Peer Production

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A further description by Umair Haque of Bubblegeneration on the impact of peer production in Media 2.0

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Peer Production

  1. 1. The Atomizing Hand The strategy and economics of peer production Umair Haque http://www.bubblegeneration.com Spring 2005
  2. 2. Intro
  3. 3. What is Peer Production? <ul><li>Communities of prosumers or amateurs who collaborate to make things </li></ul><ul><ul><li>Wikipedia </li></ul></ul><ul><ul><li>Metafilter </li></ul></ul><ul><ul><li>Flickr </li></ul></ul><ul><ul><li>OhMyNews </li></ul></ul><ul><li>By… </li></ul><ul><ul><li>Sharing information about inputs and outputs… </li></ul></ul><ul><ul><li>… which creates pooled knowledge </li></ul></ul><ul><ul><li>...which increases the efficiency of future production </li></ul></ul><ul><ul><li>And having open access to the means of production </li></ul></ul>
  4. 4. Why Share? <ul><li>Altruism </li></ul><ul><ul><li>Because we care </li></ul></ul><ul><li>Reputation </li></ul><ul><ul><li>Because there are spillover signalling effects </li></ul></ul><ul><li>Reciprocity </li></ul><ul><ul><li>Because of implicit or explicit social control </li></ul></ul><ul><li>Money </li></ul><ul><ul><li>Because there are explicit incentives </li></ul></ul><ul><li>Fun </li></ul><ul><ul><li>Because we derive social utility from doing so </li></ul></ul><ul><li>Etc… </li></ul><ul><ul><li>… .No definitive answer (yet). </li></ul></ul><ul><li>Empirical effects are unambiguous </li></ul><ul><ul><li>File-sharing, Wikipedia, threadless, etc demonstrate that peers do share </li></ul></ul>
  5. 5. Why Join a PP Community? <ul><li>Simple answer: </li></ul><ul><ul><li>Because you can do stuff more efficiently than by yourself </li></ul></ul><ul><ul><ul><li>By taking advantage of others’ sharing? </li></ul></ul></ul><ul><ul><li>No! </li></ul></ul><ul><ul><li>PP is not free riding – in fact, the opposite happens: increasing returns </li></ul></ul><ul><ul><ul><li>When you do & make stuff, new knowledge is a side-effect </li></ul></ul></ul><ul><ul><ul><li>Knowledge in a peer production community is a public good </li></ul></ul></ul><ul><ul><ul><li>New users are attracted in proportion to the size of the knowledge pool </li></ul></ul></ul><ul><ul><ul><ul><li>Because it’s the strongest signal of potential marginal productivity gains from joining that community </li></ul></ul></ul></ul><ul><ul><ul><li>And new users increase everyone else’s productivity, growing the knowledge pool </li></ul></ul></ul>
  6. 6. Why is Peer Production Important? <ul><li>Peer production enjoys very special economics </li></ul><ul><ul><li>A new kind of scale economy which enables massively distributed and ultraspecialized microproduction… </li></ul></ul><ul><ul><ul><li>Distributed economies of scale </li></ul></ul></ul><ul><ul><li>Which lets knowledge about production pool within the community… </li></ul></ul><ul><ul><li>Which creates sustainable supply-side increasing returns </li></ul></ul><ul><li>Under certain conditions, peer production communities will be more efficient than firms or markets </li></ul><ul><ul><li>To understand why, I’ll try and explain why peer production is really about cheap coordination atomizing production… </li></ul></ul><ul><ul><li>… which makes it a fundamentally new mode of production </li></ul></ul><ul><ul><ul><li>Or at least one analogous to modes of production that disappeared a very long time ago, like the putting-out system </li></ul></ul></ul><ul><ul><li>… which makes it a great opportunity (or a great threat) </li></ul></ul>
  7. 7. Network Economics 1.0 and 2.0 Primer
  8. 8. Network Economics 1.0 <ul><li>Demand-side viral effects </li></ul><ul><ul><li>Massively decreases user acquisition cost </li></ul></ul><ul><ul><li>Low-cost imitation barrier to protect early-mover advantage </li></ul></ul><ul><li>Demand-side network effects </li></ul><ul><ul><li>One key resource: consumption network </li></ul></ul><ul><ul><li>“ Metcalfe’s law” – marginal utility increases in network size </li></ul></ul><ul><ul><ul><li>No upper bound factored in – misreading of econ lit. </li></ul></ul></ul><ul><ul><li>Switching costs rise nonlinearly with network size </li></ul></ul><ul><ul><li>Increasing returns to adoption </li></ul></ul><ul><li>Strategic intent: scale – grow adoption </li></ul><ul><ul><li>Rapid growth of network size </li></ul></ul><ul><ul><li>“ Demand-side economies of scale” </li></ul></ul><ul><li>Search economies dominate strategy </li></ul><ul><ul><li>How costly is it for you to find stuff on the network? </li></ul></ul><ul><ul><li>Cheapest solution wins: utility of network bounded by search mechanism </li></ul></ul>
