Monetizing Web 2.0
This post is an extract of a larger (and must read) post at “a consuming experience”
By applying principles of economics and management theory to analyse the nature and characteristics of digital goods and Web 2.0, economist Thierry Rayna (Thierry Rayna’s papers / articles) and management scientist Ludmila Striukova (some papers) reach some pertinent conclusions and make some interesting and thought-provoking suggestions on the economics of the digital world.
As summary the Incentives to Web 2.0 content producers are currently mainly provided not through price, as in a traditional free market, but through advertisement income. The problem this creates is that the relationship between ads income and value is loose, so market distortions and inefficiencies are likely to result.
The other big part is that most Web 2.0 content creators are mainly incentivised by non-financial considerations (reputation, altruism etc) which don’t tie in with the social value of what they produce.
Web 2.0 doesn’t operate like a simple traditional market, because of two key factors: the economic nature of digital goods (which means the main issue with monetising Web 2.0 is the large volume of freeriding, i.e. piracy), and transaction costs coupled with the low value of most Web 2.0 content. So, what are “transaction costs”?
Transaction costs and search costs
In economics terms, transaction costs (the costs incurred in making an economic exchange) will include search costs (the costs of checking what’s the best or most suitable product, where is it available, which seller offers the lowest price etc).
There are 2 types of search costs: external search costs (monetary cost and opportunity cost of the time taken searching) – depends on technology etc, and are usually the same for everyone; and internal search costs (cognitive costs) – which vary with the individual consumer (thinking time / load to formulate search queries, analyse results in order to make decisions, etc).
Search engines like Google have reduced external search costs effectively to zero, but cognitive costs remain, and indeed will grow with the amount of information to be processed. Search costs are further increased by the availability of more and more content generally (because Web 2.0 has facilitated content creation by the masses), more and more of which is relatively invisible / inaccessible content i.e. private” content which is not indexed by the search engine (whose existence also increases external search costs), and more and more of which is multimedia content like videos, images – not accessible to search engines unless the content producer tags it.
Web 2.0 – the costs, incentives and inefficiencies
It costs content creators / publishers time / money to tag their content accurately, and producers by and large don’t directly benefit from their contributions, so why should they expend even more time / effort on tagging? So, they don’t.
Now if I upload a video without tagging it, it costs other people (lots of people, potentially the whole connected world) extra time to try to find my video via current search engines (or, perhaps more likely, to find other stuff that they’re really looking for amongst the extra “noise” added by my content!). The publisher fails to tag, yet it’s society, not the publisher, who has to bear the extra (retrieval) costs. It costs society more than it cost the creator. (That’s what economists call a “negative externality“).
The result, as with other negative externalities: too much untagged multimedia content is produced by publishers, increasing search costs more and more, which, as the authors put it, is socially inefficient. Less content, but fully tagged, would actually be more beneficial to society.
Most contributors don’t benefit directly (or indeed financially) from their own produced content. So, why do people contribute to Web 2.0? Incentives are similar to those with open source software: the immediate satisfaction of bug fixing/producing content, delayed benefits (reputation, ego gratification, career improvement), altruism and community identification. These incentives, along with the desire to publish accurate facts particularly in areas of personal interest (Wikipedia contributors), and the attractions of receiving positive (or indeed any) feedback, are sufficient to motivate production of at least some content.
Also, although it’s rare, some professional bloggers do make money, a few of them good money, through ads, affiliate commissions, product sales, donations etc. However, substantial investment is needed first to generate reputation (participation in forums, online communities, social networking sites) and traffic (marketing the blog: knowledge of blog publishing software, feed aggregators, blog carnivals, SEO, tagging etc). Indeed, to create a successful blog, as much time has to be spent on marketing as creating content.
The main issue is that, presumably with the exception of professional blogs (which are rare), the (often subjective) incentives for Web 2.0 contributors, the private benefits perceived by the contributors, don’t match up to the social value, the actual benefit to society, of their contributions: contributions benefit the contributor more than they benefit society. (In economics terms, there’s a “positive externality“.)
Although there are some incentives to produce valuable high quality Web 2.0 content, unfortunately there’s no Web 2.0 mechanism to systematically ensure that the incentives for producers / creators match up closely enough with the social value of their contributions. (Despite the long tail concept, which might suggest that all content has some social value, research shows that in fact, on e.g. YouTube, 10% of videos in fact account for 90% of the views.)
