Book Review: Wired for Innovation

“Wired for Innovation: How Information technology is Reshaping the Economy” by Erik Brynjolfsson & Adam Saunders, MIT Press, 2010.

Main argument of the book is that the so-called “productivity paradox” of the period 1970-1995, whereby the adoption of IT failed to boost per capita productivity growth in the US, is now seen to be due to a lack of concomitant investment in organizational capital. In other words, people tended to “computerize” existing tasks in a brain-dead way, without investing in new business processes, employee training, and the like. The literature shows that the period 1995-2008 saw far greater gains, but only for those companies that combined new technology with a range of complementary practices around job redesign, openness of information, and empowerment of workers.

These “complementarities” are not just the “best practices” beloved of management consultants of every stripe, but aspects of a company’s culture, including things like profit sharing, flexible work hours and reorganization of workflows to really capitalize on new technology, so that even where there are fewer jobs, these jobs are more interesting than before. These practices are only effective if they work together to reinforce each other, both incenting workers and helping them innovate. Studies show that productivity programs such as TQMS don’t produce results otherwise.

Secondary related topic is that GDP tends to underestimate the value generated by IT innovations. The argument is that traditional measures of inputs and outputs used by the government do not capture “consumer surplus”, i.e., the net benefit that consumers derive from a product or service after you subtract the amount paid. E.g., various studies claim that eBay alone generates several billion a year in consumer surplus, and Amazon’s used book sales generate tens of millions in surplus, given aggressively low pricing. Another study found that the government’s 10 year regulatory delay in allowing cell phone usage cost consumers about $100 billion in lost surpluses!

Chapter 6, on ‘Incentives to Innovate in the Information Economy’ is especially worth reading, for an economist’s view of our world. The authors characterize information as a ‘non-rival good’, i.e., if I consume a piece of information that doesn’t prevent anyone else from consuming it (unlike a piece of cake, say). They also argue that people are reluctant to pay full-price for information goods, since they don’t know how useful they will be until they consume them (by which time they have already paid). Bundling is advocated, because it gets you away from the problem of pricing individual pieces of information in a situation where the marginal cost is close to zero (so that formulas like marginal cost plus a markup don’t work).

Another consequence of information being a non-rival good is ‘knowledge spillovers’, which typically mean that the private return for innovation will be less than the return for society as a whole. (Think about cell phones, and the value they create for society compared to the returns for cell phone companies.) The authors argue that this kind of disparity leads to a ‘chronic underinvestment in R&D’ by the private sector. Even within a single corporation, like Thomson Reuters, you can see this play out. Individual business units that invest in R&D often feel that other businesses that benefit from the ‘spillover’ are freeloaders who have not taken the risk or borne the cost of R&D, but nonetheless derived its benefits. This is why companies like 3M try to take a broader view of R&D cost-benefits across the organization as a whole.

Finally, the authors address the issues of price dispersion and low-cost copies of information goods, and how disruptive they really are. With respect to pricing, studies show that Amazon retains market share, even though it doesn’t actually have the lowest online books prices, thanks to their customer experience and reputation. (This doesn’t bode very well for Walmart in their current price war with Amazon over holiday sales.) With respect to low-cost copies, the authors argue that high availability can create demand for publishers’ wares under some circumstances. For example, lending libraries created readership and stimulated book sales rather than depressing them; more recently, VCRs created demand an insatiable demand for video.

At 150 pages, this is a slim, dense book that contains many insights into the forces behind innovation. Unlike many of the volumes that one finds in airport bookstores, the facts and claims are backed by citations to recent research. Although the main theme is really the relationship between innovation, IT and productivity, there are many interesting reflections upon leadership, change, knowledge, value and the distribution of wealth. It’s not a light read, because it doesn’t shrink from complexity, but it’s not turgid either. The authors are from MIT’s Sloan School and U Penn’s Wharton School, so you are getting an up-to-date view of the very latest thinking at these august institutions.

Book Review: Free

Chris Anderson of “Long Tail” fame has done it again with his latest book, “Free”. I reviewed his NetGain talk earlier in this blog, so I won’t go through all the basics again. His concept is that, in a highly competitive online market, price falls to the marginal cost of adding a new user, which is close to zero.

He distinguishes between three different models of “free”: the cross-subsidy (basically a come-on, like the free sample or the loss leader), the two-sided market (one customer subsidizes the other, e.g., advertisers subsidizing magazine readers), and the “freemium” model (upgrade users from a free version to a more capable version of your product, or a range of ancillary experiences).

His historical preamble is both amusing and informative, explaining the origins of common phrases such as "free lunch" and "jumping on the bandwagon." There are sidebars containing detailed examples of companies that play in the free space to a non-trivial extent. His comments on the dilemma currently facing the media industry are unsparing and incisive.

"Free" is a good read, being both very clear and non-redundant. Anderson has had a long and successful career in quality publishing, as well as being a well-known blogger. For my money, he is up there with Nicholas Carr and Malcolm Gladwell as a really insightful writer on technology, business and social trends. At about 250 pages, this is a book you can read in a small number of sittings, and then refer back to, as needed.

His message can be summarized as follows: a version of your current digital assets will one day be abundantly available free of charge, so you have to keep moving up the value chain. Furthermore, it often makes sense to give away some part of your asset base to some part of your potential market to gain attention, reputation and good will. You can then successfully monetize other, higher value, opportunities arising from all this buzz, possibly by charging just a fraction of your users.

He cites many interesting examples, e.g., Skype giving away computer-to-computer calls, but charging for computer-to-phone calls, Second Life giving away virtual tourism but charging for virtual land, etc. My main problem is that they are mostly drawn from the mass-market, consumer space, not the professional space.

Even in the consumer space, experiments with free are ambiguous. For example, local newspapers have had a mixed experience with free, as Anderson acknowledges. There is the whole issue of how readers (and more to the point advertisers) value free publications, especially those that were once sold at a price. He also acknowledges that free has a habit of turning billion dollar businesses (classified ads in newspapers) into million dollar businesses (like Craigslist). Scale seems to be everything, as well as getting your sums right.

Perhaps the most interesting passages for me concerned Google: its vast economies of scale; its use of free for various purposes (goodwill, data gathering, ad delivery); and the concern of execs like Eric Schmidt that publishing companies may suffer to an extent that they are no longer able to generate quality content to be searched. Not every aspect of the Internet economy is a zero-sum game, and Google probably knows that the sooner the media industry finds new business models to maintain its creative output the better for all concerned.

The book ends with a handy guide to the rules, tactics and business models that seem to work in the free economy. Appropriately enough, free versions of the book are available, e.g., in an abridged form as an audiobook. (For a while, an advanced copy was also free on the Web as a pdf.)