  9. 9. Network Economics 2.0 <ul><li>Supply-side viral effects </li></ul><ul><ul><li>Massively reduces prosumer acquisition costs </li></ul></ul><ul><ul><li>Low cost imitation barrier to protect early-mover advantage </li></ul></ul><ul><li>Supply-side network effects </li></ul><ul><ul><li>Two resources: producer network and knowledge pool </li></ul></ul><ul><ul><li>“ Haque’s Law” – marginal productivity increases in network size </li></ul></ul><ul><ul><ul><li>Upper bound: diseconomies of scale – large user network size creates knowledge network coordination costs </li></ul></ul></ul><ul><ul><li>Switching costs rise nonlinearly with both </li></ul></ul><ul><ul><li>Increasing returns to knowledge </li></ul></ul><ul><li>Strategic intent: speed – accumulate knowledge </li></ul><ul><ul><li>Rapid growth of knowledge pool </li></ul></ul><ul><ul><li>Doing & making things faster than competitors </li></ul></ul><ul><li>Coordination economies dominate strategy </li></ul><ul><ul><li>How costly is it for you to make & do stuff on the network? </li></ul></ul><ul><ul><li>Cheapest solution wins: network utility bounded by coordination </li></ul></ul>
  10. 10. Markets and Firms: Production 1.0
  11. 11. Apologies <ul><li>Five somewhat painful slides to follow </li></ul><ul><ul><li>Bear with me, because they’ll help us explain why and when firms are less efficient than peer communities </li></ul></ul><ul><ul><li>This is the most complicated part of the presentation </li></ul></ul><ul><ul><ul><li>OK, I’m lying…  </li></ul></ul></ul><ul><ul><li>… skip to the Summary slide if (when) you can’t take it anymore </li></ul></ul>
  12. 12. Property Rights Organize Production <ul><li>We will call 1 and 2 rights of coordination because they organize production </li></ul><ul><ul><li>Liquid markets for 3 and 4 are prevalent </li></ul></ul><ul><ul><ul><li>Equities, fixed income, options, futures </li></ul></ul></ul><ul><ul><li>Markets to assign coordination rights often fail because of relatively high transaction costs </li></ul></ul><ul><ul><ul><li>Copyright is the canonical example </li></ul></ul></ul><ul><li>Firms coalesce to economize on transaction costs of coordination rights assignment when markets fail </li></ul><ul><li>Right to use economic resources </li></ul><ul><li>Right to modify form and substance of resources </li></ul><ul><li>Right to benefit from use of resources </li></ul><ul><li>Right to transfer resources </li></ul>
  13. 13. Understanding Firms <ul><li>What do firms do? </li></ul><ul><ul><li>Coordinate: </li></ul></ul><ul><ul><ul><li>The most efficient way to turn inputs into outputs… </li></ul></ul></ul><ul><ul><ul><li>… By internalizing the uncertainty inherent in risky transactions... </li></ul></ul></ul><ul><li>But economizing on transactions isn’t costless… </li></ul><ul><ul><li>Firms replace transaction costs with coordination costs </li></ul></ul><ul><ul><ul><li>How are coordination rights distributed within the firm? </li></ul></ul></ul><ul><ul><ul><li>Within the firm, who can access the means of production and key inputs? </li></ul></ul></ul><ul><ul><ul><ul><li>Costs of administrative overhead </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Internal transaction costs: negotiation, bargaining, and enforcement of coordination rights </li></ul></ul></ul></ul><ul><ul><ul><li>These are essentially costs of information sharing and processing – firms internalize information costs, where they can be ‘managed’ </li></ul></ul></ul><ul><ul><li>As long as coordination costs stay less costly than transaction costs of inputs, firm is an efficient way to produce </li></ul></ul><ul><ul><li>But they don’t, because…. </li></ul></ul>
  14. 14. Coordination & Hierarchy <ul><li>Negotiating for coordination rights becomes combinatorially costly </li></ul><ul><ul><ul><li>I want a top engineer on my team </li></ul></ul></ul><ul><ul><ul><li>I negotiate with 4 VPs </li></ul></ul></ul><ul><ul><ul><li>Each VP negotiates with each other </li></ul></ul></ul><ul><ul><li>Coordination cost explosion in firm size – negotiation doesn’t scale </li></ul></ul><ul><ul><li>How do we deal with this? Hierarchy – centralized decision-making </li></ul></ul><ul><li>Hierarchy is designed to minimize coordination costs </li></ul><ul><ul><li>In firms, coordination rights are governed by authority embedded in hierarchical implicit or explicit contracts </li></ul></ul><ul><ul><ul><li>You’re my boss, you choose the ‘best’ products and features </li></ul></ul></ul><ul><ul><ul><li>I’m the product manager, so I get the top engineers </li></ul></ul></ul><ul><ul><li>Hierarchy minimizes coordination costs by economizing on information </li></ul></ul><ul><ul><ul><li>Managers and administrators collect and process information from subordinates </li></ul></ul></ul>
  15. 15. Coordination Diseconomies <ul><li>Minimizing coordination costs by economizing on information creates a big problem… </li></ul><ul><ul><li>Private info is never made completely public </li></ul></ul><ul><ul><ul><li>Bosses, middle managers, bureaucracy, politics, bullsh*t, inertia all make revealing private info costly </li></ul></ul></ul><ul><ul><ul><li>Memos, reports, and meetings lose tacit info </li></ul></ul></ul><ul><ul><ul><li>Disutility: authority sucks </li></ul></ul></ul><ul><ul><li>In firms, we can’t know if efficient solutions to assigning coordination rights are reached </li></ul></ul><ul><ul><ul><li>Because information, expectations, and preferences about inputs and outputs are never fully revealed </li></ul></ul></ul><ul><li>Coordination diseconomies (1): </li></ul><ul><ul><li>The efficiency loss of hierarchy in assigning the best coordination rights, due to information loss </li></ul></ul><ul><ul><li>This is an opportunity cost of hierarchy – we may forego a better coordination rights assignment </li></ul></ul>
