The Economics of the Broadband Media Value Chain

Looking at the last few weeks events, I see quite a lot of jargon being thrown around, not always with real understanding. Therefore I thought it would be helpful if we summarised the big picture. This is a high level view, but as a model allows fairly reliable strategic prediction.

The Broadband Media Value Chain

Its worth looking at the forces driving change across the overall value chain - this simple model gives the gist of it.



From left to right:

Content Creation

The cost per unit of content creation has dropped considerable, due to:

- costs of equipment to capture, process and store content have been reduced considerably over the last few years, so that video programs and digitally rendered content of fairly high quality can be made very cheaply

- cost of finding existing content has also dropped (and more is available) allowing repurposing / mashups / mixes into new formats.

This has meant that more and more people can afford to make content, to the extent that ordinary users are making podcasts, videocasts, machinima, animation - ie User Generated Content

Aggregation and Publishing

This area comprises 5 main functions - collating, editing content, publishing, promoting and billing content. These functions in the pre internet environment were usually combined by publishing houses in any media industry. However, a number of forces are impacting them:

- Search allows end user to collate their own content at very low cost, leading to the "Long Tail" effect where users can find increasingly niche content.

- Social Media, in various forms, is driving collation and editing of content via recommendations from friends, aggregated groups (eg Amazon). Social Media is interesting in that the creators and the users are in effect one and the same, which means

- Online billing and payment (eg paypal etc) has removed much of the the friction of paying for goods - not just financial, but many people appreciate avoiding travel and salesmen.

- Open Source has allowed people to build new aggregation systems at a fraction of the costs of even a few years ago, and the software - in many cases - works better than commercial software.

- A Webservice standard set has allowed these new model, low cost, highly re-usable aggregation systems to distribute content at far lower costs than previous approaches.

One of the impacts of the emergence of these new aggregation approaches has been the shift of advertising to the new aggregators. Google (Search based Aggregation) being a case in point, but the real killer is the death by a million cuts as millions of small new aggregators (including this blog) chip away at user attention, and thus Advertising money.

The net result has been the extreme pressure on traditional aggregators' (Newspapers, Music Companies, TV studios) margins while simultaneously taking away their advertising revenues

Distribution

Probably the major catalyst of the entire Broadband Media value chain was the glut of bandwidth built out in Web 1.0....this has crashed the cost of distributing signals by several orders of magnitude in a decade.

Combined with IP standards, this removed the proprietary nature - and oligarchic nature - of distribution channels that most mass media industries had - TV, Radio (licence), Newsprint (physical supply chain setup cost) - the only oligarchies still left fairly untouched today is the mobile operators' channels

Simultaneously, the costs of hosting has also dropped as the technology moved from cages of machines to racks of machines to blades of motherboards, and the price of memory also dropped by 2 orders of magnitude from Web 1.0 to Web 2.0. At the same time, the software costs for nack-end systems dropped, so hosting today is far more of an intelligent platform (cf Amazon Cloud) than "port, power and ping".

WiFi also has revolutionised distribution, mainly by end-running the mobile operators (and their oligarchy rents) and allowing on-the-move connection to the internet for laptops and increasingly other end devices. WiFi has also allowed a huge number of people to connect multiple devices on home LANS very cheaply

Customer Environment

Anyone who was around in Web 1.0 will tell you that many of the ideas going round in Web 2.0 were thought of a long time ago. The difference is the impact of Moore's Law (devices have got cheaper) and Metcalfe's law ( newtork based services become more useful as more people use them) meant more people want to buy them.

Cheaper devices and better distribution allowed more people to go online, thus driving the pull through (ie customer spend) for more services and content, which made the networks more useful, which persuaded more people online.....increasing penetration even more.

Another trend has been the convergence of services over different devices - PC, mobile, more powerful games machines, PDA's - are increasingly capable of accessing the same service (or a subset), driving not just number of users, but the available time when the services can be used.

The (N)et result has been a combination of cost reduction across the supply chain of several orders of magnitude, allowing new users to come on board, coupled with the previously restricted part - distribution - becoming an open good. Result - major potential pull through.

Furthermore, the reduction of cost across the board means the entire value chain is less capital intensive, so new services to support the pull through can be set up much more cheaply. In Web 1.0 the theoretical ideal structure was the "massless" business, which owned nothing but its ability to connect user to creator. This is a lot easier to execute today.

(Contrast this with Planet Mobile, where distribution is still a costly, closed good, where devices are non standard and non interoperable, and transport speeds are increasing far more slowly)

The strategic implications are profound - in general, throughout history, when radical new communications technologies have emerged (radical as in the reduction in the economics of communication, the overall transaction cost of a unit of communication) then the entire socio-economic structure of societies tend to change - market economies, social structures, cultures, settlement patterns (just look at the impact of the motor car).

One of these changes has been the use of this communication medium to restructure the functions in a company. Ronald Coase noted in the 1930's that the size and structure of an enterprise is largely a function of transaction costs. Reduce these costs, and the size of organisations reduces. Change that, and the structure of many of our life patterns (settlement, lifestyle, work pattern) shifts. Offshoring, Outsourcing, the rise of Web Workers are all outcomes of this trend.

