The Economics of Crowded Markets

I read a great article on O'Riley Radar about how the big players (read: Google and the New York Times online) on the Internet are behaving like the big banks, who, when facing a turn in the tide against ridiculous growth, used subversive tactics to try to maintain that growth.

What atrocity could golden Google possibly commit? Well, as a high-flying public company with several years of growth, Google started to slow down late last year. That slow down was occurring as the "product life cycle" signaled that web search may have been beginning to mature. Tim O'Reiley, in his infinite wisdom, was able to notice their actions as early as then, and cited another clever clogs called Bill Janeway, who drew parallels to Google with the banks' actions a few years ago.

As Bill explains:

"The price of a trade a generation ago was regulated by the exchanges: it cost approximately 22 cents per share to trade an institutional-size block of stocks on the New York Stock Exchange. The ability to fix commissions reflected the historical fact that the brokers had long been large, relative to their customers. Unable to compete on price, some firms competed on the quality of their investment research, and brokers’ relations to clients were based on the information and insights they could provide (others competed in less respectable ways).

As pension funds, mutual funds, and other institutional investors grew to dominate trading, they successfully broke the NYSE cartel. Once the exchanges no longer regulated the price of a trade, prices fell over time to current levels of a fraction of a cent per share: for large trades, effectively zero. As a result, some sell-side firms tried to charge directly for research and found that their buy-side clients were unwilling to pay. Instead, they were investing money saved from commissions to build their own research staffs. Two other things happened. Seeking an alternative subsidy for sell-side research, most firms repositioned their research staffs as marketing arms of their corporate finance firms, a strategy that blew up spectacularly with the Bubble in 2000–2002. More important, firms began to trade against their clients for their own account, such that now, the direct investment activities of a firm like Goldman Sachs dwarfs its activities on behalf of outside customers."

One thing innovation does is drive out older inefficiencies, and charging someone $.22 to transfer information from one party to the other is the definition of waste. And when a company's means of subsistence proves to be inefficient, and starts to get squeezed, it is only natural for that company to fight back. There are two solutions: fight to maintain the status-quo, or wriggle free through innovation and invention. The latter is of course the harder of the two, and is the reason why entrepreneurs are so successful at being "destructive creators."

Google is responding to their pinch releasing more and more products that maintain focus - and web traffic - on their products:

Google's announcement of Knol shows that they understand some of their key business drivers very well; With as much as 5% of the search result links for popular terms going to Wikipedia pages, a solution to capturing some of that traffic in an environment that Google can control and display ads on makes good business sense...

Now the last thing I want to do is imply that Google doesn't innovate - I think Google is our generation's proudest example for innovation. In fact, I believe that this issue has largely been resolved, thanks to Google's new browser, Chrome. The potential Chrome will realize in freeing up system resources for more advanced web applications is a discussion for a different time.

We can't say the same f0r the New York Times online, which people are complaining about sacrificing their journalistic quality by keeping all of the links in their articles internal. This practice redirects readers to other related articles, which increases web traffic, however at the cost of relevance to the story.

However, I'm more optimistic than O'Reiley. Switching costs are as low on the Internet as they possibly could be - the only thing keeping people looking at the New York Times is the New York Times' brand power. If this practice continues to dilute that brand, then we should see consumers shift to a different service. The same goes for O'Reiley's complaints about other web services that attempt to lock people into their brand - the very nature of search should allow them to seek quality elsewhere.

The web is the most meritocratic economy man has ever developed. This only means good news for us.