  16. 16. Coordination & Specialization <ul><li>And…hierarchy does not eliminate coordination costs </li></ul><ul><ul><li>It minimizes them </li></ul></ul><ul><ul><li>Coordination costs still exist </li></ul></ul><ul><ul><ul><li>Direct costs </li></ul></ul></ul><ul><ul><ul><ul><li>Admininstration, middle managers, bureaucracy </li></ul></ul></ul></ul><ul><ul><ul><li>Indirect costs </li></ul></ul></ul><ul><ul><ul><ul><li>Agency and influence costs – politics! Incentives dulled </li></ul></ul></ul></ul><ul><li>Coordination bounds specialization </li></ul><ul><ul><li>It’s economical to coordinate activities until marginal cost of coordination exceeds marginal gain from specialization </li></ul></ul><ul><ul><ul><li>Intuition: even in firms, coordinating 10,000 microactivities isn’t economical </li></ul></ul></ul><ul><ul><ul><li>Or: 10 managers can coordinate 1000 activities, 100 managers can’t coordinate 10,000 activities </li></ul></ul></ul><ul><ul><ul><li>Marginal cost of coordination increases exponentially in firm size </li></ul></ul></ul><ul><li>Coordination diseconomies (2): </li></ul><ul><ul><li>Specialization gains hits a coordination cost wall </li></ul></ul><ul><ul><li>Implication: eliminating coordination costs can realize specialization gains </li></ul></ul>
  17. 17. Summary: Modes of Production <ul><li>Markets fail </li></ul><ul><ul><li>Because of high transaction costs </li></ul></ul><ul><li>Firms coalesce but value creation is bounded by </li></ul><ul><ul><li>High coordination costs, which limit any specialization gains </li></ul></ul><ul><li>Hierarchies coalesce but value creation is bounded by </li></ul><ul><ul><li>Coordination diseconomies </li></ul></ul><ul><ul><ul><li>Total cost of hierarchy is high </li></ul></ul></ul><ul><ul><ul><ul><li>Coordination costs bound specialization gains… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>… and opportunity cost is optimal coordination righst assignment </li></ul></ul></ul></ul><ul><ul><ul><li>Or: a trade-off between specialization gains and information loss </li></ul></ul></ul><ul><ul><ul><li>The more you minimize coordination costs, the more information you lose… </li></ul></ul></ul><ul><ul><ul><li>… but the more you minimize coordination costs, the greater specialization gains you realize </li></ul></ul></ul><ul><li>A more efficient form of organization… </li></ul><ul><ul><li>… escapes the information loss vs specialization gains tradeoff, and realizes advantages in both </li></ul></ul><ul><ul><ul><li>Zero coordination costs wenable huge specialization gains </li></ul></ul></ul><ul><ul><ul><li>Not having to economize on information means optimal assignment of coordination rights </li></ul></ul></ul>
  18. 18. Coordination & Specialization Coordination costs Specialization gains Coordination costs bound specialization gains Size Value Coordination costs exceed specialization gains
  19. 19. Coordination Diseconomies Hierarchy costs Specialization gains Coordination diseconomy : total costs of hierarchy are coordination costs and opportunity cost: not choosing the best coordination rights assignment. Specialization is effectively bounded at a small maximum efficient scale. Can trade off by either coordinating more, and losing less information…or coordinating less, and realizing greater specialization gains. Size Value Opportunity cost – information loss – increases costs of hierarchy Total costs exceed specialization gains
  20. 20. Peer Communities: Production 2.0
  21. 21. Peer Production <ul><li>PP vaporizes the real-world costs of assigning coordination rights </li></ul><ul><ul><li>Information sharing mechanisms aggregate and reveal private information and preferences frictionlessly </li></ul></ul><ul><ul><ul><li>About inputs </li></ul></ul></ul><ul><ul><ul><ul><li>What are the most efficient ways to produce our good? </li></ul></ul></ul></ul><ul><ul><ul><li>About outputs </li></ul></ul></ul><ul><ul><ul><ul><li>What are our most successful goods likely to be? </li></ul></ul></ul></ul><ul><ul><ul><li>Using explicit mechanisms </li></ul></ul></ul><ul><ul><ul><ul><li>Voting, ranking, pricing </li></ul></ul></ul></ul><ul><ul><ul><li>Or Implicit mechanisms </li></ul></ul></ul><ul><ul><ul><ul><li>Tags, playlists, reputation </li></ul></ul></ul></ul><ul><ul><ul><li>Without coordination costs… </li></ul></ul></ul><ul><ul><ul><li>… so there’s no efficiency loss of centralized decision-making like in firms </li></ul></ul></ul><ul><ul><li>How…? </li></ul></ul>
