Posts tagged ‘Advertising’

Unclogging the Pipes – Does the Net Need a Joe the Plumber?

With all the focus these days on Joe the Plumber, I couldn’t resist the desire to use the nation’s newest cliché. But this post’s topic is not on the issue of taxes on small business that Joe so artfully brought to the forefront but rather on the issue of the effect of net neutrality regulation for businesses selling online. The issue has gained importance in the past year, even prompting Senator Obama to declare it a priority in his first year if elected to office of President. (Broache 2007)

What Is Net Neutrality?

Net neutrality is unfettered access to content on the Internet. Net neutrality legislation would prevent Internet providers from controlling user access to certain content on the Internet. The Internet’s function is to move content from provider to user. While this seems obvious enough for those of us who have grown accustomed to a growing Internet, some believe that there lurks a growing potential for Internet Service Providers, who control access to the Internet, to begin using that control in such way as to filter or limit access to certain sites and services.

To understand the threat this imposes, it is helpful to view the Internet as a broad set of connected pipes. Data travels through these pipes, known as bandwidth, which is shared among consumers. When some consumers devote large amounts of time to downloading music, streaming movies, and consuming other forms of rich media, they essentially begin clogging the pipes of the Internet which affects the service to other consumers that share the pipe. To reduce this effect, ISPs can either upgrade (e.g. widen) the pipes, improve the technology (e.g., speed data through the pipes) or reduce the traffic at either its source or destination. Unfortunately, widening the pipes or improving technology takes money, and many of the ways that ISPs can raise this money have been viewed as impediments to providing a neutral network that does not discriminate based on the nature or source of the content that moves through it. Ways that ISPs could raise this money involve charging the users, charging the content providers, or filtering the content that goes through the current pipes.

Currently, many ISPs charge the consumers a flat fee for unlimited access to the pipes. This method of charging consumers essentially has the lighter Internet users subsidizing users that download large volumes of rich media. Recently some ISPs have begun allowing consumers to self-select into the wider or faster pipes via tiered and metered usage pricing schemes. For example, I pay $10 more per month to have my broadband service delivered at download speeds up to 20.0 megabits per second – supposedly double the speeds that 10.0 customers receive. Presumably, it allows me to work on my blog while my spouse searches the Internet, my older son plays Xbox Live, my daughter talks to friends using VOIP (our phone service via our ISP) and my other son works on his school project on his laptop - all without any significant loss in performance of these online activities. Although tiered pricing is not new (i.e., it was used by ISPs such as AT&T Broadband, Charter Communications and Cox Communications as early as 2002 to curb illegal movie downloading and music swaps), ISPs around the nation are testing similar plans (again). For example, Time Warner’s latest plan is to allow consumers to choose a tiered plan based on usage while allowing customers to monitor their usage in order to choose the right plan. (Bosworth 2008) “One way or the other, as video becomes a bigger part of overall broadband usage, it is inevitable that usage-based plans supplant current ‘all you can eat’ plans. Video is the reason.” (Kim 2008) In Australia, the three major ISPs use a price discrimination plan based on quotas that limit the access of the consumer to the Internet and charge heavier users who go over these quotas additional usage fees. (Winterford and Hill 2008).

In each of these cases, paying for service upgrades is coming from charging the users of the content. Where the biggest source of concern seems to be is that ISPs might begin charging content providers who provide and encourage the use of the many forms of rich media, such as YouTube, iTunes, MSN, Yahoo, peer-to-peer sites, etc. Content from these sites tend to “clog the pipes” more so than text content. The fear is that ISPs will charge premium fees to these content providers to prioritize and push their content through the pipes at faster rates than providers who don’t pay premiums. Or ISPs might simply charge premiums to content providers who have sites heavily laden with rich media. In which case, those firms with deeper pockets will be more successful at reaching and serving the consumer. With net neutrality legislation filtering or slowing content would be illegal. An example of what such legislation might look like can be found in a bill introduced into the Senate in January 2007 co-sponsored by Senator Obama and his former Democratic opponent Hillary Clinton titled the Internet Freedom Preservation Act. A similar bill was introduced into Congress titled the Internet Freedom Preservation Act of 2008 in February 2008. Neither bill seems to have made it out of committee.

A recent case that led to sanctions by the FCC (which represented its first net neutrality ruling) brought the issue of a non-neutral net into the spotlight. Comcast, the nation’s second largest ISP, was managing (or delaying) the use of bandwidth by its consumers with respect to peer-to-peer technologies such as BitTorrent. These activities gobble up bandwidth and clog the network pipes. Comcast claims that it simply limited these activities during high Internet traffic times. In a joint statement in March, Comcast and BitTorrent issued a joint statement that they were working together to solve the bandwidth issue and that government intervention is unnecessary. “Both BitTorrent and Comcast expressed the view that these technical issues can be worked out through private business discussions without the need for government intervention.” Regardless, the FCC’s decision to sanction Comcast came on August 1, 2008. On September 5, 2008, Comcast filed a suit against the FCC to overturn the decision. Also, as a result of the suit, beginning on October 1, 2008, Comcast will include a quota or monthly cap on users in its pricing strategy. These quotas are extremely high and meant to snare only the highest bandwidth hogs. This plan is an alternative to slowing a particular service or access to any one site.

What Does Net Neutrality Mean for Small Businesses Selling Online?

