Sunday, October 4, 2015
Will Cloud Computing Prices Keep Dropping to Zero, or Close to It?

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.
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.
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.
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.
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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