Mustafa Suleyman, DeepMind cofounder and now Microsoft AI's CEO argues that, because of artificial intelligence, "the economics of information are about to radically change because we're going to reduce the cost of production of knowledge to zero marginal cost."
At least two observations are possible. The perhaps-negative view is that such thinking tends to happen with technology bubbles. The perhaps-positive interpretation is that a major disruption of information-related businesses and industries--perhaps on a greater scale than the internet--is possible.
Most digital products can have marginal costs close to zero, which is quite different from physical goods.
It might be fair to note that what Suleyman refers to is marginal cost, not sunk cost. In other words, the cost of information infrastructure is one matter. The cost of producing the next unit can be marginally close to zero.
Think about communications infrastructure and platforms, where the sunk cost of networks is quite high and very capital intensive, while the cost of producing the next unit is almost immeasurably low. All that has huge costs for many content creators, distributors and firms in many industries.
“Near-zero pricing” (or the perhaps-better known expression of “marginal cost pricing”) is a business principle that underpins and complicates business strategy in a wide range of industries, ranging from internet apps to computing; retailing to media; communications and consumer electronics.
Marginal cost is a universally accepted pricing principle, representing the incremental cost to produce one more unit. The key idea is that it is profitable to keep producing additional units right up to the point where marginal cost and marginal revenue hit zero. At that point, one stops producing, as losses will occur.
But physical goods and digital goods have different marginal cost curves. For a communications service provider, at some point there is so much demand that a network has to be upgraded. That adds capital investment cost, so the marginal cost actually has to rise.
Digital products are different. Once the original is created, the marginal cost can actually remain infinitesimal, even with vastly-greater usage. That also implies that retail price can be very close to zero, and still yield a profit.
In fact, some believe zero marginal cost might be among the most-important business drivers in the early 21st century, though the idea remains controversial.
A company that is looking to maximize its profits will produce “up to the point where marginal cost equals marginal revenue.” In a business with economies of scale, increasing scale tends to reduce marginal costs. Digital businesses, in particular, have marginal costs quite close to zero.
In other words, the incremental cost of adding one more Gmail user or one more Facebook user are infinitesimally small.
But marginal costs also are immeasurably small even in some industries with high capital intensity. What, for example, is the incremental cost to supply one more megabyte of internet access capacity; one more minute of voice usage; one more text message, on a network that already is built and operating?
To be sure, additional sales help most businesses, digital or physical. But profit margins for digital goods--based in large part on near-zero marginal costs--often exceed those of physical goods.
But the danger of pricing at marginal cost (increasingly a price very nearly zero) is that “where there are economies of scale, prices set at marginal cost will fail to cover total costs.”
Think of the “sunk cost” of building a mobile or fixed network. Retail pricing has to be set at a level that allows recovery of that initial network cost, plus profit. So overall pricing cannot be set at the marginal cost of the last units, but at a rate including recovery of sunk costs.
Add to that the possibility that product prices for the end user also include revenue generated by third party partners (advertisers, retailers on a platform) and end user consumption can actually be subsidized.
The point is that even if the incremental cost of supplying one more megabyte of data consumption, one more minute of a voice call or one additional text message is quite close to zero, a service provider cannot price at marginal cost, forever.
That accounts for the business advantage many app, content and services providers hold over a facilities-based connectivity provider selling apps and services. An over-the-top app provider does not have to recover a physical network’s sunk costs.
If Suleyman is correct--and many will disagree--we could see dramatic new disruptions of existing information-based industries and activities as well as the potential creation of entirely-new industries.
The near-zero marginal cost of digital goods has led to the emergence of various business models. to Freemium models, advertising-supported content, and almost anything that can be bought “as a service” provide examples.
Digital platforms and marketplaces that leverage create massive scale and network effects that create the platform for revenue and monetization. Using past history, when low marginal cost created cloud computing, software as a service, social media, video and audio streaming, digital versions of physical products (e-books) emerged, AI is likely to produce new products, platforms and industries.
As was the case for the internet impact on digital goods in general, AI has the potential to alter any number of functional costs. How much of that impact will be incremental, and how much exponential, remains to be determined.