According to Cummings (2007), small businesses fear that telephone and cable companies will “rig the system so that the Web pages of premium-paying customers would open faster and be ranked higher than those that don’t pay the extra fee.” This puts smaller businesses at a disadvantage to larger businesses. She quotes Branch Heller, a retiree in Delaware, who says the law is needed to ensure that big corporations can’t dominate the Internet by censoring content or slowing — or blocking — links to their competitors’ customers.”

This issue particularly affects small businesses that sell or provide rich media content such as movies, music, interactive games, training videos, etc. online. ISPs could use their positions to slow access to these sites. Another fear is that Internet service providers may want to charge premiums to prioritize traffic connecting to some sites. Better and faster service would be provided to sites of firms who pay higher premiums.

However, another issue is that many small businesses are also turning to various forms of rich media for advertising online. Rich media advertising is a fast growing form of online advertising. This form of advertising may include sound, video, or Flash, and with programming languages such as Java, Javascript, and DHTML. These slow the loading of web content and may add a strain on the network. The Interactive Advertising Bureau is attempting to set standards for this media to reduce the strain. Examples may be found here. DoubleClick’s study of its online advertisers learned that customers are 5 time more likely to click video ads, that video ads usually play at least 2/3 of the way through, that users click the video “Play” button more than they click on image ads, and that 8% of video ads generate a user reaction. Some rich media ads even allow consumers to interact with the seller even without leaving the current site they are visiting. PointRoll says that rich media accounted for 116% click-through rate over standard banner ads and that consumers spend an average of 14.7 seconds of time with the brand. These are all topics for posts on another day but these stats will lead to an increased interest and therefore use of this pipe clogging media. Control of access to that media is feared to be in the hands of those who hold the pipes. Because of that control, proponents of net neutrality want preventive legislation. Opponents say that legislation leads to further regulation of the Internet.

What Are the Presidential Candidates’ Views of Net Neutrality?

One look at the Presidential candidates’ websites illustrates the extent to which both candidates use rich media on the net. Both Presidential candidates have opinions about net neutrality, and as expected, their views fall along party lines. Senator Barack Obama believes that net neutrality should be legislated.

“I will take a backseat to no one in my commitment to network neutrality…Because most Americans have a choice of only one or two broadband carriers, carriers are tempted to impose a toll charge on content and services, discriminating against Web sites that are unwilling to pay for equal treatment. This could create a two-tier Internet in which Web sites with the best relationships with network providers can get the fastest access to consumers, while all competing Web sites remain in a slower lane.” (Interview with CNET News)

Here are some relevant and related excerpts from Obama’s Technology Plan:
• Barack Obama strongly supports the principle of network neutrality to preserve the benefits of open competition on the Internet.
• Obama will encourage diversity in the ownership of broadcast media, promote the development of new media outlets for expression of diverse viewpoints, and clarify the public interest obligations of broadcasters who occupy the nation’s spectrum.
• Barack Obama and Joe Biden will use technology to reform government and improve the exchange of information between the federal government and citizens while ensuring the security of our networks. Obama and Biden believe in the American people and in their intelligence, expertise, and ability and willingness to give and to give back to make government work better.
• Obama and Biden believe we can get true broadband to every community in America through a combination of reform of the Universal Service Fund, better use of the nation’s wireless spectrum, promotion of next-generation facilities, technologies and applications, and new tax and loan incentives.
More on Senator Obama’s views can be found here.

Senator John McCain believes that net neutrality should be regulated only if necessary. McCain’s plan focuses on letting markets and firms go as far as possible in ensuring a neutral network and use regulation only when the market fails. Perhaps the negotiations between Comcast and BitTorrent are an example of such a settlement.

“In general, I believe that we need to move to a different model for enforcing competition on the Internet. Its focus should be on policing clearly anticompetitive behavior and consumer predation. In such a dynamic and innovative setting, it is not desirable for regulators to be required to anticipate market developments, intervene in the market, and try to micromanage American business and innovation.” (Interview with CNET News)

McCain’s technology plan suggests that existing antitrust legislation can handle many of the issues that may arise that cannot be privately negotiated. Some excerpts from the McCain Technology Plan:
• Given the enormous benefits we have seen from a lightly regulated Internet and software market, our government should refrain from imposing burdensome regulation. John McCain understands that unnecessary government intrusion can harm the innovative genius of the Internet. Government should have to prove regulation is needed, rather than have entrepreneurs prove it is not.
• John McCain will focus on policies that leave consumers free to access the content they choose; free to use the applications and services they choose; free to attach devices they choose, if they do not harm the network; and free to chose among broadband service providers.
• John McCain does not believe in prescriptive regulation like “net-neutrality,” but rather he believes that an open marketplace with a variety of consumer choices is the best deterrent against unfair practices.
• As President, John McCain would continue to encourage private investment to facilitate the build-out of infrastructure to provide high-speed Internet connectivity all over America. However, where private industry does not answer the call because of market failures or other obstacles, John McCain believes that people acting through their local governments should be able to invest in their own future by building out infrastructure to provide high-speed Internet services.
More on McCain’s views can be found here.

Net neutrality is sure to become an issue that resurfaces again and again. The issue is so large that I can’t possibly have done the topic the justice it deserves here, but hopefully it is a little less mysterious. In my Bibliography and Additional Reading, I included additional sources if you have further interest in the issue.