  22. 22. Coordination Economies <ul><ul><li>Because information and preferences are public, most efficient coordination rights assignment is transparent </li></ul></ul><ul><ul><ul><li>Public information regulates which inputs… </li></ul></ul></ul><ul><ul><ul><ul><li>code, people, designs </li></ul></ul></ul></ul><ul><ul><ul><li>… are granted access to means of production… </li></ul></ul></ul><ul><ul><ul><ul><li>platform, community, architecture </li></ul></ul></ul></ul><ul><ul><ul><li>… to create the outputs predicted to be most successful. </li></ul></ul></ul><ul><ul><ul><ul><li>T-shirts, games, OS kernels, music </li></ul></ul></ul></ul><ul><ul><li>Frictionless, hyperefficient assignment of coordination rights: coordination economies </li></ul></ul><ul><ul><ul><li>PP can assign more efficient coordination rights more cheaply than firms or markets </li></ul></ul></ul><ul><ul><ul><li>And so can realize gains from ultraspecialized production </li></ul></ul></ul><ul><ul><li>Coordination economies are a significant source of strategic cost advantage </li></ul></ul>
  23. 23. Coordination Economies <ul><li>How does PP achieve hyperefficient assignment of coordination rights? </li></ul><ul><ul><li>PP model is an implicit or explicit auction for access to means of production </li></ul></ul><ul><ul><ul><li>Implicit or explicit price mechanisms combined with price or quantity auctions </li></ul></ul></ul><ul><ul><li>Generally: </li></ul></ul><ul><ul><ul><li>Peers self-select into activities – ex-post coordination </li></ul></ul></ul><ul><ul><ul><li>Distributed local information is aggregated </li></ul></ul></ul><ul><ul><ul><ul><li>Implicit price of access to means of production is established </li></ul></ul></ul></ul><ul><ul><ul><li>Peers are granted access to means of production (or not) </li></ul></ul></ul><ul><ul><ul><ul><li>If peer activity value as measured by aggregate utility is greater than implicit price as measured by aggregate bid </li></ul></ul></ul></ul><ul><ul><li>Production without coordination costs </li></ul></ul><ul><ul><ul><li>No need to economize on information – massively distributed info processing, just like in real-world markets </li></ul></ul></ul><ul><ul><li>Costs incurred are market costs </li></ul></ul>
  24. 24. Summary: Firms, Markets, and Communities <ul><li>PP Models combine the microeconomic DNA of markets and firms: </li></ul><ul><ul><li>Places where people can exchange decentralized information about preferences and utility (markets) </li></ul></ul><ul><ul><li>In order to coordinate centralized actions of consumption and production (firms) </li></ul></ul><ul><ul><li>Without the coordination costs of real-world firms </li></ul></ul><ul><ul><ul><ul><li>… or transaction costs of real-world markets, which create firms </li></ul></ul></ul></ul><ul><ul><ul><li>Which scale combinatorially with firm size – cost explosions </li></ul></ul></ul><ul><ul><ul><li>Which makes complete information revelation uneconomical in firms </li></ul></ul></ul><ul><ul><ul><li>Which makes it impossible for firms to assign the most efficient coordination rights </li></ul></ul></ul><ul><ul><li>Peer production is theoretically hyperefficient </li></ul></ul><ul><ul><ul><li>It can assign the most efficient coordination rights more cheaply than real-world firms or markets </li></ul></ul></ul><ul><ul><ul><li>Or: PP lets the most talented people make the coolest things </li></ul></ul></ul>
  25. 25. Costs Shape Modes of Production Markets Transaction costs Firms Peers Coordination costs Information loss Hierarchies Market failure Sharing costs Corpocracy Growth failure Atomization Failure point Organization Type of failure
  26. 26. Coordination Arbitrage <ul><li>What’s the implication of coordination economies? </li></ul><ul><ul><li>Coordination arbitrage </li></ul></ul><ul><ul><ul><li>Entrepreneurs will begin to use coordination economies – PP’s natural cost advantage – to atomize value chains </li></ul></ul></ul><ul><ul><ul><ul><li>They will target industries with high coordination costs (and large efficiency losses due to information economization) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The coordination economy-diseconomy differential is the largest here: coordination arbitrage </li></ul></ul></ul></ul><ul><ul><ul><li>Rents will be redistributed to peers as peer demand intensifies and outstrips supply </li></ul></ul></ul><ul><ul><ul><ul><li>Prizes on Yahoo Labs’ prediction market </li></ul></ul></ul></ul><ul><ul><ul><li>Firms will not disintegrate, they will move up and down the value chain </li></ul></ul></ul><ul><ul><ul><ul><li>Peer management </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Platform supply </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Goods for which means of production/inputs access is limited or protected </li></ul></ul></ul></ul>
  27. 27. Peer Production Economics
  28. 28. …So What?! <ul><li>Where things get really interesting </li></ul><ul><ul><li>After all, firms can (to an extent) realize coordination economies by using sharing/internal market mechanisms </li></ul></ul><ul><li>PP redefines two economic orthodoxies </li></ul><ul><ul><li>Diminishing marginal productivity </li></ul></ul><ul><ul><ul><li>Resources become less efficient at the margin </li></ul></ul></ul><ul><ul><ul><li>Marginal productivity of variable inputs declines as quantity increases </li></ul></ul></ul><ul><ul><li>Increasing returns </li></ul></ul><ul><ul><ul><li>Positive demand-side network externalities: Your joining the network increases it’s value to me </li></ul></ul></ul><ul><ul><ul><li>Demand-side lock-in: My high up-front learning costs increase my switching costs </li></ul></ul></ul>… So what makes peer-production special?
