Monday, February 09, 2009

Some comments for my new group of students

When I start teaching a new group of students about the Economics of the Internet and the Digital Economy I like to pick out some recent news stories and try to relate them to topics we will be covering on the course.

The first topic that we look at is the general pattern of the growth and development of the Internet itself. I emphasise that although the Internet has been around since the late 1960s (Vint Cerf has given the official birth date as 2nd September 1969 - see [1]) it was only in the mid-1990s, with the development of the World Wide Web and its easy to use browser interfaces, and the opening up of the Internet to commercial uses, that the Internet really took off. Network externalities then meant that once there was a critical mass of Internet users, growth was very rapid indeed. Internet usage figures for June 2008 (Source: - see [2]) show that nearly one and a half billion of the world’s population of about 6.7 billion people are Internet users – that’s a penetration rate of nearly 22%. Of course penetration rates vary considerably between countries (one manifestation of the so-called “digital divide”). There were plenty of headlines last month when it was confirmed that China had overtaken the United States as the country with the greatest number of Internet users; there are now about 298 million Internet users in China compared with 223 million users in the US. The growth in the number of Internet users in China is worthy of comment – the figure represents a growth of around 42% on the previous year – but the penetration rate in China is quite close to the world average, at 23%, compared with about 73% in the US. (See BBC [3] and Pew Internet and American Life Project [4] for details]. One other point to note about the figures for China is that 117.6 million of Internet users there access the Internet from mobile phones. This mode of access to the Internet is indeed gaining ground around the world and offers hope to people in some underdeveloped countries where there is limited landline and cable infrastructure for Internet connections.

Here in the UK last week saw the publication of an interim report for the government on Digital Britain [5] – the full report is due later this year. The report is partly about the future of public service broadcasting but also discusses how the country’s broadband network can be extended and improved. About 60% of UK households now have broadband Internet access but the government wants everyone to be connected (there is talk of replacing the Universal Service Provision which has long applied to telephone services with a similar requirement for broadband access). There has been an ongoing debate about the extent to which the public sector should get involved with investment in Internet infrastructure or whether it is best just to leave these matters to the market. Things may change a bit now in the light of the credit crunch and consequent recession. Gordon Brown has recently been quoted as saying that the digital economy will play a crucial part in lifting Britain out of recession. In the US President Obama has already announced a $825 billion stimulus package which includes money to expand high-speed Internet access in rural and underserved communities.

Interestingly the recession may not be affecting eCommerce as much as the High Street. Overall online sales slowed slightly in the US in the “holiday season” at the end of last year, but not as much as retail sales generally. Amazon recorded its best ever profits in the last quarter of 2008, up 9% on the previous year at $225m (Source: New York Times [9]).

Another issue that we discuss on the course and which has remained unsettled for a number of years concerns collection of sales taxes on online purchases in the United States. In much of the world, including all the countries in the EU, online retail sales are subject to value added taxes in just the same way as they are for High Street purchases. In the United States things are more complicated, mainly because of tensions between state and federal (national) jurisdictions. Twenty-two states participate in the Streamlines Sales Tax Project which is an attempt to harmonise the rates and collection of sales taxes across the country, but in many states sales tax is not collected for online transactions, particularly when the firm selling the product does not have a physical presence in the state where the consumer lives. Since the Internet Tax Freedom Act of 1998 there have been several moratoriums announced on the implementation of online sales taxes, meaning that for many people it was cheaper to buy online than offline. This has led to a number of distortionary effects, possibly over-diverting sales to the online channel. It has also caused major losses of tax revenue to some state and local authorities who are then limited in the extent to which they can budget for public services. With a new Democratic Administration in government in the United States and even more pressures on local government funds due to the recession, things may at last change – something for us to watch.

Something else that might change is the stance of the Federal Communications Commission in the United States towards the big hi-tech companies like Microsoft. Julius Genachowski, a former Harvard Law School class-mate of Barrack Obama, has now taken over as the head of the commission and he has quite a bit of experience in working with an for Internet companies. Several commentators have speculated that he will tend to be more supportive of small newly established companies and open technology standards rather than naturally siding with the big incumbents who often want to impose their own proprietary standards. Microsoft, who have recently released version 8 of their web browser Internet Explorer and who will also soon launch Windows 7, appear to be still facing antitrust challenges form the European Union over the bundling of IE as part of Windows. Microsoft has already had to pay around a billion euros in fines to the EU, mainly over the bundling of Windows Media Player which was judged to be anticompetitive. However it may be harder to argue that consumers are prevented from making a choice in the case of browsers as Internet Explorer has lost quite a bit of its market share in recent years to alternative browsers. Net Applications figures recently had IE still dominant with about 68% market share but with Mozilla’s Firefox now with about 21%, Safari having 7.9% and Google’s new browser Chrome already with 1%.