Bibliography and Additional Reading

Broadband Access Policy: The Role of Antitrust, J. Thomas Rosch, June 13, 2008, http://www.ftc.gov/speeches/rosch/080613broadbandaccess.pdf

No Need Now For New Net Neutrality Regulation, Tom Giovanetti, 05/03/2006 http://www.ipi.org/ipi/IPIPressReleases.nsf/0/c656d6236605f60785257163007936e8?OpenDocument

Inside Obama and McCain’s Conflicting Takes on Net Neutrality, Glenn Derene, October 8, 2008, http://www.popularmechanics.com/technology/industry/4286547.html?series=46

Frequently Asked Questions about Net Neutrality, http://www.savetheinternet.com/=faq

Obama pledges Net neutrality laws if elected president, Anne Broache, October 29, 2007, http://news.cnet.com/8301-10784_3-9806707-7.html?tag=mncol;txt

Net neutrality is an ‘American problem’, Brett Winterford and Julian Hill, ZDNet.com.au, 24 September 2008, http://www.zdnet.com.au/insight/communications/soa/Net-neutrality-is-an-American-problem-/0,139023754,339292161,00.htm

Test of Tiered Pricing for Broadband Access, Gary Kim, Thursday, January 17, 2008, http://ipcarrier.blogspot.com/2008/01/test-of-tiered-pricing-for-broadband.html

Time Warner To Test Metered Pricing For Broadband, Martin Bosworth, Jan. 17, 2008, http://www.consumeraffairs.com/news04/2008/01/tw_bandwidth.html

Obama Biden Technology Plan, http://origin.barackobama.com/issues/technology/#open-internet

John McCain Technology Plan, http://www.johnmccain.com/Informing/Issues/cbcd3a48-4b0e-4864-8be1-d04561c132ea.htm

Comcast to Appeal FCC’s Decision On Internet Blocking, Amy Schatz, September 5, 2008, http://online.wsj.com/article/SB122055137368500197.html?mg=com-wsj

Comcast to Cap Data Transfers at 250 GB in Oct., Chloe Albanesius, 08.28.08, http://www.pcmag.com/article2/0,2704,2329170,00.asp

Video Ad Benchmarks: Average Campaign Perfomance Metrics, A DoubleClick Rich Media and Video Report, February 2008, http://www.doubleclick.com/insight/pdfs/dc_videobenchmarks_0702.pdf

The Human Face of Net Neutrality, Jeanne Cummings, April 9, 2007, http://www.politico.com/news/stories/0407/3461.html

For the Love of Blogs

I attended a presentation this week by a fellow colleague, Dr. John Whitehead, from Appalachian State University, at the Kentucky Economic Association meetings on the topic of “blogonomics“. He presented very insightful information on the topic of economics blogs. The data also shed some light on blogging and who is blogging in general. This led me to think about what role blogging plays in the business of selling online.

What is blogging?

By now, most online users that would be reading this post will know that a blog is a “web log” and the blogosphere is the online community of weblogs. A Pew Internet and American Life Project found that about 39% of the online population reads blogs. Technorati publishes an annual “State of the Blogosphere“. The report is loaded with statistics about who is blogging. According to Technorati, U.S. Bloggers tend to be male (57%), over 35 (58%), employed full-time (56%), earn more than $75,000 (51%) and college graduates (74%). Of interest to small business is that more than four in five bloggers post product or brand reviews. One-third of bloggers have been approached to be brand advocates. According to Sifry (2008), there were 70 million weblogs in early 2008 with 120,000 new weblogs started each day. 3000-7000 of the new blogs are likely to be splogs (fake or spam blogs).

What does blogging mean to small business?

Zahorsky defines a business blog as “a corporate tool for communicating with customers or employees to share knowledge and expertise.” A business can use a blog to do a number of things such as provide commentary, product reviews, event or sale information, social networking, and the like. Kyrnin suggests that blogs can be a powerful tool for marketing and promotion. Yet only about 41 percent of small businesses have their own websites, so a much smaller portion would actually have blogs.

According to Socialtext.com, 12.2% of the Fortune 500 companies have blogs that are “active public blogs by company employees about the company and/or its products”. A listing is provided here: http://www.socialtext.net/bizblogs/index.cgi. This site also analyzes 30 blogs from the list and puts them on a “bias” graph according to whether or not the blog provides “casual & colloquial” or “logical & formal” information or commentary. This is interesting information shedding light on the why’s and how’s of corporate blogging.

Blogs, however, are a simple, low-cost easy way to keep consumers informed and keep your site fresh and changing. In a recent post, I talked about the role of article marketing in raising PageRank and keeping content changing. These are important for raising your position in SERPs (search engine results pages). A blog is a similar and related way to do this. Zahorsky suggests using blogs to answer frequently asked questions, promotions, contests, new and forthcoming product information, photos, and news. He suggests keeping blog posts short, keyword heavy, and full of links. (I tend to prefer long posts less often, but there are no set rules on blogging as long as it is useful.)

So what are some economics of blogs?

Briefly, here are some thoughts on this topic.