  29. 29. PP Economics are Revolutionary <ul><li>PP models create increasing returns 2.0: </li></ul><ul><ul><li>Sustainable supply-side increasing returns </li></ul></ul><ul><ul><li>How? </li></ul></ul><ul><ul><li>2 key mechanisms </li></ul></ul><ul><ul><ul><li>Distributed economies of scale create increasing marginal productivity </li></ul></ul></ul><ul><ul><ul><ul><li>Cars, computers, electronics, books, songs…. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Many hands make light work at the margin </li></ul></ul></ul></ul><ul><ul><ul><li>Knowledge externalities create increasing returns to adoption </li></ul></ul></ul><ul><ul><ul><ul><li>My productivity increases in network size </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Your joining the network increases my value to it </li></ul></ul></ul></ul><ul><ul><ul><ul><li>… because our knowledge in collaboration increases marginal productivity for lumpy goods </li></ul></ul></ul></ul>Increasing marginal productivity of labor
  30. 30. Peer Production Economics Distributed Economies of Scale and the Atomization of Production
  31. 31. Ultraspecialization and Microproduction <ul><li>Massively distributed ultraspecialization </li></ul><ul><ul><li>Doesn’t work in the real world… </li></ul></ul><ul><ul><li>Tiny chunks of ultraspecialized activities are valueless in isolation </li></ul></ul><ul><ul><ul><li>Lumpy goods take time and collaboration to make </li></ul></ul></ul><ul><ul><ul><li>Who will pay for 1/1000 th of one of the ten car production activities? </li></ul></ul></ul><ul><ul><li>Even less economical to assign coordination rights for ultraspecialization </li></ul></ul><ul><ul><ul><li>Hierarchy or markets can’t handle it </li></ul></ul></ul><ul><ul><ul><ul><li>How do you coordinate 10,000 tiny chunks of ultraspecialized activities in the RW? How do you contract/pay for 10,000 tiny chunks of ultraspecialization in the RW? Combinatorial cost explosions… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Combining microchunks requires costly coordination, integration, contracting, payment relative to every other microchunk </li></ul></ul></ul></ul><ul><ul><ul><ul><li>If 10,000 microchunks, 10,000 x 9999 coordination+transaction costs necessary </li></ul></ul></ul></ul><ul><ul><ul><li>Massive coordination diseconomies for ultraspecialized collaboration </li></ul></ul></ul><ul><ul><li>Result: market and firm failure for ultraspecialization in the real world </li></ul></ul>
  32. 32. Distributed Economies of Scale <ul><li>But… </li></ul><ul><ul><li>PP enables cheap, optimal assignment of coordination rights at any level of divisibility </li></ul></ul><ul><ul><ul><li>Overcomes coordination diseconomies </li></ul></ul></ul><ul><ul><ul><ul><li>By leveraging cheap information sharing mechanisms to costlessly regulate access to inputs and means of production </li></ul></ul></ul></ul><ul><ul><li>Coordination economies make organizing microproducers for ultraspecialized production viable </li></ul></ul><ul><ul><ul><li>Distributed economies of scale… </li></ul></ul></ul><ul><ul><ul><li>… Yield specialization gains </li></ul></ul></ul><ul><ul><ul><ul><li>Finer and finer input divisibility lets us each specialize in our comparative advantage </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Not simply ‘many hands make light work’ – many specialized hands make production more efficient </li></ul></ul></ul></ul><ul><ul><ul><li>PP community can be a more efficient producer than firm at large scale </li></ul></ul></ul><ul><ul><ul><ul><li>If enough microproducers contribute enough microchunks </li></ul></ul></ul></ul>
  33. 33. Coordination & Specialization Firm coordination costs Specialization gains Size Value PP coordination Costs PP coordination costs exceed specialization gains Firm coordination costs exceed specialization gains Coordination costs bound specialization gains. Since peer community coordination costs scale linearly, peer communities realize more gains
  34. 34. Supply-Side Externalities <ul><li>What can an ultraspecialized network of microproducers do? </li></ul><ul><ul><li>Peers contribute ultraspecialized microchunks of value activities </li></ul></ul><ul><ul><ul><li>I can produce 1/100 th of a DAC and 1/50 th of a spreadsheet application </li></ul></ul></ul><ul><ul><li>These microchunks are combinatorial, not additive </li></ul></ul><ul><ul><li>So… </li></ul></ul><ul><li>Network effect: positive supply-side externality </li></ul><ul><ul><li>My marginal social productivity > my marginal private productivity </li></ul></ul><ul><ul><li>I can’t make lumpy goods efficiently by myself… </li></ul></ul><ul><ul><li>… Your joining the network increases my value to it in 2 ways </li></ul></ul><ul><ul><ul><li>Microchunk modularity explodes production set </li></ul></ul></ul><ul><ul><ul><ul><li>Combinatorial explosion in feasible activities </li></ul></ul></ul></ul><ul><ul><ul><ul><li>n^n-1 possibilities: 4 activities produce 64 possible combinations </li></ul></ul></ul></ul><ul><ul><ul><li>Microchunk reusability yields increasing marginal productivity </li></ul></ul></ul><ul><ul><ul><ul><li>I can reuse microchunks you’ve contributed in the past </li></ul></ul></ul></ul><ul><ul><ul><li>In econ-speak, microchunks are non-rival and non-excludable in production </li></ul></ul></ul>
