Ever wondered why Airbnb took off but you didn’t notice until everyone started talking about it at the same time? Or how Tumblr was the one blogging platform that everyone was spending all their time on, more so than Facebook? There is no secret to how these services become huge trends and market giants. They used a system that only works because of how businesses economics works online.
Old Economics of Business
Lets say you wanted to buy a pair of shoes so in order to do this you would have to get in your car and drive to the store and look at their current items in stock. If you find an item you like then you can give them money and in return they will give you the shoes you want. The same works for services, if you ask a plumber to come fix your clogged sink then you will pay them after they are solved your problem.
The market works in a way that money is exchanged for a service or product based on your need or demand. This helps keep some businesses going but using this model does little, in terms of growth, if you don’t offer discounts or special promotions which cost money to do. Large companies before the internet had to find ways to build their customer base, sometime using a referral program that offer money back if new customers were signed up. This took a very long time to work and never amounted to more than a few within everyday. Advertising was done through the yellowpages, on billboards, radio and TV. In order to become a monopoly at some point tough business practices were needed.
New Economy of Business
Google started off like any other search engine online, offering searches that provided relevant results that matched to what the user wanted. Never once has Google asked me to pay before searching in all the years that I have used them. The same for any other search engine online. The last time I used an app that I downloaded, I had the option of using just their free version so I could still use their services. This whole internet thing has upended up business works now.
I could literally use tons of free programs and ads without ever paying for anything, including the internet (if I only relied on free public wi-fi systems), and get all my work done at no cost to using the software (google docs, office lite, Zoho docs) and even find a potential dating partner (another industry that is taking over online). So how did Google become the 900 lb guerrilla in the room? How did Facebook become the dominant social media platform? And why did Airbnb take off when I could just search through Craigslist for a room to rent?
Understanding the Internet Economy
Jean Tirole, Nobel Prize winner in Economics, talks about the two sided market issue in his paper entitled, Two-SIded Markets: A Progress Report, and in which one side is the consumer and the other side is the developer or even advertiser in some cases. It is very difficult to regulate a company that offers their product for free but turns into a monopoly down the road. These free products are what help grow users because they are the value they bring into the company; the more users a company has the more numbers they can show to advertisers who will pay them money to show their products to those users.
User growth is what drives many companies to be valued higher than they normally would be if using the old business model of valuation. Tumblr has millions of blogs and is valued very high but has little profit to show for it but they keep getting money. Tumblr continues to grow, despite its struggle to make a lot of money, because anyone can get on and create as many blogs as they like for free. Normally if people had a high demand for something the price of it goes up, so if lots of people wanted to create a blog, it would make sense to raise the price of entry to doing that. But in the internet economy that doesn’t work. It would push other people to a site that offers free blogging services. If all the blogging platforms would to suddenly put up huge paywalls for blogs then what it stopping someone from creating another blogging platform that combines all the blogs special features out there and offer it for free? Nothing, infact they would soon become the dominant blogging platform online and you wouldn’t need to advertise because all your users would do it for you because it is free while everyone else is asking for money.
Jean Tirole talks about the hidden dangers in these new market tendencies because it is so easy for a small idea online to turn into a giant monopoly in a shorter period of time. How can you regulate and manage something a company does when their main product is free? This is one of the challenges that Mr. Tirole has sought out to answer. The dynamics are different and so is the consumer interaction so how does a market balance itself out when old businesses still use the old model? In some industries it might always be the case that you will have to pay in order to use their service or product but how soon might that all change when new ideas are being created in the form of apps. I can now swap my leftovers with someone in my neighborhood using an app that lets me do that. If I was driving along and needed a restroom but no gas stations were nearby I can use an app that lets me find people offering their restroom for a price. AIrbnb struggled to get started but found their niche, they run up against lots of regulation even today so what is stopping someone from creating an a service that lowers the cost and price for services that have always relied on the old business model?
To learn more about Jean Tirole and his price winning work check out the links below