Opportunity costs: Blogging is a low-cost, low-tech, no entry barrier, and scalable way to promote your company. However, the opportunity costs can be high. Blogging takes time. In the business world, the oft quoted phrase “time is money” couldn’t hold more true. The opportunity costs of blogging include the sales and productivity lost when blogging as opposed to operating one’s business. Technorati finds that one in four bloggers spends ten hours or more blogging each week and more than half spend at least five hours weekly on their blog. For many small business men and women, this time is better spent organizing their business and drumming up sales. Thus, blogging often gets put on the “good idea for later” list of things-to-do. So the question then becomes whether or not the benefits of blogging outweigh these costs. According to Technorati, one in ten professional and corporate bloggers pay staff to contribute to their blogs.

Marginal analysis: We just mentioned the opportunity costs of blogging. These costs increase as more and more time is spent blogging. As with most economic questions, we assume rational behavior. In other words, an activity should be continued as long as the marginal (additional) benefits exceed the marginal (additional costs). The benefits of blogging for small business include improved customer and employee relations from the provision of information and the potential increase in PageRank and SERPs positions with major search engines. There is also the potential for advertising and affiliate sales revenue as well.

Advertising: Blogs can be used to promote your brand or as a direct revenue producer via advertising revenue. According to Technorati, professional and corporate bloggers are more likely to include search ads, display ads, and affiliate marketing. One in four bloggers uses three or more means of advertising. In the same study, Technorati, reports the mean annual investment in a blog is $1020. Bloggers that include advertising tend to invest more, about $1800 on average, and corporate bloggers invest the most with an average of $3,790. The average annual revenue is more than $6,000. This revenue average is deceptive because most advertising revenue is earned by the top 1% of bloggers. The major determinant of advertising revenue is traffic to the site. The high earning bloggers receive more than 100,000 unique visitors per month. If no one reads the blog, then the profits earned from the blog will be quite low. Therefore, it is important to provide good quality content that will keep folks coming back.

Asymmetric Information: Nobel prize winning economist, George Akerlof, received his Nobel in 2001 for formalizing the concept of the “lemons” problem. The lemons problem is a result of asymmetric information. Asymmetric information is a situation in which one party in a transaction has more or superior information compared to another. With regards to blogs, this situation is one of adverse selection - deceptive behavior that takes advantage of information asymmetries before a transaction. Akerlof explained adverse selection using the case of used cars. The seller of the car knows more about the history of the car than the buyer. The seller will happily take the price of a good quality car for a lemon but will not accept the price of a lemon for a good quality car. If the buyer on the other hand believes there is some positive probability that the car might be a lemon, they will not want to pay the price of good used car at all. As a result, fewer good cars are sold on the used car market, and a distrust of the entire market develops. Read more. In other words, when someone reads a blog, they don’t always know about the qualifications of the author. Anyone can fire up a blog at a moment’s notice without any need for experience or knowledge. If a person learns that the information is uncertain after they have read the blog, they may grow to distrust all blogs as a result. The amount of time they invest into reading blogs will be reduced by the suspicion that the information may be frivolous, untrue, or incomplete. As a result of this problem, you will begin to see more ratings systems and listings develop to help sort the good quality information from the vast sea of frivolities. In consideration of this issue, I am honored that you have read this far!

Demand and Supply: Much of the conversation above alludes to this topic of supply and demand. My colleague, Dr. Whitehead, and his co-author, Aaron Schiff, are making one of the first attempts of which I am aware to actually estimate the supply and demand for blogs. Their focus is more on the economics blog writers, who, like myself, tend to write for self promotion, or, as I would prefer to put it, “the dissemination of knowledge in our area of expertise.” The major problem, of course, in this market is the determination of a “price”. The demand for such information would likely yield a low price for many of us. And as they show in their research, the concentration of the market is very low with no real entry barriers. The supply of small business blogs would more likely depend on the costs mentioned above for the provision of information concerning products and services and the demand for such information by consumers, employees, and advertisers.

Moral to the story

Blogs can be a very useful tool for promoting your small business and boosting your online sales. The provision of a blog is inexpensive in dollar terms, but the costs are not negligible when the value of your time is considered. These costs must be compared to the value of sales conversions from improved search engine results, direct promotion, information provision, and advertising revenue. Done properly, blogs could be profitable for selling online.

Bibliography and Additional Readings

Sifry’s Alerts, David Syfry, http://www.sifry.com/alerts/archives/2008_09.html, September 2008

How to Blog Your Way to Small-Business Success, Matthew Bandyk, September 26, 2008, http://www.usnews.com/articles/business/small-business-entrepreneurs/2008/09/26/how-to-blog-your-way-to-small-business-success.html

All Technorati information comes from Technorati’s State of the Blogosphere 2008, http://www.technorati.com/blogging/state-of-the-blogosphere/

Blogging Is Bringing New Voices to the Online World: Most Bloggers Focus on Personal Experiences, Not Politics, 7/19/06, http://www.pewinternet.org/PPF/r/130/press_release.asp

About.com, What a Blog Can Do For Your Small Business, Darrell Zahorsky, http://sbinformation.about.com/cs/ecommerce/a/bblogs.htm

How to Use a Blog for Non-Diarists: A Blog Can Hellp Your Business Even if You Don’t “Blog”, Jennifer Kyrnin, http://webdesign.about.com/cs/weblogs/a/aa061603a.htm

The Worldwide What? Only 41% of Small Business Owners Have Websites, Warrillow & Company, 2008, http://www.warrillow.com/weeklyNews.aspx

Blogonomics, John Whitehead, http://www.env-econ.net/2008/10/blogonomics.html, October 2008

Using Economies of Scale to Make the Sale

Exploiting economies of scale was a driving strategy during the dot com boom of the 1990s. Internet firms raced to get the right domain name, get to market first, and then capture the most market share regardless of cost. This first-mover strategy worked for some and failed miserably for others. Capturing the most market share as fast as possible would seem unreasonable for small businesses wanting to sell online. So how can they exploit economies of scale?