  35. 35. Distributed Economies of Scale <ul><li>In general: </li></ul><ul><ul><ul><li>Your activity set means my marginal productivity is enhanced </li></ul></ul></ul><ul><ul><ul><li>Productivity increases in number of ultraspecialized microproducers </li></ul></ul></ul><ul><li>Distributed economies of scale </li></ul><ul><ul><li>10 specialized car activities become 1000 ultraspecialized car activities </li></ul></ul><ul><ul><ul><li>…… creating more ways to recombine activities to improve efficiency …allowing greater reusability of activities to improve efficiency </li></ul></ul></ul><ul><li>Distributed economies of scale </li></ul><ul><ul><li>Recombining and reusing microchunks incurs massive coordination costs in the real world </li></ul></ul><ul><ul><ul><li>Not all activity combinations in exploded production set are valuable… </li></ul></ul></ul><ul><ul><ul><li>… and dividing activities doesn’t always yield marginal productivity gains </li></ul></ul></ul><ul><ul><ul><li>Finding beneficial combinations – assigning coordination rights efficiently – is costly </li></ul></ul></ul><ul><ul><li>But cheap information sharing makes searching for best coordination rights assignment frictionless </li></ul></ul>
  36. 36. PP and Firm Production Functions Firm coordination costs Firm production function Labor/Network Size Output PP production function Firm is more efficient producer PP community is more efficient producer PP marginal productivity exceeds firm marginal productivity Distributed economies of scale mean that at large scale, peer communities enjoy a significant cost advantage over firms
  37. 37. Microproducers & Ultraspecialization <ul><li>Ultraspecialization examples </li></ul><ul><ul><ul><li>Jane knows everything about ab exercises (consumption externality) </li></ul></ul></ul><ul><ul><ul><li>Dave’s built replicas of every shoe since 1500 (production externality) </li></ul></ul></ul><ul><ul><ul><li>Al knows everything about 80s Italo Disco (hobby) </li></ul></ul></ul><ul><ul><ul><li>Trekkies, game mods, blogging, </li></ul></ul></ul><ul><li>Why do microproducers ultraspecialize? </li></ul><ul><ul><ul><li>Production or consumption externalities </li></ul></ul></ul><ul><ul><ul><li>Hobbies </li></ul></ul></ul><ul><ul><ul><li>Local effects: family, friends </li></ul></ul></ul><ul><ul><ul><li>But mostly because they can : </li></ul></ul></ul><ul><ul><ul><ul><li>the Net’s slashed search costs – specialization is less costly than it used to be </li></ul></ul></ul></ul><ul><li>How did ultraspecialization evolve? </li></ul><ul><ul><li>… </li></ul></ul>
  38. 38. Traditional Value Creation Publishing: finance, marketing, procurement Management mediates transactions between primary value activities Management coordinates and exploits complementaries between supporting value activities Traditionally, value activities were integrated because market transaction costs were high Production : creation, editing, finishing
  39. 39. Disintermediation: Integration to Disintegration Publishing : finance, marketing, procurement Management coordinates and exploits complementaries between supporting value activities Disintermediation: Markets mediate transactions between primary value activities Cheap information disintegrates traditional value chains: value activities rearrange in horizontal layers, yielding efficiency gains Production: creation, editing, finishing
  40. 40. Microproduction: Disintegration to Atomization Cheap coordination atomizes disintegrated value chains: value activities rearrange in microchunks, yielding efficiency gains Publishing : finance, marketing, procurement Community mediates transactions between primary value activities Community coordinates and exploits complementaries between supporting value activities Production : creation, editing, finishing
  41. 41. Microproduction: Distributed Economies of Scale Microchunks have a positive supply-side network externality: a peer’s private productivity is less than his social productivity Why? User N contributes green microchunk G . This microchunk is reusable . Microchunk reuse increases marginal productivity: G’s complementarity with other microchunks reduces the marginal cost of future productivity. This microchunk is modular . Microchunk modularity explodes production set. G’s complementarity with other microchunks creates explosion in product set possibilities.
  42. 42. Distributed Economies of Scale - Summary <ul><li>Coordination economies enable ultraspecialized production </li></ul><ul><li>Ultraspecialized production realizes network FX from reusing and recombining activity microchunks </li></ul>Tiny bits of ultraspecialized knowledge can, aggregated across enough peers , make peer production economically advantageous, because of supply-side network effects Marginal productivity increases in network size 2 Mechanisms 1 Effect
  43. 43. Condition: Lumpy Goods <ul><li>Distributed economies of scale obtain under 2 conditions </li></ul><ul><ul><li>Lumpy goods and divisible inputs </li></ul></ul><ul><li>Lumpy goods supply functionality in discrete bundles </li></ul><ul><ul><li>Computers, cars, runways, sunglasses </li></ul></ul><ul><li>They require specialized knowledge in multiple activities </li></ul><ul><ul><li>Coordination, learning, and switching costs of production are high </li></ul></ul><ul><ul><ul><li>Because opportunity cost of specialization is not knowing other activities </li></ul></ul></ul><ul><ul><li>10 activities required to make a car: </li></ul></ul><ul><ul><ul><li>10 workers/car - 1 activity each </li></ul></ul></ul><ul><ul><ul><ul><li>Each worker is specialized – gains to specialization </li></ul></ul></ul></ul><ul><ul><ul><li>2 workers/car - 5 activities each </li></ul></ul></ul><ul><ul><ul><ul><li>Only 2 activities/worker are specialized, workers must still perform remaining 8 – relative productivity loss </li></ul></ul></ul></ul><ul><ul><li>Marginal productivity increases in workers </li></ul></ul><ul><ul><ul><li>More activities/worker lower productivity </li></ul></ul></ul>
