Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

NETWORK EFFECTS AND FIRST-MOVER ADVANTAGES

I have looked at how innovation, something inherently uncertain and cumulative, is financed, and at the dynamics of that finance. We have also explored how the risks and rewards of innovation have been shared problematically, with medical drugs being the most severe case in point. Now, I want to look at another aspect of innovation: the effect of modern digital networks on the ability of a few firms to achieve monopolies in their markets.

In just a few years, firms such as Google, Facebook, Twitter, Amazon and eBay have come from nowhere to being almost indispensable in the lives of billions of people around the world. These companies increasingly dominate how we find information, connect and communicate, maintain our friendships, document our lives, shop and share our thoughts with anyone who cares to listen. The new technologies behind these companies have revealed – or created – in us new wants and needs. Any number of firms, each with broadly similar technologies, might have met these needs. Many have tried. But what is interesting is how quickly and how comprehensively such a small number of firms have come to dominate. And with this dominance comes the ability to extract value on a massive scale.

How has this happened? The answer lies in the characteristics of innovation, where small differences of timing, foresight or chance can have consequences out of all proportion to the initial disparity. Anyone who gains an initial advantage – in setting a standard or capturing part of a ‘sticky’ market – can be very hard to displace. And as their dominance becomes entrenched, they are able to capture a disproportionate share of the value in the market.

The history of many innovations demonstrates these dynamics very well. The internal combustion engine has retained its dominance for over a hundred years, not because it is the best possible engine, but because through historical accident it gained an initial advantage. Subsequent innovations did not seek to supplant it, but clustered around improvements to it, so that it became post factum the best engine. 60The same goes for the QWERTY keyboard layout, named for the first six letters on the top from left to right. In the days of mechanical typewriters, the very inefficiency of this keyboard layout gave it an advantage over alternatives such as the faster DVORAK layout because the mechanical keys would jam less frequently. The mechanical necessity for the QWERTY layout has long passed in these days of electronic keyboards, but its advantage has remained. Once people learned how to type using the QWERTY layout they resisted change. This social inertia meant its arbitrary initial advantage got locked in.

Such examples show the potential for dynamic increasing returns to scale (the more subscribers the better), from innovation due to path dependency (continuing to use a practice or product because of past preference for it) or social inertia, even when the initial advantage may be slight or arbitrary. Another example of the phenomenon are so-called ‘network externalities’. Just as the value of a telephone increases as the number of people its owner can connect to rises, so a social network becomes more valuable to its owner if more people join. Facebook or Twitter do all they can to increase the number of subscribers: the bigger the network, the stronger the company’s position.

Networking Profits

All this sounds fine until you ask yourself what it might mean for the size of companies. A strong source of increasing returns to scale necessarily expands companies. Google’s size is a direct result of the network effects typical of Internet-based services. Google is not just a search engine. It is also an email address (Gmail), a conference call maker (Google Hangout), a document creator and editor – all designed to maximize the advantages of sticking to Google: you cannot use Google Hangout without a Gmail address.

What’s the problem? Giant online firms like Facebook, Amazon and Google are often portrayed by their managers and by their apologists as ‘forces for good’ and for the progress of society rather than as profit-oriented businesses. 61Excited advocates have talked of a rising and revolutionary ‘sharing economy’, or even of ‘digital socialism’, 62advancing a rosy view according to which digital platforms ‘empower’ people, giving us free access to a wide range of services, from social networking to GPS positioning and health-monitoring. Silicon Valley is starkly and favourably contrasted with Wall Street. The Valley bridges the consumption gap by providing services that everyone can access, almost independently of their income; the Street intensifies the concentration of power and wealth in the hands of the 1 per cent. 63

Of course the Internet giants are valuable to their users, sometimes greatly so. They can add to people’s well-being and in some cases increase their productivity, for instance by making it easier and faster to find some web content, route, person or book. But the view that these services are offered to everyone for free out of Silicon Valley’s goodwill, with the aim of ‘empowering’ people and creating a more open world, is exceedingly naïve. A more realistic analysis should start from a grasp of how these firms work and where their profits come from, with an eye to assessing their overall social impact in terms of value creation and value extraction.

Firms like Google, Facebook and Amazon – and new ‘sharing-economy’ firms like Airbnb and Uber – like to define themselves as ‘platforms’. They don’t face a traditional market, in which the firm produces a good or service and sells it to a population of potential consumers. They operate, instead, in what economists call two-sided markets, developing the supply and demand sides of the market as the lynchpin, connector or gatekeeper between them. On the one side, there is a service offering to users. On the other side, there is a market offering to other firms – from sales to advertising space to information on users’ behaviour. Firms have long operated in more than one market. The peculiarity of two-sided markets, however, lies in how the two sides are connected. As the number of users on one side of the market (using a search engine or joining a social network) rises, clicks on ads and information on consumers’ behaviour also increases, boosting profitability in the other side of the market. It suits Google and Facebook to charge their users nothing: they need as many people as possible to join to make the product they sell to firms on the other side of the market more attractive. ‘Socialism’, digital or otherwise, doesn’t come into it.

We should not see Google, for example, as providing services for free to its users. Rather, it is users who provide Google with necessary inputs for its production process: their looks on ads and, most importantly, their personal data. In return, they obtain online searches and other services. The bulk of Google’s profits come from selling advertising space and users’ data to firms. If something is free online, you are not the customer, you are the product. 64Facebook’s and Google’s business models are built on the commodification of personal data, transforming through the alchemy of a two-sided market our friendships, interests, beliefs and preferences into sellable propositions. The so-called ‘sharing economy’ is based on the same idea. For all the hype about ‘sharing’, it is less about altruism and more about allowing market exchange to reach into areas of our lives – our homes, our vehicles, even our private relationships – that were previously beyond its scope and to commodify them. 65As Evgeny Morozov has warned, it risks turning us all into ‘perpetual hustlers’, 66with all of our lives up for sale, while at the same time undermining the basis for stable employment and a good standard of living.