What Are Economies of Scale?

Economies of scale occur when a firm’s long run average costs per unit fall as its production output grows. For example, if a firm builds a factory to produce bunny slippers, and then only produces two pairs, the average cost of each pair is pretty high! However, if the factory produces hundreds of bunny slippers, the average cost per pair is pretty low. When long run average costs are falling as production increases, the factory is exhibiting increasing returns to scale. This continues until production reaches the level that achieves minimum efficient scale – an output level that generates the lowest average cost per unit. However, in most cases, there are limits to how big the factory can get before its average costs per unit actually begin to rise. This is when the firm encounters diseconomies of scale. For further understanding of the technical aspects of economies of scale, a good reading can be found here (http://tutor2u.net/economics/content/essentials/economies_scale_scope.htm).

What Are Some Examples of Firms that Exploit Economies of Scale?

Firms from the early dot com era used size in an attempt to exploit economies of scale. Two such firms are described here. Webvan was a firm established in 1999 providing the convenience of online grocery shopping. In order to succeed, the firm felt the need to provide a vast delivery service. It raised $1.2 billion dollars from venture capitalists. The original plan was to create automated distribution centers in 26 target markets – with each being 350,000 square feet in size and about $30 million in cost. (http://ecommerce.hostip.info/pages/1080/Webvan-Group-Inc.html) The idea was to grow large, take advantage of economies of scale, have reduced prices and convenience, and out sell the competition. Being big in size would allow them to spread out their high fixed costs over their large market share, obtain volume pricing from wholesalers, and speed delivery to the consumer. Ultimately, 10 distribution centers were built or purchased. But the firm way overestimated demand. Economies of scale could have been exploited if the demand had been there. Since it was not, they perhaps should have started out smaller even if it meant having higher average costs. Hodson and Laseter (2001) contrast Webvan’s failure with the success of Peapod, another online grocery service. They find that Peapod’s relative success was due to the fact that Peapod delivered groceries collected from local retail stores. Since they did not have their own distribution centers, their variable costs were high, yet their fixed costs were low. Peapod is still delivering groceries and increasing the number of markets they serve today.

On the other hand, Amazon.com is another online store with humble basement beginnings that grew rapidly and massively in the early 1990s. Originally selling only books, it now sells music, videos, electronics, toys, and more. Jeff Bezos began Amazon.com in 1994 and began attracting venture capital by 1995. Amazon’s strategy was to “Get Big Fast”. By 1999 the company’s sales had exceeded $1.6 billion, but the company was still generating losses. Not only had the company become large, it had clearly become too large and began facing diseconomies of scale. This led Mr. Bezos to order the firm to “get the crap out” and reduce the scale of business (Frey and Cook, 2004). Over the next few years, Amazon began teaming up with other retailers, such as Toys R Us, and later allowed additional smaller third parties to begin selling via the Amazon.com online store. It was not until 2002 that the firm finally reported a quarterly profit. Amazon.com is a success story that supports the “Get Big Fast” theory; however, even Amazon learned that there is minimum efficient scale and a point beyond which diseconomies kick in.

What can we learn from this for selling online?

As will become evident over the course of this study, reaching and driving traffic to your site will become increasingly important. As the early dot com firms learned, being first to market, having the great domain name, or having the largest production or distribution capabilities does not guarantee success. The familiar phrase “if you build it they will come” does not apply to most online business. I did a quick Google search on digital cameras for sale and turned up over 700,000 results. Without sufficient investment, you very well could be the seller in result 699,999. For an online small business, sources of economies of scale include large fixed costs such as wharehouses or advertising campaigns, set up costs such as a quality website, ownership of specialized resources, division of labor or learning by doing, or purchases of large indivisible containers of inventory or other forms of volume purchasing. Setting up a quality online site and business model that can handle the fluctuations in demand may be quite expensive, but the benefits could be well worth the investment. A small business needs to study their potential market well. The managers need to understand and not overestimate the potential demand for their product. But it is important to not think too small either. Many parents have not forgotten the debacle of Toys R Us in 1999 when many Christmas toys could not be delivered in time for Christmas. “During 1999, Toys R Us did not have adequate inventory and fulfillment capabilities to meet the online demand for its products.” (http://www.internetlibrary.com/cases/lib_case424.cfm)

Bibliography and Further Reading:

http://ecommerce.hostip.info/pages/1080/Webvan-Group-Inc.html, Inc Webvan Group

http://www.strategy-business.com/press/enewsarticle/22494, Sweeping Webvan into the Dustbin of History, Nicholas Hodson and Tim Laseter, 8/13/01

http://seattlepi.nwsource.com/business/158315_amazon28.html, How Amazon.com survived, thrived and turned a profit: E-tailer defied predictions it would do none of those, CHRISTINE FREY AND JOHN COOK, seattlepi.com, January 28, 2004.