  44. 44. Condition: Divisible Inputs <ul><li>Divisible inputs </li></ul><ul><ul><li>Inputs must be able to be unbundled in arbitrarily fine increments by microproducers </li></ul></ul><ul><ul><ul><li>You can contribute a sentence, a paragraph, or an essay </li></ul></ul></ul><ul><ul><ul><li>… a scene, a script, or a review </li></ul></ul></ul><ul><ul><ul><li>… a playlist, a vocal track, or lyrics </li></ul></ul></ul><ul><ul><li>For some goods, this is not possible (yet) </li></ul></ul><ul><ul><ul><li>Inputs are indivisible – can’t be unbundled </li></ul></ul></ul><ul><ul><ul><ul><li>Because of cost, technology, regulation, or specialization </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Examples: cars, runways, oil rigs, MRI scanners </li></ul></ul></ul></ul><ul><ul><ul><li>Which goods have divisible inputs? </li></ul></ul></ul><ul><ul><ul><ul><li>Digital media: music, films, books </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Designs for low-complexity physical goods: T-shirts </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Knowledge resources: Wikipedia, journals, blogs, genes </li></ul></ul></ul></ul><ul><ul><li>Without input divisibility, microproduction isn’t possible </li></ul></ul>
  45. 45. Peer Production Economics Knowledge Externalities and Increasing Returns
  46. 46. Recap <ul><li>PP models create increasing returns 2.0: </li></ul><ul><ul><li>Sustainable supply-side increasing returns </li></ul></ul><ul><ul><li>How? </li></ul></ul><ul><ul><li>2 key mechanisms </li></ul></ul><ul><ul><ul><li>Lumpy goods and distributed economies of scale </li></ul></ul></ul><ul><ul><ul><ul><li>Cars, computers, electronics, books, songs…. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Many hands make light work at the margin </li></ul></ul></ul></ul><ul><ul><ul><li>Supply-side knowledge externalities </li></ul></ul></ul><ul><ul><ul><ul><li>My productivity increases in network size </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Your joining the network increases my value to it </li></ul></ul></ul></ul><ul><ul><ul><ul><li>… because our knowledge in collaboration increases marginal productivity for lumpy goods </li></ul></ul></ul></ul>Increasing marginal productivity of labor
  47. 47. Knowledge Pools <ul><li>Knowledge pools are repositories </li></ul><ul><ul><li>… for information sharing mechanisms about inputs and/or outputs </li></ul></ul><ul><ul><li>They store the community’s aggregated preferences and expectations… </li></ul></ul><ul><ul><li>To act as a collective memory for the PP community </li></ul></ul><ul><li>Examples: </li></ul><ul><ul><li>Product/feature reviews (Yahoo! Finance msg boards) </li></ul></ul><ul><ul><li>Tutorials, guides, and walkthroughs (GameSpy walkthrus) </li></ul></ul><ul><ul><li>User reputation systems (eBay seller feedback) </li></ul></ul><ul><ul><li>Stored product rankings (Amazon product rankings) </li></ul></ul><ul><ul><li>Archived playlists, tags, links (Blogdex archives) </li></ul></ul><ul><ul><li>Metainfo about community production (Metatalk.metafilter) </li></ul></ul><ul><ul><li>… Other metainfo </li></ul></ul>
  48. 48. Knowledge Resources <ul><li>Why is knowledge important? </li></ul><ul><ul><li>Knowledge enhances productivity by more efficient use of inputs </li></ul></ul><ul><ul><ul><li>Intuition: algebra vs arithmetic </li></ul></ul></ul><ul><ul><li>Knowledge is an experience effect: a result of learning-by-doing </li></ul></ul><ul><li>Knowledge pool is the key resource for PP communities </li></ul><ul><ul><li>Users will select PP communities where they their marginal productivity is maximized </li></ul></ul><ul><ul><li>Knowledge pool is strongest signal of potential productivity gains </li></ul></ul><ul><ul><ul><li>Signals potential productivity gains of joining community independent of network size </li></ul></ul></ul><ul><ul><ul><li>Or: signals current productivity per peer </li></ul></ul></ul><ul><li>And since microchunks are non-rival in production </li></ul><ul><ul><li>Knowledge resources don’t get exhausted – they grow </li></ul></ul><ul><li>Knowledge pool is a resource stock </li></ul><ul><ul><li>That accumulates according to flow of knowledge externalities </li></ul></ul>
  49. 49. Knowledge Externalities <ul><li>Recap: private info and preferences about inputs and outputs is aggregated and made public </li></ul><ul><li>This info sharing has a macro supply-side externality: </li></ul><ul><ul><li>Storing aggregated info creates a knowledge pool for the community to learn from/access/utilize </li></ul></ul><ul><ul><ul><li>Inputs become more efficient </li></ul></ul></ul><ul><ul><ul><li>Output quality increases </li></ul></ul></ul><ul><ul><ul><li>Knowledge pool is a public good which acts as an input to increase the efficiency of future inputs </li></ul></ul></ul><ul><li>Initial knowledge pool is additive … </li></ul><ul><ul><li>My productivity increases when you join the network </li></ul></ul><ul><li>… Ongoing knowledge pool is cumulative </li></ul><ul><ul><li>Every time we collaborate to produce a good, new knowledge is produced </li></ul></ul>
  50. 50. Knowledge Pool Knowledge is an externality of value activities: learning-by-doing Knowledge pools when information and preferences shared during peer production are stored This knowledge enhances future productivity by informing peers about how to most efficiently modify inputs in order to produce the most-desired outputs Value activities (brown) have a knowledge externality, which flows into knowledge pool (silver).
