Web dev at the end of the world, from Hveragerði, Iceland

Filling in the gaps – the dynamics of zero marginal cost

If I had to pick one and only one bad writing habit of mine (I have many) I’d like to fix, it would be my tendency to skip over the things I find obvious.

Vaulting over major gaps in the reasoning and logic of a piece is justifiable if you can trust that most of your readers share your worldview and experience but otherwise it’s just a recipe for frustration. But once you start filling in the gaps, it’s hard to know where to stop unless you have a clear picture in your head of who you’re writing for.

Part of the fun in my podcast with Tom is that most of the time our worldviews are different enough to let the listener follow our conversation without falling into one of these logic gaps but similar enough for us to delve relatively deep into a specialised subject.

There is a moment, though, in the latest episode where we do skip ahead a bit, based on a shared understanding of the dynamics of the dynamics involved in selling what are essentially virtual goods. There’s a risk that many of our listeners will be left behind, stuck on one side of the gap, scratching their heads because I just started to make even less sense than usual.

It’s the moment in the episode where I insist that subscription-based business models are the only viable business model for ebooks, long term.

Which is a point that deserves a bit of unpacking, not skipping.

This point, specifically:

Trying to maintain a high per-unit price for a virtual good is extremely hard in the long term. Maybe even impossible.

What is a high price for a virtual good? It largely depends on the industry and the market but for anything sold to consumers it’s anything above the penny gap: getting a consumer to part with any money for a virtual good is really hard.

Note that I said hard, not impossible. Consistently charging a per-unit price for a virtual good over an extended period of time requires concerted effort, a well thought out strategy, and a clear value proposition.

The reason is that once a product’s marginal cost (the cost of producing one more unit of the product) hits zero, all of the price and distribution dynamics of the product change completely. Core to this change is that when the cost of producing one more unit hits zero, it usually does so for everybody that has a unit of the product, not just the initial producer. Under normal conditions, production (as opposed to design and development) requires a great deal of both capital goods and human capital (design and development is normally more heavy on human capital than on capital goods).

Producing a zero marginal cost product requires neither, the only capital good required is a computer (and that includes mobile phones) and the only human capital is generally your ability to press a button. Under these circumstances, the ability of any given market, no matter what it is or how big, to maintain a non-trivial per-unit price point is severely compromised. Your product usually ends up selling at price points that make a dunkin' donuts cup of coffee look like a Veblen good.

DRM doesn’t change the equation in any meaningful way. Any market that is large enough to sustain a DRM system is also large enough for there to be both the demand and talent that results in that DRM to be broken. The more complicated and hard to break the DRM system is, the larger the market has to be to sustain it (DRM is expensive) and a larger market will be able to bring more resources to bear to break it. In a way, all that DRM does is turn the consumer of a zero marginal cost product into a mirror image of the producer: all of the costs are up front in the design and development phase, while production and distribution are essentially free.

This dynamic severely constrains the producer’s ability to set prices. Digital piracy is like an open vent that is constantly siphoning off demand from your supply-demand pricing mechanism. The higher the prices, the higher the pressure and the more steam flows out of the piracy vent. It takes constant effor to counteract the loss of demand caused by the piracy vent.

(It bears mentioning here that the worst news possible for producers is if there is no piracy or attempts to pirate. Since there is no such thing as perfect DRM, no piracy means there is no demand for your product, in which case you’re totally screwed and nothing you’re doing will ever matter.)

What sort of constant effort are we talking about?

Not DRM, that’s for sure. All of the risks inherent in DRM are on the producer side: it adds cost (potentially fatal in a low-margin content business), limits flexibility, forces integration, and compromises your ability to partner with a varity of service providers.

The worst case scenario for DRM is if it raises the marginal cost of the product above zero for the producer (e.g. with a per-unit licensing cost) while the marginal cost for pirates remains zero. DRM, under these circumstances, has destroyed your ability to compete with piracy, not increased it.

No, the effort here is on the organisational, systemic, and business model level and there are only so many ways that can be done.

  • The endless race: you can churn out content at a moderate price at a pace that the pirates in your sector can’t keep up. This works best if piracy in your market is largely unorganised and uncoordinated.
  • Connect with Fans and give them a Reason to Buy (CwF + RtB), which requires substantial investment in community-building.
  • Services: anything ranging from production services to ad- or subscription supported content. Much harder than people seem to think.
  • Focus on products that don’t have a zero marginal cost, like print, events, or big-screen cinema.
  • Some combination of the above.

The endless race is hard to consistently execute in the lng term and is hard to pull off for larger markets. CwF+RtB works well for individual creators but requires both skills in community-building as well as a huge dollop of business acumen. That’s all in addition to the ability to create something people actually want. The biggest issue with CwF+RtB for companies is that it is hard to scale. Services is where everybody with scale is going: Amazon’s Kindle Unlimited, Prime, and Prime Video; Netflix; Cable TV; Apple Music; and even Marvel Unlimited. The core differentiator seems to be who is the intended service user. Consumer-level services require scale and are very hard to execute while business-to-business services seem to be able to support a little bit more diversity.

Finally, one thing that film studios and big trade publishers agree on is that they both prefer to build their businesses on a foundation of products that are relatively hard to replicate at scale. Studios' main driver of profit are big screen cinemas, everything after that is gravy. Big publishing’s main profit driver, similarly, are blockbuster titles printed in massive quantities and distributed to almost any location with retail floor space.

None of these tactics leave much space for the individually sold plain old ebook. Unless big players in the industry make a substantial effort, odds are that the movement to Kindle Unlimited (as well as author services like Patreon) in the indie space, and the shift back to print in the traditional space, will consistently over time deflate the ebook market.

Of course, given the limitations of Kindle Unlimited (and of ebooks in general) odds are also good that this will result in a substantial unmet demand for digital reading that someone will inevitably capitalise on.

This is most of what went through my mind, unsaid, in the podcast when me and Tom were talking about subscription.

Hope it clarifies the conversation a bit.

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