On the course we look at the problems of spam, phishing e-mails and online fraud from an economist’s point of view. It is easy to see why there is so much spam. The cost of sending out millions of e-mails is minimal compared to the revenue that can be obtained even if there is a very low response rate. Economists have proposed various market solutions usually involving low priced e-mail “stamps” that would have little impact on legitimate e-mail (charges could even be waived if the recipient of a message confirms that it is not unwanted) but would help internalise the externalities imposed on the rest of us by spammers. The Guardian recently reported (6th January) that the Anti-Phishing Working Group (APWG) estimates that there are about 150 million phishing e-mails sent each day.

One of the things that we look at in considering firm’s strategies in the digital economy is mergers and acquisitions behaviour in the hi-tech sector. Forbes magazine recently described 2008 as the year of non-deals and noted that the value of deals that fell through exceeded the value of those deals that did go through. Prominent amongst the non-deals last year was the Microsoft-Yahoo takeover that never happened. It will be interesting to see if this is revived during 2009.

The music industry has been affected more than most by the Internet with file-sharing hitting CD sales and causing music companies initially to adopt a very heavy-handed approach in pursuing through the courts people illegally acquiring digital music files. With the success of Apple’s iPod and iTunes, legal digital downloads have now become well-established and other companies such as Amazon have tried to get in on the act. Some recent developments that we will consider on the course are Apple’s decision to drop Digital Rights Management (DRM) protection of the millions of songs available from iTunes and its policy of variable pricing of tracks (see [13]).

A big topic last year was “cloud computing” (the move towards keeping software and data on big servers across the Internet so that the end-user’s device becomes more of a terminal). Users are already accustomed to this approach with their e-mail, and many also keep their collection of photos and video clips on Flickr or MySpace. Now they can do the same with spreadsheets, word-processed and other documents, allowing access from multiple points on the Internet which has advantages for people on the move or who wish to give shared access to files. The key to this as a commercial success, as with many online services, has been advertisements, especially contextual ads that target those likely to have an interest in the products being advertised. Google has, of course, been the big player here and it will be interesting to see what else it does in the coming year, especially as it can call upon the advice of the well-known expert on the economics of the digital economy, Hal Varian. It will also be interesting to see if, as Brad Stone and Ashlee Vance suggested in the New York Times [16], the “cloud” computing model will mean problems for Microsoft as more people switch to simple netbooks (running with Linux operating systems) to access the Internet.

Using advertising to generate revenue to support online services is not the only viable business model. If, like Wikipedia, you can get volunteer enthusiasts to provide your content for free while at the same time picking up donations to cover your core costs you can operate without advertising or the need for subscription or pay-as-you-go fees; Wikipedia raised about $6.2 million in 2008 including $3 from the Alfred Sloan Foundation (source: Associated Press, 2nd January 2009 ).

Another site that depends on user-generated content is the social networking site Facebook. As it celebrated its firth birthday last week it was reported that it has now overtaken MySpace with 150 million active users (compared with 130 million users). Facebook does depend on advertising revenue and market research company eMarketer is predicting that Facebook’s US advertising revenue will fall by 20% this year to $208 million. What will founder Mark Zuckerberg do with Facebook? Is there a long-term business strategy, or will he sell it on to a bigger company?


[1] A Brief History of the Internet, version 3.32, Vint Cerf et al, The Internet Society (ISOC) Last revised 10 Dec 2003.
[2] World Internet Users and Population Statistics.
[3] Surge in Chinese internet users. BBC News 14th January 2009
[4] Degrees of Access, Susannah Fox and Jessica Vitak, Pew Internet and American Life Project, July 2008
[5] Digital Britain: The Interim Report. Cm 7548, Department for Culture, Media and Sport and Department for Business, Enterprise and Regulatory Reform.
[6] Plans target Digital Britain push. BBC News 11th January 2009.
[7] Mixed reaction to digital plans. BBC News 29th January 2009
[8] Broadband ‘in every home by 2012’ BBC News 29th January 2009
[9] Technology Gets a Piece of Stimulus. Steve Lohr, New York Times 26th January 2009
[10] Profit rises at Amazon as shoppers seek deals. Brad Stone, New York Times, 30th January 2009
[11] Buying on Web to avoid sales taxes could end soon. Rachel Metz, Associated Press, 13th January 2009.
[12] Facebook clocks fifth birthday. Maggie Shiels, BBC News 5th February 2009.
[13] Apple drops DRM copy protection from millions of iTunes songs. Bobbie Johnson, The Guardian 6th January 2009
[14] Microsoft is accused by EU again. BBC News 17th January 2009
[15] EU aims to sever IE, Windows link. Erika Morphy E-Commerce Times 19th January 2009
[16] $200 laptops break a business model, Brad Stone and Ashlee Vance, New York Times, 25th January,


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