Explain why the cost structure associated with many kinds of information good and services might imply a market supplied by a small number of large firms. (At the same time, some Internet businesses such as grocery home deliveries have continually suffered steep losses regardless of scale. Explain why.) Could lower transaction cost in ecommerce ever make it easier for small suppliers to complete? As noted in Chapter 3, network externalities are often an important aspect of demand for information goods and services. (The benefits to customers on using software, participating in electronic markets, or using instant messaging increase with the number of other users.) How might network externalities affect firm operating strategies (pricing, output, and advertising) and firm size?
The cost structure associated with many information goods and services often implies a market supplied by a small number of large firms due to several reasons.
Firstly, the production and distribution costs of information goods and services are often high. This is especially true for goods that require expensive research and development, creation of intellectual property, or content generation. These costs create barriers to entry, making it difficult for small firms to compete with larger ones that have more resources and economies of scale. As a result, a small number of large firms dominate the market.
Secondly, information goods and services often have high fixed costs and low marginal costs. Fixed costs are the costs that need to be incurred regardless of the quantity produced or sold, while marginal costs are the costs associated with producing one additional unit of the good or service. This cost structure creates economies of scale for larger firms, as they can spread their fixed costs over a larger output. In contrast, small firms with lower output struggle to cover their fixed costs, putting them at a competitive disadvantage.
However, there are instances, such as with certain internet businesses like grocery home deliveries, where even large firms struggle to make profits and continuously suffer losses. This can be attributed to high variable costs associated with these services, such as the cost of transportation, perishable items, and last-mile delivery. Regardless of scale, these variable costs can eat into the profit margins, making it difficult for firms to cover their expenses.
Lower transaction costs in e-commerce can potentially make it easier for small suppliers to compete. E-commerce reduces the need for physical infrastructure and intermediaries, thereby lowering transaction costs. This can benefit small suppliers by enabling them to reach customers directly and offer their products or services at competitive prices without the need for extensive distribution networks. Furthermore, e-commerce platforms and marketplaces provide smaller suppliers with the opportunity to leverage the network effects of existing platforms, reaching a larger customer base.
Network externalities, as discussed in Chapter 3, refer to the increase in the value of a product or service to an individual as more people use it. In the context of information goods and services, network externalities can have significant implications for firm operating strategies and firm size.
With positive network externalities, the value of the product or service increases as more users join the network. This can lead to a self-reinforcing cycle where more users attract even more users. In terms of firm operating strategies, firms may employ pricing strategies such as offering the product or service for free or at a low cost initially to attract a critical mass of users. Once a large user base is established, the firm may then monetize the network by charging higher prices or implementing advertising models.
Network externalities also impact firm size. In order to benefit from network externalities, firms need to achieve a critical mass of users. This often requires significant resources and marketing efforts, favoring larger firms that have the financial means and brand recognition to attract and retain users. Smaller firms may struggle to reach critical mass and may find it difficult to compete with larger firms that already have an established user base.
In summary, the cost structure associated with information goods and services often leads to markets supplied by a small number of large firms due to high fixed costs, economies of scale, and barriers to entry. However, lower transaction costs in e-commerce can potentially level the playing field for small suppliers. Network externalities can affect firm operating strategies and firm size, with larger firms often benefiting from the positive network effects.