Showing posts sorted by relevance for query near zero pricing. Sort by date Show all posts
Showing posts sorted by relevance for query near zero pricing. Sort by date Show all posts

Sunday, October 4, 2015

Will Cloud Computing Prices Keep Dropping to Zero, or Close to It?

Amazon Web Services has cut prices about 50 times. So will it keep doing so? Most would say “yes.” Will other suppliers such as Google and Microsoft follow suit? Most would also say “yes.”

In most industries, “ruinous” levels of competition often are said to represent a “race to zero” in terms of retail pricing, with negative implications for firm or industry sustainability.

But AWS has chosen such a strategy deliberately. AWS rationally has decided to keep cutting prices as the foundation of its business model.  

“How can that be?” is a reasonable question for any outside observer. How can a market leader in cloud computing literally price its core services at nearly zero, in either consumer (free computing, free storage, free apps)  or business markets (cloud computing, storage, apps or platform)?

After all, big data centers and the software, hardware, real estate and energy required to run them are substantial.

The business advantages of huge scale are part of the answer. Firms such as Amazon and Google count on the fact that only a few providers, with enormous scale, can afford to compete in such a market.

So gaining scale, then lowering prices, feeds a virtuous cycle where additional customers, buying more services, allow the supplier to gain even more scale and drop prices even more, attracting yet more customers.

With sufficient scale, “scope” also becomes relevant: AWS and other leading cloud computing suppliers can sell additional services and features to the customers they already have aggregated.

So even if a “race to zero” has generally been considered dangerous and unsustainable in big existing markets, it is the foundation of strategy in many new digital--and some emerging physical markets--as well.

It is hard to compete with a competitor that gives away what you sell. That, in fact, is precisely the logic often driving business strategy in the Internet realm.

That strategy is at work with voice over IP, instant messaging, online streaming video and audio, Internet access, search and most “print” content. Many would agree, but note that these all are non-tangible, digital products. That notion is correct.

In most “physical product” areas, the Internet has lead to reduced prices, or less friction, but surely not to “near zero” levels.

That, of course, is not really the issue. The issue is a competitor’s ability to destroy enough gross revenue--and strategically, profit margin--as to break the market leader’s business model.

This is a rational strategy for some new contestants because they actually have other revenue models that are enhanced when an existing supporting market is “destroyed.”

In a real sense, Apple gains business advantage when content prices are very low. That helps it sell devices enabling content consumption. Facebook and Google gain when each additional Internet user is added, since they make money on advertising.

Prices for physical good distribution do not have to reach “near zero,” only “near zero profit,” for whole markets to be disrupted.

An attacker able to create a positive and sustainable business case in a market that is perhaps smaller (in terms of overall revenue) still wins is the attacker emerges as a market leader in the reshaped market.

One example: many observers would say that the chief revenue stream for Costco, the discount groceries retailer, is membership fees, not groceries. Likewise, the business model for most movie theaters is concessions, not admission tickets.

That is one sense of the term “zero billion dollar market.”

The strategy is inherent in business models used by many leading application, device or service providers.

The difference is that the trend is extending beyond businesses that are inherently “digital.” Some see shared vehicle businesses as disrupting the automobile market on a permanent basis. Shared accommodations businesses have potential to disrupt the commercial lodging business.

Without a doubt, we will see spreading efforts to replicate such sharing models in most parts of the economy where ownership is the dominant retail model.

Suppliers of cloud computing, especially infrastructure as a service (IAAS) but even the biggests segment--software as a service--also must directly confront pricing strategies that deliberately aim to reach near-zero levels.

There are several analogies you might might apply, to Moore’s Law, marginal cost pricing or experience curves, for example. Some might say that same logic is embedded in much of the economics of the Internet as well.

The notion is that, over time, performance vastly improves while retail price either remains the same or also shrinks, not just on a per-bit or per-instance basis, but absolutely, adjusted for inflation or not.

Suppliers of network bandwidth and computer chips long have had to create or recraft businesses built on such assumptions.

The obvious business implications are stark. Many firms, in a growing range of industries, face competitors who literally base their business models on marginal cost pricing, near zero pricing or actual “free” prices.

Those competitors can do so because widespread use of the “near zero” or “zero” price function allows them to make money indirectly. For Amazon, the other way is retailing all manner of products. For Google and Facebook the other way is advertising. For Apple the other way is device sales.

In all those cases, the direct revenue contribution for one input--while important--is less important than ubiquity or huge scale as it relates to the primary revenue model.

“Zero” levels of pricing are a fundamental reality in a growing range of industries. How successfully the legacy providers can adapt always is the issue. In many cases, the answer is “we won’t be able to do so.”

Some would say that is an example of creative destruction. But it is destruction, nevertheless.