Another impact of smaller units is the requirement for 3rd party trust to increase - its just too expensive to have unique contracts and/or deep personal relationships with thousands (millions) of small units. In addition, as no Aggregation or Distribution service has customer lock-in, their unique value is less tangible - thus Trust is thus a critical component in this new model for them as well. In addition, Trust is what makes people willing to spend money online.

Established players really struggle in shifts like this, as typically their entire structure - cost base, business model, company culture - are typically no longer in synch with the new models required, but to shift requires root and branch change from the top, and those turkeys seldom vote for Christmas.


The Mass Economy, the Edge Economy, and the Economy of You

The "Mass Economy" is built around high setup and transaction costs. When setup costs are high then the economics of producing many units, once set up is complete, is rational. Users would prefer more tailored services, but costs are exhorbitant so only the few can afford them, so the majority put up with mass services at more affordable costs. (And as a corollary, they put up with advertising as a further form of subsidy). When transaction costs are high, large organisations emerge to allow lowest cost workflow - hence the rise of the Mainstream Media Aggregators, who could collate, edit, publish and bill for content far more cheaply than smaller structures.

The "Edge Economy" - simply speaking - is the movement of value from the centre to the right and left of the supply chain above, as the costs (and thus surplus) of the Aggregation and Distribution functions reduce. In its simplest form, users want to find content, creators want to find users, and all in between is just friction. Some argue that there are other edges at the top and bottom of the picture - new distribution networks at the bottom, new aggregation services at the top. I personally don't like this view, as it confuses the cause - the economic shifts in aggregation and distribution - with the effect - the shift of value out to the owners of talent (creators) and demand (customers).

However, the "Edge" is a misnomer in many ways - possibly a better way to look at it is actually how the economics of production shift as setup and transaction costs reduce. Here is a standard product / process matrix:



In the old models, the tradeoff between volume and value was linear - broadcast (and mass newspapers) was a mass production model, pushing a lowest cost - and lowest common denominator - product to the customer. On the other extreme, the "market of one" was extremely expensive to serve with mass media techniques, so was limited to a very small market. In the middle were various attempts at bulk-breaking - Magazines, Pay-TV, Desktop Publishing - in order to serve smaller audiences with higher value choice. In general, advertising was mainly used to reduce the cost of the low choice, mass media.

(In fact part of todays' Advertising Industry's problem stems fom this - after 70 odd years of focus on mass production advertising, its having to get its head around small market advertising - and its a far way away.)

We are now in transition to include 2 other newly possible models - and the old models are being diaggregated (ie losing value) before the newer models have captured it fully.

Firstly, that of low value, low volume production - most User Generated Content falls into this category. It exists because the cost of creating, aggregating and distributing it is very low, and it relies on niche to find its markets - the classic Long Tail strategy

Secondly, that of high value, high volume - this is the holy grail of the "Market of One", the "Daily Me", the "Economy of You" - the creation, collation and distribution of just those service components that I want from a huge mass of reusable components.

In both these new models, lower transaction and setup costs are in evidence - they both rely on the Aggregation / Distribution functions to be lower cost / lower friction than before.

(In this perspective, technologies such as AJAX, widgets etc are second order effects - they exist only insofar as they reduce friction, and as soon as a better one comes long, it will be adopted instead.)

The online advertising industry desperately wants to interject itself into the high value game, but if history is any guide Ads are typically used to subside low grade (ie UGC) services. Insofar as Advertising tries to interject itself into the high value end, if it increases friction without sufficient benefit it will (in an open value chain) simply be avoided. In the olde days, it had the unassailable position of being free, but today "Free", "Open" and "Piracy" are competing zero-cost business models without the friction

The strategic problem the Ad industry has (apart from no longer being lowest cost provider) is (i) its not that big - c 2-3% of GDP, ie it cannot fund more than a fraction of the services, so alternatives to it by definition have to evolve, and typically grab the high end, (ii) its a friction, so always risks rejection if there is a choice, and (iii) it is also structurally in transition, so has to complete that process internally before it can really play.

A Worked Example

Take the ecosystem of general purpose Social Networks. These are Aggregators, but as they own neither the content creation (Social networks are a slightly unique case in that one customer's activity creates another customers' content, but the general case remains), nor a controlled channel to the customer, they exist only insofar as they reduce the friction of allowing content and customer to find each other.

What (most) Social Network aggregators are therefore attempting to do is to enclose users, by creating sufficient aggregation value (ie making it hard to export their networks) so that switching costs are higher than the necessary increase in transaction friction. This is of course a delicate balance...and the problem Aggregators have is that there is actually not a lot of surplus in this game (cf edge effects plus User Generated plays) at a per-transaction level, so they are very keen to take Advertising subsidy. Unfortunately, being low value, the sort of intrusion needed to generate enough revenue increases friction (and typically reduces trust, a key part of a Social Net value proposition), so bringing the service closer to the switching cost.

This game is exacerbated by another property of networked services - they are closed loop. In good times this means a "virtual cycle" occurs, as good news build on itself and rapid growth is possible. Unfortunately, the opposite is true, and that slight shift in friction vs switching cost can also lead to a vicious cycle, where a service can collapse rapidly as well.

(And as anyone who has dealt with such feedback loops can tell you, once they tip they are very hard to turn round quickly - they tend to overshoot and undershoot, and the problem with the latter is they can hit the floor before turning round.).

Hope that helps - its a summary after all - feel free to comment, criticize, credit etc.