hyperdeflation

49. Understanding Media 2.0 Returns & Scarcity Quantity Price Micromedia explodes media supply… Production costs Attention costs … attention 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

50. Media 2.0 Models: Aggregators, Platforms, and Reconstructors

51. Understanding Micromedia Microchunk Microchunk Microchunk Micromedia Entry Entry Entry Blog Track Track Track Playlist Snippet Snippet Snippet Podcast

60. Understanding Micromedia Platforms Entry Entry Entry Blog Comment Comment Comment Link Citation Trackback Complements & Consumption Info

61. Understanding Smart Aggregators Entry Entry Entry Smart Aggregator Entry Entry Entry Blog Blog Entry Entry Complements & info Complements & info Complements & info Blog Blog Blog Complements & Info Complements & info Selected Micromedia

62. Understanding Reconstructors Entry Entry Entry Blog Reconstructor Entry Entry Entry Consumption info Consumption info Consumption info Blog Blog Entry Entry Entry Personal ‘Cast

63. Understanding The Media 2.0 Ecosystem Smart Aggregator Reconstructor Entry Entry Entry Microplatform Blog Blog Blog Comment Personal Cast Personal Cast Personal Cast Entry Entry Entry Entry Entry Entry Selected Micromedia Selected Micromedia Selected Micromedia Entry Entry Entry Blog Blog Personal Cast Entry Blog Comment

65. Media 2.0 Strategy: Snowballs, Connected Consumption and Increasing Returns

69. Maximizing Value Creation Preference Continuum A Utility Distribution of preferences has fat tails A’s disutility increases in Z-ness Z B C D E Aggregate utility Z’s disutility increases in A-ness Efficiently allocating attention becomes vital when attention is scarce. Maximizing value creation by matching content with preferences.

70. Maximizing Value Creation Preference Continuum A Utility Z B C D E Mass media producers don’t 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. Blockbuster 1 captures half Total value created Blockbuster 2 captures half Total value lost

71. Maximizing Value Creation Preference Continuum A Utility Z B C D E Micromedia producers can efficiently target content to each niche’s 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. Snowball 1 captures niche Total value created Snowball 2 captures niche

72. Value Creation and Plasticity Preference Continuum A Utility Z B C D E 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. Snowball 1 captures niche Total value created Snowball 2 captures niche

78. Mass Media Returns: The Blockbuster Effect Motion picture revenues Output Value Demand Cinema DVD, VHS Consumer goods tie-ins TV & Cable syndication

79. Micromedia Returns: The Snowball Effect Micromedia revenues Value Demand Published personally Aggregated by aggregator Output Syndicated by hi-traffic site Reviewed by hi-visibility pub

80. Snowball Example: Blog Micromedia revenues Value Demand Published on personal blog Syndicated by link aggregator Syndicated by Yahoo News Output Syndicated by Slashdot

81. Snowball Example: Podcast Value Published on website Aggregated by podcast aggregator Reviewed by the NYT Output Syndicated by BoingBoing Micromedia revenues Demand

83. Popularity and Quality Firm coordination costs Media 2.0 Quality Popularity Media 1.0 … Quality drives popularity hyperefficiently Quality drives popularity inefficiently

86. Micromedia at the Margin Firm coordination costs Traditional media returns PP is a More Efficient Producer Value Micromedia returns Traditional media realizes higher returns Micromedia realizes higher returns Micromedia marginal return exceeds traditional media return Output

92. Beyond the Long Tail Demand Quantity Price Supply A smaller number of blockbusters… … And a growing number of snowballs … Create new value, which raises the equilibrium price of media, and also increase demand elasticity

104. An Instructive Case Study DJ Clubbers Producer Demand Supply Demand Supply

107. Thank You