http://www.peapod.com/corpinfo/GW_index.jhtml;jsessionid=KQBQI1NDDUQN4CQBD0WCFEQ, Company History, Peapod.com.

http://www.internetlibrary.com/cases/lib_case424.cfm, Toys R Us.com, LLC v. Amazon.com, Docket No. C-96-04 (Superior Ct. N.J., March 1, 2006), Internet Library of Law and Court Decisions.

http://tutor2u.net/economics/content/essentials/economies_scale_scope.htm, Essential Economics: Economies of Scale and Scope

Sweet Tweets for Selling Online

Twitter is a rising new potential tool on the horizon for small business. With Twitter, a small business owner can send short messages, or “tweets”, concerning product specials, important links, information, discounts, events, news, polls, etc., to the mobile phones of consenting customers, through RSS feeds, and to its own website or blog with one short post. According to (http://www.toprankblog.com/2008/05/top-10-twitter-uses/), the top three uses of Twitter are sharing links to items of interest to a user’s network (34%), networking for new contacts (18%), reinforcing current network contacts (16%) – all relevant activities for small business.

Twitter was launched in 2006 by Jack Dorsey, Evan Williams, and Biz Stone as part of a podcasting company called Odeo. Twitter is a free service where originally users were to post the answer to the question “What are you doing?” in 140 characters or less – a number just shy of that allowed by most mobile phone carriers for texting services. Designed for users to report the day to day fuss of everyday life to family and friends, Twitter has evolved into a communication tool with a variety of uses. For example, Democratic Presidential candidate Barak Obama announced his vice presidential running mate, Joe Biden, using Twitter’s free text messaging capability to over 60,000 Twitter followers on August 23 at 2:22 a.m. (http://twitter.com/BarackObama). Seconds after the July 22 earthquake that hit southern California, the first tweet by “thevixy” that simply stated “earthquake” beat the news media reports by four minutes. The search term “Earthquake” already had thousands of updates on Twitter Search before the AP came out with a report 9 minutes after that first tweet. (http://blog.twitter.com/2008/07/twitter-as-news-wire.html). Businesses like Dell (http://twitter.com/DellOutlet), JetBlue (http://twitter.com/JetBlue), Zappos (http://twitter.com/zappos) and Whole Foods (http://twitter.com/WholeFoodsLA) use Twitter to make announcements to interested customers who have signed up to receive their updates.

What is Twitter?

Twitter is a social online network that is part of today’s Web 2.0. It is a mixture of blogging and texting – known as micro blogging. Twitter is a system that sends messages (tweets) from members to followers (tweeple) who subscribe to receive them. Interested individuals who do not wish to receive messages via text messages to their mobile phones can follow tweets via feeds, instant messages, and the member’s twitter page. They can also conduct searches (http://search.twitter.com/) on various Twitter keywords and even subscribe to the feed of the query.

Currently, the service is offered for free to its users and produces no revenue stream for its investors. So how does a company operate with no revenue stream or known business plan? Twitter is funded (to the tune of about $22 million) by venture capitalists Bijan Sabet with Spark Capital, Jeff Bezos of Bezos Expeditions, Union Square Ventures and Tokyo-based Digital Garage who believe that once Twitter reaches an undetermined critical mass it can be monetized (i.e., some sort of revenue stream can be created). The investors are relying on the power of network effects. Other Web 2.0 companies that began without a business model that also rely on network effects are Google, Facebook, and YouTube.

What are network effects?

In economics, these are also known as “demand side economies of scale” popularized by Carl Shapiro and Hal Varian in their book Information Rules. The idea is that demand for products with potential network effects does not have the traditional downward slope. In fact, it initially slopes upward and then downward. This is because the value of connecting to a network depends on the number of other people already connected to it. In other words, willingness to pay increases as more users join the network, but it then decreases as the network gets very large.

As an example, a few years ago we bought our first phone with caller ID. I told my son that he would be able to see who was calling. He was so excited about caller ID that I began to suspect his excitement. I asked why it was so interesting to him. He said, “I can’t wait to see Jerry the next time he calls, but that screen sure is small!” He had confused caller ID with a video phone. While video phones would have been cool, why haven’t they taken off? I would not purchase a video phone unless I knew that a majority of people that I call also had video phones. Otherwise, that feature of the phone is useless. Therefore, the more people I know that have video phones, the more I am willing to pay – TO A POINT. There is some point where its value to me does not exceed the value of the next best alternative. And would that value be enough to cover the costs? The videophone (or picturephone) has been around as far back as 1964 (http://archives.cnn.com/2000/TECH/computing/09/05/picture.phones.ap/); however, the demand has never been such that willingness to pay by users covered the cost to allow the market to reach a critical mass for success.

With network markets like Twitter, there is a critical mass to be reached, as well, which is the smallest size of the market that can be sustained at a particular price. For those who like a graphical image, this is illustrated below. The graph plots willingness to pay with the size of the market. The market will continue to grow after the critical mass point as more people who value a larger network more than price join the network, but there will be some point when willingness to pay by additional users to enter the large network begins to fall and may even fall to zero. The question for Twitter is to determine at which point, as the price is raised from zero to some positive amount, will the willingness to pay at least remain high enough to cover the marginal (additional) costs of providing the service. They want to find the network size such that most of those who highly value the service have already joined, n*. If Twitter begins to charge users, membership will decline. Thus it is in Twitter’s interest to have reached a market size greater than n* before it begins charging. Then the question becomes to choose the P where the associated n* generates a revenue sufficient to cover costs and maximize profit.