Web 2.0 is unusual in being the source of both negative and positive externalities at the same time. The production of more Web 2.0 content costs society more than it costs the creator; and the extra content benefits the creator more than it benefits society (Web 2.0 paper pg. 9): “Unfortunately, this means that low (social) value content is very likely to be over-produced, while high (social) value content is, probably, produced in insufficient quantity, thereby leading to an inefficient outcome”.
The large supply of content reduces the market value of all online content generally, and thereby reduces the supply of good quality content. Too much free (or low cost) low quality content competing for consumers’ time and attention crowds out the good quality content (in economics, the market for “lemons”). Where there are information asymmetries between buyers and sellers, e.g. regarding the quality of Web 2.0 content (producers know more about the content than consumers do; consumers won’t know the quality of the content till after they’ve consumed it), what’s known as “adverse selection” applies: “bad” products are more likely to be selected than good ones.
Where there’s adverse selection, consumers’ willingness to pay is usually a weighted average of the quality present in the market. So if there’s proportionally a lot of low quality content, consumers’ willingness to pay becomes close to zero – so much so that higher quality content may be driven out of the market altogether.
To counter adverse selection, producers normally use “signalling” to indicate the quality of their product objectively and clearly. But signalling is unlikely to be effective in Web 2.0: usual signalling strategies (guarantees, money back etc) don’t generally apply to Web 2.0 content; the cost (especially for bloggers) of signalling may not be thought worthwhile; the value of content to the consumer is often subjective rather than objective in Web 2.0, so it’s hard to arrive at universal signalling criteria; and their lack of market knowledge / experience in assessing the market or social value of their product means the multitude of amateur producers may overestimate the quality of their own content and decide to signal, while producers of higher quality content may not signal; and finally, professional bloggers need to spend as much time promoting their blogs as writing them, as the current incentive system is more about the blogger’s ability to play the rules of the game and make their blog more well known than others than it is about the quality of their content. [Is the point here that signalling doesn’t work with blogs because it’s fame rather than quality which matters there? Here I’d have liked to see more evidence / research and economics explanations as to why that’s the case.]
In summary, Web 2.0 is largely non-monetary and suffers from economic inefficiencies like search costs, crowding out and adverse selection: the costs and benefits of producing extra content, to the creator and to society, don’t match up, so too much low quality content is produced, which drowns out / drives out the good content.
Possible business models for Web 2.0
The authors, as previously mentioned, feel that the “free, funded by advertisements” business model often used in Web 2.0 is inefficient, in terms of the market and society, because there isn’t close enough a link between ad income and the market / social value of the Web 2.0 content produced. What alternative models might be used?
Pay per use. Monetizing Web 2.0 by switching from a free to “pay per use” or “pay per access” model would involve large transaction costs as there would be an enormous number of transactions owing to the huge amount of content and large numbers of producers.
Micropayments are the most likely way due to the relatively low value of most content. But micropayments won’t be worthwhile, and so won’t be adopted, unless the transaction costs are low enough – and that’s not just the monetary costs e.g. payment systems fees, but also opportunity costs (time spent on and leading up to the purchase) and cognitive costs (again on and leading up to that particular purchase).
For consumers, “pay per use” costs them in terms not only of money but also time and cognitive costs, e.g. checking out options fully to ensure they’re forking out their hard-earned (even micro) cash on the best value product for them. And with experience goods, even extensive research may not help – only actual consumption enables proper evaluation. Also, there are the costs of coordinating with the supplier, entering into a contractual relationship, and the potential costs of dealing with any problems that might arise (which people would shrug off if it was free). For relatively low value goods, would the extra “hassle factors” (including search costs) be worth it to consumers, even if the actual monetary spend is very small?
For producers / providers, even reducing transaction costs for pay per use might not make pay per use profitable enough – with information goods the best route to profit has normally been to bundle information goods and/or their use, so much so that different independent producers get together to package all their goods together into one bundle sold in one transaction (e.g. MacHeist), and thereby lower transaction costs.
All of which is why the authors think pay per use doesn’t seem to be a viable way to monetise Web 2.0.
