THE CONSEQUENCES OF THE DIGITAL DISRUPTION FOR THE ECONOMY

By Martin Weigert

[This article published November 8, 2009 is translated from the German on the Internet, netzwertig.com/2009/11/08/strukturwandel-die-folgen-der-digitalen-disruption-fuer-die-volkswirtschaft/.]


In a linked world, middlemen become superfluous. The costs for the production and distribution of all kinds of goods and services fall. The consequences of the digital disruption for the economy are deep.

The greatest social and economic revolution since industrialization opens up unlimited possibilities for people and businesses. This revolution makes our daily routine easier, changes the way we work together, supports global communication and worldwide trade and alters politics. Old business models break down; new models arise. Many things have already changed. Numerous areas are at the beginning of their deconstruction and reconstruction caused by the digital disruption.

While the development and growth in quality of life for people is great, we must be clear about the challenges of digitalization for the economy. The collapse of several business models and branches important in the past will confirm this in the next years.

The triggers are two significant characteristics of an interconnected world that ensure a whole series of economic branches will be completely superfluous: first the cancellation of the necessity of mediators and secondly the possibility of offering goods and services free of charge on the Web on account of minimal distribution costs.

In the following, I name three examples on which one or two factors together brought about far-reaching changes of one branch.

CLASSIFIED ADS: CRAIGSLIST

Since time immemorial, one important source of revenue for newspapers was the classified ad (job openings, real estate, automobile insurance offers and so forth). Private persons and businesses that want to place ads had to pay for that. However a superior rival appeared with the Internet. With online portals, placing advertisements is more convenient and often even free of charge.

The best example is Craigslist, the largest classified ad portal of the US. With a few exceptions (like job offers in several large cities), anyone can place a classified ad free of charge. According to Alexa, Craigslist is No. 32 of the most visited websites of the world. Craigslist earns only an estimated $100 million annually while the sales of US newspapers from classified ads declined between 2005 and 2009 from around $16 billion to around $5 billion.

Other factors may have also contributed to the collapse of classified ad revenue of the print realm. The numbers paint a clear picture. Although Craigslist is the leading contact address for classified ads in the US, it only gained a fraction of what newspapers earlier amassed from advertisements with its free of charge strategy. For Craigslist, however, this not a problem since it has a minimal cost structure with around 30 co-workers and the margins are still dazzling.

With the help of the Internet, 30 co-workers do the work that expensive sales divisions of hundreds of newspaper houses accomplished in the past and made a million-dollar business out of the former billion-dollar business.

REFERENCE WORKS: WIKIPEDIA

Ten years ago everyone had the 30-volume Brockhaus encyclopedia (or the encyclopedia series of another publisher) on his or her bookshelf. Today there is Wikipedia. With the digital non-profit encyclopedia, the necessity of shelling out 3270 euro (current price) for 30 volumes of Brockhaus abruptly ends. The knowledge of the world is now free of charge in dozens of languages from every computer with an Internet connection.

Hardly surprisingly the Brockhaus publishing house in 2008 decided not to continue the reference work beyond the 21st edition. Wikipedia has made the middleman – encyclopedia publishers all over the world – superfluous and instead made private persons into knowledge suppliers. This often happens with conflict as the current discussion around Wikipedia shows. Nevertheless Wikipedia is one of the greatest success projects on the Web.

MUSIC DISTRIBUTION: FROM ARTIST DIRECTLY TO LISTENER

For decades, value creation in the music branch looked like this. Record firms signed contracts with artists, pressed, promoted and sold their albums and earned a golden parachute. The musicians themselves received a share of the revenues making a couple of them – the best known – into millionaires.

With the Web, the mediator in this value-creation chain is increasingly superfluous. The great network and the marketing power of the major labels are still enough to change more or less nobodies into stars and fill stadiums. But musicians who have no pleasure living in dependence can now simply cancel their label and digitally sell their productions themselves with minimal costs and a global target-group.

In most cases, such a step leads to a quantitatively lower range (one can then forget about being played on the radio). But thanks to the unneeded middleman, revenues do not need to be shared any more. A gifted band that makes its albums available free of charge as MP3s will find a few hundred people interested in a premium variant as a DVD, poster or t-shirt – who want to say “Thank you” very simply with a donation.

Only one performer in a thousand will become rich this way. Most musicians do not want to drive throu9gh the neighborhood with a Hummer or own a villa with five bedrooms. They simply want to earn a livelihood with music. In the age of digitalization, this is easier than before if one is good and can market oneself.

CONSEQUENCES FOR THE ECONOMY

Craigslist takes billions from the classified ad market. Wikipedia destroys the business model of publishers all over the world. Performers with web- and marketing skill drop their record companies. These are three examples of many. I could have chosen others. Authors cancel publishing houses to publish e-books under their own direction. A handful of video-on-demand retailers make thousands of video-stores unnecessary. Amazon displaces the stationary business as online travel services replace their stationary counterparts. Decentralized blog-networks like the Huffington Post reach the range and sales of renowned newspapers – at a fraction of their costs. Services for P2P credits like smava or Zopa penetrate the domain of banks and make possible credits between private persons.

This list could be easily continued. On one hand, businesses become no longer competitive or completely superfluous on account of a business model not adjusted to the digital realities and an unsuited organization.

On the other hand, new firms and projects arise that take over these functions and do them better – usually with considerably less human labor. The many hundreds of thousands of video stores, travel agencies or book dealers who become unnecessary in the course of the digital revolution are not replaced to the same extent by new online services. Very different personalities are sought than stationary retailers.

One of the consequences of the real change is the fact of a progressive automation that leads to less (and qualitatively changed) need for manual workers. The economies must adjust to this world and finally accept effective and better processes as an achievement, not a threat. A redefinition of the term “unemployment” is inevitable like a renewed discussion of the question of an unconditional basic income.

A second deep consequence is clear in the scenario intimated in the above examples. Imagine a state where nearly all middlemen disappear and “free” determines price policy. All digital contents are collaboratively presented, offered under “Creative Commons” licenses and distributed without intermediaries through platforms like Wikipedia.

A few great E-commerce suppliers dominate in trade enabling direct marketing of products for private persons and businesses. All the mediators in the value-creation chain have disappeared. The absence of these actors leads to lower prices since mediators usually set aside their part of the cake.

This is an ideal state from the consumer’s perspective. With the global linkage, the necessity of mediators drops out in many sectors. Their function was buying and reselling products or services and gaining a profit. The Web takes over the task of the middleman and works better and more objectively on account of the minimized drive for profitability.

But what would be a paradise for consumers resulted in serious tax shortfalls for the state. The capital flowing in the market and the tax revenue of the state decline if I can access all immaterial goods without having to pay and material goods are also cheaper on account of unnecessary middlemen and the greatest possible transparency.

New material needs could arise that ensure that the capital moving on the market will not decrease – for example through the heightened need for affordable private mini-planes for everyone. Even in the realm of virtual worlds, a completely new global economy could arise in which zealous trade with virtual goods occurs – largely outside the range of national financial authorities. Still the question what generally falling prices for products and services will mean for the money stream must be raised.

In my eyes, it is important to call attention to the possible repercussions of this current development on the economy. These are challenges that are insoluble. Nevertheless a changed way of looking at things and the radical renunciation on past ways of thinking and acting are necessary. One thing is clear: many things will not be what they were.