Graphical Illustration of a Market with Network Effects

Graphical Illustration of a Market with Network Effects

What will Twitter’s profits look like?

Twitter currently covers the SMS charges on its end for the services provided by Twitter (however, it does not cover the costs of members to update their accounts from their mobile devices or the costs of receiving messages on their mobile devices.) On August 13, Twitter stopped sending “tweets” via SMS to countries other than the U.S., Canada, and India (http://blog.twitter.com/search?q=sms+costs) due to the “disproportionate” operational costs of using foreign billing services. Twitter has also limited the number of people that a member could follow to 2000. While a good portion of Twitter’s costs are due to charges for SMS messaging (a.k.a., texting), there are also the costs of server space, bandwidth, programming, database management, employees, etc.

It is not believed that Twitter will begin charging personal users. In their own blog, Mr. Stone reports that Twitter will not pursue a revenue supported business model until it can provide a “reliable and robust” service, thereby acknowledging the many troubles of a network growing faster than its infrastructure can currently support. (http://blog.twitter.com/2008/06/welcoming-bijan-and-jeff.html) If Twitter does not begin charging users directly, its other potential revenue streams can come from advertising revenue on individual web pages or in search results, advertising in text messages, charging corporations and businesses that use Twitter to communicate to a large commercial audience. Advertising on individual pages is not likely to generate sufficient revenue since many consumers don’t go to the Twitter homepages. They receive and post from cell phones via text messaging. This has been test marketed in Japanese markets (http://www.technewsworld.com/rsstory/64258.html?wlc=1220381088). This same article speculates that Twitter may be gearing up to put advertising in search results since the recent acquisition of Summize.com. Customers who search are looking for information on a specific topic and may be more responsive to targeted advertising. Advertising in text messages on cell phones would not be permitted and sending an advertisement as a text message might alienate consumers – especially those that pay per text message. Then there is the “freemium” model which includes continuing the free service for the smaller users, but charging a premium to users with large followings. “Dell says that it made well over $500,000 in sales from sending special offers from its Dell Outlet store to its Twitter group, which began in June 2007.” (http://www.wired.com/techbiz/people/news/2008/08/portfolio_0804) Yet Bob Pearson, Dell’s VP for Communities and Conversations, says that it would “probably not” be willing to pay for use of Twitters services. Dell has about 1500 followers.

Conclusion

The final message of using Twitter for businesses selling online is that eventually Twitter WILL need a profitable business model. The investment of $22 million is based on the bet that a large market will ultimately be a huge money maker. Expect that businesses with large followings will ultimately pay something and therefore subsidize personal use; however, if its use in business becomes popular, this will become just the cost of a marketing alternative.

Additional Reading:
http://www.attentionmax.com/blog/2008/05/psychographics_of_the_twitterati.php, Psychographics of Twitterati, AttentionMax
The True Meaning of Twitter, Lashinsky, Adam; Burke, Doris. Fortune, 8/18/2008, Vol. 158 Issue 3, p39-42, 3p
Top 10 Uses of Twitter, Lee Odden, May 15, 2008, http://www.toprankblog.com/2008/05/top-10-twitter-uses/, online Marketing Blog
Information Rules, Carl Shapiro and Hal Varian, Harvard Business School Press, 1999

If You Give a Mouse a Cookie..

Does this sound like you? You have heard of cookies on computers. You may have heard something about deleting them and preventing websites from putting them on your computer, but when you did that, you found it very difficult, if not impossible, to effectively navigate the web. Then you resigned yourself to being cookied because you didn’t know what else to do. So what are cookies? And why do we have to have them? And how are they relevant for selling online?

What are cookies?

Cookies are simply small text files placed on your computer by a website that you are visiting (or may not be, as we will learn) that store information about you on your own computer so that it can be accessed later. This is how the computer “recognizes” you when you return (or when you visit other sites affiliated in some way with the website you visited). If you delete these cookies, then the website(s) will not know you when you visit again. Since nearly all ecommerce websites these days will place cookies on your computer, how your browser handles cookies will affect your use of these websites.

The Good, the Bad, and the Really Ugly

Cookies were “cooked up over a weekend [by Marc Adreessen and Vint Cerf] … because there was no way to do a shopping cart”.* They learned that if a website could put a small file on the customer’s computer with an ID that would help identify the customer for the entire visit to the site, then shopping would be easier. The cart would remember all the goods placed in it by that customer ID while the customer shopped. While this idea created convenience for customers and eliminated a huge barrier to selling online, it also created a doorway to potential privacy abuse that is still being debated today.

Cookies can be classified in several ways. One such way is to identify cookies as permanent or temporary (session) . Permanent cookies remain on your computer after you leave the website that you were visiting. Whether they remain there a week, a year, or forever, depends on whether or not the website puts an expiration date in the cookie. However, cookies are not required to have an expiration date. When you return to that website at a later date, the website will search for its cookie and learn information from your last visit, such as the date and time of your visit, your IP address, and various browser and computer information (such as the version of your browser, the resolution of the monitor you use, etc.). The cookie may also be used to store user ID and password information, as well as, surfing habits and interests. This information may be matched with the site’s own transaction log of information that it has for you on its server, such as your preferences, clickstreams, search terms, purchase history, etc. In this manner, the website develops a “user profile” for you. How the store uses this information is at the center of the privacy debate today.