Subscription fees. A subscription route may be better (e.g. to a feed), as it would reduce the volume of transactions (subscription once per year instead of per use). But it won’t work for all Web 2.0 content – e.g. irregularly published content is hard to price, and there would still be lots of transactions given the large number of content producers. A subscription via an intermediary like YouTube, probably flat fee to reduce transaction costs, might work – they could then further divvy up fees amongst creators based on e.g. usage. Yet no attempts along those lines have so far worked out. [Note: I’d have liked to see examples here, and suggestions of reasons based on principles of economics as to why they’ve not worked out and aren’t considered viable.]
In Web 2.0, participants are both consumers and providers, so exchanges between them are many and frequent (which according to transaction cost theory is why firms and corporations arose: there’s a point where transaction costs become too high for exchanges between individuals in a market environment, resulting in the creation of “non-market entities” like companies). Charging for so many exchanges would be very costly, particularly in terms of time and cognitive resources, so it’s not surprising that a very collaborative environment like Web 2.0 has developed into an environment which is primarily non-monetary. But will it always stay that way?
Another way to monetise Web 2.0 – a “demand-driven” Web?
The authors believe the key challenge to monetising Web 2.0 is: how to better align incentives for producers with social value (i.e. how to incentivise providers to produce higher quality content), in light of the economic characteristics of digital goods as public goods (which means piracy can’t in practice be prevented, so reproduction / distribution of existing digital goods won’t be very profitable), without incurring excessive transaction costs (e.g. how to reduce the volume of transactions).
They suggest one method which would address all 3 of those issues: instigate a demand-driven Web 2.0, instead of or alongside the current supply-driven Web 2.0 – i.e. publish content (whether pre-existing or created to order) only to order.
That should incentivise the production of high quality content as those demanding it would be willing to pay for it, and producers who believe their content has high value would wait for demand before publishing (while those who think their content is relatively low value will still continue to publish).
Access to the first ever unit of any digital good can be fully controlled, so at the time of first publication it can be charged for, but after it’s been published copies will become available to lots of people over time, so there’s little point in insisting that every copy has to be charged for forever, or trying to restrict access or copying (and a compulsory charge only for the initial publication would also reduce transactions, and therefore transaction costs, compared with pay per use). However, because it will take time for the goods to spread amongst consumers, some people may still be willing to pay for early access to it (as in the case of e.g. breaking news), so it’s possible for the producer and first buyers to charge for access in the meantime – which means initial buyers should be willing to pay even more for the first unit, as they can charge for access to their copy in the early days. A new field of research in economics has in fact shown that an efficient competitive market can be achieved with digital goods, even though they’re public goods, as long as there is “finite expansibility” (i.e. they don’t spread through the economy instantly).
The authors think such a demand-driven Web would involve an intermediary with whom potential providers register existing content on offer (e.g. tagged holiday pics) or their ability to produce content (e.g. coding skills), and potential consumers register their needs and demands. The intermediary’s system would match suppliers and buyers, who would agree on price, etc. After supply of the digital good, although the producer retains the copyright in it everyone – buyers too – would be allowed to distribute or resell it. A reputation system could also be used (feedback, ratings etc presumably).
While a demand-based system would not guarantee an efficient market, it could work alongside and complement the existing Web 2.0 to increase the proportion of high quality content on Web 2.0 and reduce search costs (because less low value content would be published and/or it would incentivise the tagging of content to make it easier to match with demand).
[Question: this might work for some things, but how would it work for other things where there isn’t an existing known demand, like new music? Fans of well known bands may be willing to pay for them to produce more songs, but what about unknowns? I suppose this is where something like Creative Commons free samples comes into it, to build up a fan base. But then persuading people to thereafter pay for new material – is that feasible? And if even the hugely popular bestselling Stephen King couldn’t get fans to pay enough for him to finish The Plant serial, what hope for others? I’d love to hear the authors’ thoughts on the “Give recordings away, make money on touring and merchandising” approach, or any alternatives. Songwriting to order, back to the days of commissioned composers, Mozart etc?]
Aside: demand-driven approach for NGO’s?