Sunday, September 20, 2020

Near Zero Pricing Remains the Top Issue Connectivity Providers Face

Near zero pricing is the term I use to describe the larger framework of connectivity provider pressures towards ever-lower prices. Others might prefer to emphasize marginal cost pricing. The point is that there is a reason the phrase dumb pipe exists. What we need to remember is that dumb pipe now is the foundation of the whole connectivity business


A caveat is that what people usually mean by “dumb pipe” is that a product is sold at low prices and generates low profit margins. But think about it: industry revenue growth now is lead by broadband services (internet access), which is, by definition, a dumb pipe service. It is a way to get access to applications, not an actual application itself. 


You might call that trend another example of the impact of Moore's Law on business and economics. And near zero pricing is a big industry issue. It might be the single-biggest issue. 


In a recent survey by Telecoms.com, the number-one threat to long-term business success was “increased pressure to lower prices” and “lower profit margins,” for example. 


source: Telecoms.com 


Agility or “speed” was also a major concern. Third on the list was competition from webscale firms including Google, Amazon or Microsoft. 


But there are good reasons why “lower prices” and “lower profit margins” are the top issues. Simply, they are the most-important result of other industry threats causing the price compression and lower profit margins: competition, the shift to internet protocol as the next-generation platform and the embedding of the whole connectivity function within the larger internet ecosystem.


Aside from deregulation of the telecom industry, which lead to competition and price competition, technology is among the root causes of price pressures. 


The most-startling strategic assumption ever made by Bill Gates was his belief that horrendously-expensive computing hardware would eventually be so low cost that he could build his own business on software for ubiquitous devices. Basically, I believe he asked himself what his own business would look like if computing hardware was free. 


How startling was that question? Consider that, In constant dollar terms, the computing power of an Apple iPad 2, when Microsoft was founded in 1975, would have cost between US$100 million and $10 billion.


The point is that the assumption by Gates that computing operations would be so cheap was an astounding leap. But my guess is that Gates understood Moore’s Law in a way that the rest of us did not.


Reed Hastings, Netflix founder, apparently made a similar decision. For Bill Gates, the insight that free computing would be a reality meant he should build his business on software used by computers.


Reed Hastings came to the same conclusion as he looked at bandwidth trends in terms both of capacity and prices. At a time when dial-up modems were running at 56 kbps, Hastings extrapolated from Moore's Law to understand where bandwidth would be in the future, not where it was “right now.”


“We took out our spreadsheets and we figured we’d get 14 megabits per second to the home by 2012, which turns out is about what we will get,” says Reed Hastings, Netflix CEO. “If you drag it out to 2021, we will all have a gigabit to the home." So far, internet access speeds have increased at just about those rates.


As frightening as it might be for executives and shareholders in the telecommunications industry, a bedrock assumption of mine about dynamics in the industry is that, over time, retail prices for connectivity services also will trend towards zero.


“Near-zero pricing” does not mean absolute zero (free), but only prices so low there is no practical constraint to using the services, just as prices of computing appliances trend towards lower prices over time, without reaching actual “zero.”


Wednesday, July 3, 2024

Near-Zero Marginal Cost for AI-Enabled Knowledge Goods?

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. 

source: IP Cariier 


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. 


Product/Service

Description

Near-Zero Marginal Cost Explanation

E-books

Digital books

Once created, distributing additional copies has negligible cost

Software

Applications, operating systems

Copying and distributing software digitally has minimal incremental cost

Streaming Media

Music, movies, TV shows

Serving content to additional users has minimal bandwidth costs

Digital Information

News articles, blogs

Sharing information online has negligible distribution costs

Online Courses

MOOCs, video tutorials

Adding more students to an online course has minimal additional cost

Cloud Storage

File hosting services

Incremental storage has very low cost due to economies of scale

Social Media

Platforms like Facebook, Twitter

Adding new users has minimal cost once infrastructure is in place

Digital Advertising

Online ads

Displaying ads to additional viewers has negligible cost

Open Source Software

Linux, Drupal

Community-developed software has near-zero distribution cost

3D Printed Objects

Custom products

Once design is created, additional prints have low material costs

Renewable Energy

Solar, wind power

Generating additional electricity has very low marginal cost

Ridesharing

Services like Uber

Adding passengers to existing routes has minimal additional cost

Home Sharing

Platforms like Airbnb

Renting out unused space has low incremental cost for hosts


“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.


source: Praxtime


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. 


source: Barbara Hoisl


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. 


Aspect

Physical Goods

Digital Goods

Production cost

Significant material and labor costs for each unit

Near-zero cost for additional units after initial creation

Distribution cost

Shipping, handling, and storage expenses

Minimal costs for digital distribution (e.g., bandwidth)

Inventory management

Requires physical storage and logistics

No physical inventory needed

Scalability

Limited by production capacity and resources

Highly scalable with minimal additional costs

Customization cost

Often expensive to customize individual units

Can be customized at little to no additional cost

Geographical limitations

Subject to shipping costs and trade barriers

Can be instantly delivered worldwide

Depreciation

Physical wear and tear over time

No physical degradation (though may become obsolete)

Replication cost

Significant cost to produce exact copies

Virtually costless to create perfect copies


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