Monday, 23 November 2015

When network effects go bad

"Final Mail Newsletter", says the December 2015 issue from a chap I buy stuff from. "Due to the increased costs of postage and decreased service from NZ Post this will be the final newsletter that you will receive via post. From 2016 the Monthly Newsletter will be sent out by email".

Nothing new there, you might think: that's how it is these days. And yet it says some important things about monopolies and network industries.

One is that we tend to assume that monopolies, and especially those 'natural' monopolies, are a fixture that we're lumbered with. There's only ever going to be one national grid for electricity transmission, only one network of letterboxes and post offices. And with that mindset comes at least some disposition towards regulation - if nothing's going to relieve us any time soon from our vulnerability at the feet of these monopolists, at least we can (say) give them a dose of price regulation and put some limits on their profiteering.

But as NZ Post shows, monopolies aren't always - I'm tempted to say, aren't often - the impregnable fortresses they look like. New tastes, new technologies, new substitutes undermine them, particularly as there is the very strong market incentive (relief from the monopoly's high prices) to find alternatives. Regulators shouldn't be naive or blasé about monopolies, and shouldn't automatically assume, Micawber-like, that some innovation will come along and get rid of the problems the monopoly is currently creating. But they shouldn't automatically assume that monopolies are forever, either, and particularly in the more technologically dynamic parts of the economy.

Another thing NZ Post's problems show is the underbelly of network effects. When they're working for you, everything gets exponentially better. When they turn against you - take your pick of 'vicious circle', 'vortex', 'vanishing up the orifice of your own infrastructure'.

In NZ Post's case, e-mail has led to "the ongoing decline in the core letters business", as it said when announcing its latest annual results: "Letter volumes declined by 10% last year and are expected to keep falling by at least that amount annually. Falling letter volumes is a reality worldwide". For any network operator, like Post, the cost of the expensive infrastructure built for peak historical volume gets spread across less and less, and either prices go up (and customers desert even faster), or you try to wind back the infrastructure, which, even if feasible, won't be costless, and may degrade service quality (even more customers head for the exits).

NZ Post's fighting back best it can, but sometimes the unwinding of network effects is spectacularly terminal. MySpace (as originally called) is my favourite example: according to its Wikipedia entry, it was valued at US$1.5 billion at its peak and in mid-2006 was the most visited website in the US. In 2011 it changed hands reportedly for US$35 million, and this year came in at #1296 in US website traffic. So when I see the EU competition authorities having a go at Google's "market power", my inclination is to say, "Is that right?"

In an unwind, it doesn't help a monopoly - and I'm not pointing fingers at NZ Post here, it's a general comment - if it's pigged it in the days of its pomp. If it's pillaged the pool of consumer surplus when the going was good - price discriminated,  bundled, manipulated service quality and product design, the whole toolkit - it's got little or no customer loyalty to brake or halt its decline. It's not just the regulators who are liable to think, mistakenly, that monopolies are forever: so do the monopolies themselves.

No comments:

Post a Comment