The “demand-driven”, “first buyer pays” (or perhaps, rather, “first request is paid for”) concept seems to me to very much tie in with the approach Alan Mitchell wrote about in FT 23 March 2008 of The Key, an experimental problem-solving community formed by 2 UK government-sponsored agencies (including the Training and Development Agency for Schools) and provided by lifestyle and concierge / management services company Ten UK, which “tries to combine human beings’ ability to understand significance and meaning with the efficiencies of new technologies” in order to build up a very focused and relevant knowledge base for a particular community. It started offline, but is now moving to the Web.
The idea is to provide information within a tightly focused community facing similar problems (in this case head teachers and other school leaders) by using individuals’ specific questions to define the content of what’s provided (my emphases):
“In The Key’s first phase, school leaders phone or e-mail questions to researchers who find the best possible answer from official sources, experts and published research. The researchers, some of whom are former school leaders, compile a full answer, with references, sources and suggestions for further reading, and tag it for future reference.
At first sight, the model looks economic nonsense. Paying for human beings to research answers to tricky questions from potentially 20,000 school leaders, one by one, would be expensive. But they are all facing similar problems; and the more times a question comes up, the lower the cost per answer. The aim is to manage the resulting information so that each answer adds to an ever-expanding knowledge base. In the first four weeks, half the questions required new research. At three months, nearly 90 per cent could be answered using existing content…
…nine out of 10 users saying it has saved an average of five hours per question. In addition, most say it has improved the way the school works because better decisions are made more quickly…”
In the second phase previously-answered questions are being made available on the Internet for direct access to the knowledge base. Thereafter, the researchers should only need to answer new questions and update old answers. “The goal is to turn ignorance (individuals’ questions) into a valuable resource”.
While this approach could extend to other fields in both public and private sectors, important issues need to be addressed to make it workable. The service must be sufficiently usable and user-centric (in terms of not just the information content provided but also the structure of the website (e.g. number and type of questions asked) and language used (the words and phraseology actually used by school leaders in asking questions, rather than by policymakers or government officials). Costs management is necessary for the community to be economically viable; relative costs could rise too high if the volume of questions falls too much, which means the knowledge base will be less useful and may not be worth the investment, or if the community is too diffuse and not narrowly-focused enough, as that means the same questions will not be repeated and again the investment not worthwhile, or if too many users use phone or e-mail rather than web self-service for their questions (which they will if the search system isn’t up to scratch). User confidence and trust in the answers need to be be maintained, i.e. that the answers will remain unbiassed (in this particular case, will politicians and civil servants stay out of the way and let policy implementers rather than policymakers set the information agenda?!) and also I think that the answers will be accurate (confidence that the researchers had suitable expertise in the field both theoretical and practical).
So it seems a possible business model would be: find a narrowly-focused field or community (a narrow focus seems to be good for blog SEO too, see item 2.7 of that post ), set up as an intermediary for that community (find and pay researchers with appropriate expertise to answer questions of course – as employees? or more likely independent contractors), charge for the service (perhaps just for running it, and/or a cut for each answer), but critically make sure the service and website are sufficiently well structured and useable for users to find what they are looking for efficiently and quickly. However, I think this approach would be less sustainable in an area where new questions keep cropping up (e.g. software support where they keep changing the software very often? Indeed, isn’t this approach much the same as that already in use within corporations that provide support for their products or services, to build up their FAQs / customer knowledge base?).
Like me you may also wonder whether The Key’s approach is more useful as a way to help a narrowly-focused, non-profitmaking community, like NGOs operating in certain niche or specialist fields where things don’t change too rapidly, to club together (perhaps with some government support) to help build up a communal knowledge base more cost-effectively, than as a way to make profits (though it does seem to be a way for the intermediary, in this case Ten UK, to make money, especially given that it’s government-financed or subsidised!). Widen the user base and charge others outside the original community a subscription fee to access it once it’s been built up?
Back to the wider issue of the suggested demand-driven Web 2.0, I think usability, costs management and maintaining user trust will be as important for a demand-driven Web 2.0 system as for The Key. It will be interesting to see to what extent a demand-driven system arises and is profitable.
I believe this research has a lot of things to consider. At rSitez, our obsession is to find better ways for our customers to make money with our social network software. We constantly think in different options to accomplish this goal, it will be worthy to explore and evaluate what possibilities these proposed business models can support.
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