Temporary, or session, cookies are deleted when you close your browser. These cookies may or may not require you to log in to a site, but they are necessary to help you navigate page to page. For example, you may desire to add goods to a cart and then continue shopping. Because of the session cookie, the site remembers items that you place in the cart. Or perhaps the site remembers you as you move through pages on forums and other social network sites.

Cookies are also classified as “first party” or “third party”. First party cookies are placed by the websites you visit and convey information only back to them. They cannot be read by other websites. One particularly nice pro is that you do not have to remember login information at many of these sites. For example, I don’t have to “log on” to the Wall Street Journal web site when I use my office computer to access it. It remembers who I am automatically. Cookies, themselves, are simply text files. As such, they cannot collect and relay private information from your computer back to the site. While this is convenient, cookies placed on my computer can store data that can be matched up with my e-mail address, phone number, and possibly my home address (if I enter personal information into a form on that site). As a note of reference, many websites will offer contests, giveaways, contact us pages, registration forms, etc., which allow them to connect your personal information with your online behavior. Then you can be targeted for email, telemarketing, and junk snail mail. While many consider that clever marketing, I would call it a hidden mouse trap. Please note that not all contact us forms and contests have this aggressive marketing intent in mind.

Third party cookies are placed on your computer by an outside website. These are common with advertising sites and affiliate programs. When you visit a site with advertising, the advertising company may also place a cookie on your computer. Then, when you visit another site that displays the advertising company’s ads, it will know more about your interests and display an ad targeted directly at you. E.g. if you visit a photography site one day and then later visit a furniture store, don’t be surprised if you see a banner advertising cameras. It’s not fate or coincidence. It’s marketing! Suppose you visit the website of your favorite movie and then click through an ad to buy the DVD which takes you to Amazon.com. This likely means the website was part of an affiliate program. The website will get a cut of your purchase, and Amazon has found a way to track your interests and purchases based on sites you visit other than its own. Because third party cookies provide the greatest potential to exploit your online behavior, they provide a greater risk to your online privacy and security.

While cookies themselves are harmless text files, it is the websites that read them that provide the problem. The debate centers around what websites do with your private information and how securely they keep it. Congress recently sent letters to 33 companies asking what they do with the information they collect from customers. Most will claim that the information is used to provide a better shopping, search and advertising experience. Yahoo sends the customer targeted ads based what on they believe are the customer’s interests as derived from their online behavior. You can actually “opt out” of receiving targeted ads from Yahoo through their privacy page. (Note it doesn’t mean that they aren’t still collecting information or that they won’t show ads – just that the ads won’t be something that you would more likely be interested in seeing.) Google replied that it prefers to place ads to the consumer based page context information. Thus, the Google ads that you see on this site “should” be based on the context of this article or previous articles. For example, Google believes that you are reading this because you have some interest in Internet privacy. If not, then the ads might have been about golf tours or Elvis Presley albums – which may show up because I mentioned them in this article. Microsoft already allows you to turn off targeted ads.

So what is the economic relevance of cookies? (These lists are not meant to be all inclusive.)

For the consumer, cookies:

-Allow consumers to personalize their online shopping experience by stating their preferences.
-Allow consumers to navigate through a website without multiple logins.
-Allow consumers to mainly see relevant advertising.
-Allow consumers to participate in Web 2.0 activities.

For the online seller, cookies:

-Allow the seller to get to know their consumers and therefore provide a more relevant shopping experience.
-Allow the seller to target consumers who are most likely to want to see their advertising.
-Allow sellers to see what pages of their sites are relevant to consumers and which ones they can eliminate.
-Allow the seller to know the locations of the consumers, the ratio of new and returning visitors, what technology the consumers use, etc. (E.g., I recently increased the width of a web site after learning that better than 80% of the viewers had browsers capable of handling it without a horizontal scroll bar.)
-Allow the seller to fully implement Web 2.0 strategies.

How will these relate to later topics we’ll discuss?

Cookies allow for clickstream tracking which identifies individual tastes, preferences, and online behavior. This allows for targeted margeting and “personalized” pricing – both of which are viewed favorably and unfavorably. Cookies also carry the potential for security and privacy abuse. Despite the potential for unfavorable results, from an economic standpoint cookies increase the efficiency of online sales, search, advertising, and communication whose previous inefficiencies had provided a tremendous barrier to online retail sales, or e-tailing.

*http://cnettv.cnet.com/9742-1_53-50002002.html, Marc Adreessen: Past and Present, Video interview of Marc Adreessen by John Battelle, May 2008

Bibliography and Other Reading:

Energy and Commerce Committee Questions Data Practices of Network Operators, August 1, 2008, http://energycommerce.house.gov/Press_110/110nr337.shtml

Google’s Response to the Energy and Commerce Committee, http://64.233.179.110/blog_resources/google_policy_davidson_letter.pdf

Spyware, adware, and internet cookies. What’s Good and What’s Bad. Privacy and Removal Tips and Help, http://cookiescache.tripod.com.

“Yahoo’s Response to Congress on Targeting May Not be Enough”, Heather Green, Business Week, August 8,2008, http://www.businessweek.com/the_thread/blogspotting/archives/2008/08/congress_turns.html