Fixed Cost in Transition

-- By MatthewCollins - 16 Oct 2012

As we continue in our progression to the internet economy, hallmarked by the marginal cost of information equaling zero, the issue of fixed costs remains. Discussed to some extent in class, I wish to delve further into the issues of fixed cost.

Fixed Cost

With marginal cost at zero, information goods should be priced at zero; they should be free. But this application of a basic economic principle rubs many the wrong way, not simply current holders of vast information stockpiles. Most people are aware of a person’s investment in a creation and, even if they don’t believe in the need for a return on that investment, are at least aware that the investment needs to be recouped lest their favorite musician/writer/director (“artist” from here on) not be able to create again.

Decreasing Cost of Inputs

What is fortunate is that the investment itself is decreasing. Discussed briefly in class, changes in technology and the organization of the internet economy itself lead to a cheapening of inputs. That technology is decreasing is an idea so near ubiquity that I simply acknowledge its effect here. As an example, as recording technology lessens in price (both hardware and software), a musical act could record and promote (and ultimately distribute) an album for hardly more than the cost of their instruments.

The second major input is of course the labor itself. Artists are putting in time and skilled effort – both salable in the labor market (the former as a Starbucks employee, the latter, in the case of a musician, as a wedding singer). Based on time alone, usually sold at minimum wage, each hour an artist puts into his creation is worth $7.25 in New York. If factoring in the skilled effort – value added is usually reflected with higher compensation – the hours invested would be worth much more in the traditional economic view. This cost is mitigated, however, by the nature of the internet. Although the free software movement is unconcerned with quid pro quo when creating, a free “bartering” system allows for labor inputs to need less compensation. If a person spent a third of their income on other now-free works, that third of income no longer needs compensation and mediating transactions are removed.

Zero Marginal Cost’s Impact on Low Fixed Cost Goods

In the traditional model, low fixed cost goods were less frequently produced. If a producer was going to make the same percent margin on either of two goods, he was more likely to begin the complex machinery of production and distribution for a $20 good than a $5 one. So we saw feature films over shorts (notice that shorter video programming – television content – was distributed via communications technology), albums over singles, “AAA” video games over simple ones.

This led to a culture of big budget, tech-forward products designed to appeal to a large audience’s taste. But the internet economy allows for low fixed cost products to get into the market and provides for the possibility of niche tastes being catered.

The popularity of the video game Angry Birds demonstrates the impact of marginal cost on these types of goods. The game was designed by a team under 28 for just $128,000 (a figure well above what it could be, but 1/10 of popular console video game Grand Theft Auto IV 's budget, released a year earlier) and was brand new IP. Such a product would be hardly worth it in a world of nonzero marginal cost – it is not substantive enough to sell for much more than $10 (at which price it would not match its $.99 sales figures) and, presuming an identical percent margin per unit, would be less desirable than a $60 game with identical marginal cost. But in the internet economy, this small creation can make its way to consumers’ hands and establish an audience. Although it is true that Angry Birds became a (somewhat inexplicable) cultural phenomenon, had the game found a niche audience of just over 100,000 users the designers could have covered their fixed cost selling the game at the music industry’s price for a song.

Impact on Taste

A common response when I run the zero marginal cost argument by my peers is concern. They wonder, in this internet economy, would they still have video games as immersive as Fallout 3? Television as well-written as How I Met Your Mother? Albums as grand as My Beautiful Dark Twisted Fantasy?

This is a somewhat conservative response. It is clear from sales data that substantially more people are interested in Angry Birds (over 100 million downloads as of 2011 than in Fallout 3 (just under 4 million as of 10/12). While shows like How I Met Your Mother are popular with young adults, almost anyone in my generation would be dishonest to say incidental YouTube? watching has not replaced some amount of channel-surfing, a trend clearly continuing. And although Kanye West’s expensive-sounding music may still be popular, it’s worth noting that 16-year old rapper Chief Keef’s first self-made single chartered higher than two of West’s four singles this year. That is to say, in sum, that tastes are changing because of the internet economy’s impact on creation and distribution.

Taste in Celebrities

Chief Keef’s “I Don’t Like,” however, became popular after a Kanye West remix of it. West himself is one of a number of celebrities – among them Neil Patrick Harris, Shaquille O’Neil, and Kim Kardashian – who successfully transitioned into the internet age by understanding its attention economy. Although in some ways reminiscent of the retardataire stars of the 90s – impeccably perfect to today’s eyes – they draw influence from “internet stars” like Jenna Marbles and Tao Lin, whose appeal is in their openness (however genuine) and connection to the audience. The internet is causing a change in taste of idolized personalities, a good that requires no "distribution" -- just attention.

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