  51. 51. Knowledge & Increasing Returns <ul><li>Leveraging this externality creates increasing returns </li></ul><ul><ul><li>Positive feedback: </li></ul></ul><ul><ul><ul><li>Network size growth increases marginal productivity </li></ul></ul></ul><ul><ul><ul><li>Increased productivity generates new knowledge faster </li></ul></ul></ul><ul><ul><ul><li>… New knowledge attracts more users </li></ul></ul></ul><ul><ul><ul><li>Or… </li></ul></ul></ul><ul><li>Your adding knowledge to the network increases my value to it </li></ul><ul><ul><li>Positive feedback: </li></ul></ul><ul><ul><ul><li>Largest public knowledge pool attracts new users </li></ul></ul></ul><ul><ul><ul><ul><li>My marginal productivity increases in network size </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Public knowledge increases in my marginal productivity </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Your marginal productivity increases in public knowledge </li></ul></ul></ul></ul><ul><ul><ul><ul><li>You join the network - my marginal productivity increases in network size </li></ul></ul></ul></ul><ul><ul><ul><li>Increasing returns – productivity creates new knowledge, which attracts users, which increase productivity, which creates new knowledge </li></ul></ul></ul><ul><ul><ul><li>Knowledge within the PP network is a public good produced as an externality of learning by doing </li></ul></ul></ul><ul><ul><ul><li>Because innovation is cheaper </li></ul></ul></ul><ul><ul><ul><ul><li>Because transaction and integration costs are vaporized </li></ul></ul></ul></ul>Doing and making cool stuff makes doing and making cooler stuff more efficient
  52. 52. Increasing Returns Overview Productivity Increase New users Which accelerates Information sharing which attracts ultraspecialized in different activities at the margin (distributed economies of scale) about inputs and outputs ultraspecialized in different activities … New users Public knowledge Which grows about the most efficient coordination rights
  53. 53. Knowledge & Community <ul><li>How is knowledge related to network size? </li></ul><ul><ul><li>Knowledge is an experience effect: learning by doing </li></ul></ul><ul><ul><li>The more you do, the more you learn </li></ul></ul><ul><ul><li>Productivity of users determines of knowledge growth </li></ul></ul><ul><ul><li>Since marginal productivity increases in network size… </li></ul></ul><ul><li>Knowledge pool should explode in network size </li></ul><ul><ul><li>Identifying and managing this relationship is the key strategic challenge in peer production </li></ul></ul><ul><ul><li>Because it’s the indicator (and driver) of increasing returns </li></ul></ul><ul><li>Speed economies become crucial </li></ul><ul><ul><li>Production throughput accelerates knowledge externalities… </li></ul></ul><ul><ul><li>… which build critical mass in pool and accelerate network growth: increasing returns </li></ul></ul>
  54. 54. Increasing Returns <ul><li>Increasing returns means: </li></ul><ul><ul><li>PP communities will be winner-take-all markets </li></ul></ul><ul><ul><ul><li>The resource to which there are increasing returns is knowledge , not just network size </li></ul></ul></ul><ul><ul><ul><li>The biggest network won’t win by default (like dot com 1.0) – the most efficient knowledge generator will. </li></ul></ul></ul><ul><ul><ul><li>Knowledge and network size are necessary to create natural monopoly dynamics </li></ul></ul></ul><ul><ul><li>Dominant strategies leverage speed </li></ul></ul><ul><ul><ul><li>To build larger knowledge pools fast… </li></ul></ul></ul><ul><ul><ul><li>Which attract new prosumers by offering discontinuous marginal productivity gains </li></ul></ul></ul><ul><ul><ul><li>… And build scale </li></ul></ul></ul>
  55. 55. Increasing Returns – A Short History <ul><li>Where else do we see supply-side increasing returns? </li></ul><ul><ul><li>Accelerating down the learning curve – BCG </li></ul></ul><ul><ul><li>Which came from… </li></ul></ul><ul><ul><li>Disembodied learning-by-doing knowledge as public good in production functions. Cumulative knowledge investment of all firms exponentially related to capital stock (Arrow) </li></ul></ul><ul><ul><li>Capital growth and knowledge externalities: (Romer) </li></ul></ul><ul><ul><li>AKA endogenous growth theory </li></ul></ul><ul><li>How do these two theories of supply side increasing returns differ from PP models? </li></ul><ul><ul><li>EGT assumes constant supply-side returns at the firm level, and increasing returns only at the industry/national level </li></ul></ul><ul><ul><li>Increasing returns in the BCG model aren’t sustainable – the learning curve flattens out </li></ul></ul><ul><li>Supply side increasing returns in PP models are sustainable as long as knowledge pool grows . </li></ul>
  56. 56. Peer Production Strategy Understanding Value Chain Evolution
  57. 57. Value Chain Evolution Peers Platform Peers Aggregator Inputs Manufacturer Marketer Distributor Retailer Cheap information disintegrates value chains, because segment consolidators realize specialization gains and economies of scope – integrated production becomes costly Cheap coordination atomizes disintegrated value chains and explodes value activities within layers, because microproducers realize distributed scale economies Inputs, Manufacturing, Marketing, Distribution, Retail Costly info and coordination integrates value activities – most economical way to produce Peers
  58. 58. Value Chains & Value Appropriation Infrastructure Content Search ISP Telco Inputs In disintegrated value chains, industry profitability migrates to the center (aka the ‘coordinator’) Manufacturer Marketer Distributor Retailer Creatives Producer Publisher Distributor Retailer 5% 20% 50% 20% 5% Why? Market power in horizontalized landscapes – layer dominance – flows from relative scope (t he center can realize the greatest marketing scope economies of scope via marketing, branding, and advertising), or relative specialization (the center can develop the most economically advantageous core competences) EG: Nike, EA, SeanJohn, Google
  59. 59. Value Chains & Value Appropriation Platform Peers Aggregator In atomized value chains, industry profitability will migrate to the edges 40% 20% 40% Inputs Platform Peers Aggregator Reconstructor 35% 10% 10% 10% 35% Why? Market power in atomized landscapes is a function of relative scale: the edges can realize the greatest relative economies of scale via demand and supply side network FX. The middle of the value chain explodes and can’t realize scale economies. Core competences for disintegrated value chain coordinators become core rigidities – value capture requires competences at both edges of the chain
  60. 60. The Explosion of the Middle Peers Peers Peers Platform Peers Aggregator In atomized value chains, industry profitability will migrate to the edges 40% 20% 40% Why? The center explodes and atomizes – hypercommoditization – and value shifts to adjacent segments , because they can realize scale economies from the exploded center’s output. Examples: Blogger, Bloglines, Flickr
  61. 61. The Commoditization of the Edge In atomized value chains, the same technology that explodes the middle commoditizes the old edges (example: cheap connectivity enables blogging). Industry profitability migrated to new edges. 40% 20% 40% Coordination Production Aggregation Blogger bloggers Bloglines AudBlog podcasters PodWorld Community Owners reviewers Become Connectivity 0-1% BitTorrent ISP
  62. 62. Value Appropriation Examples In atomized value chains, industry profitability will migrate to newer (and newer) edges Platform Peers Publisher Aggregator Reconstructor 35% 10% 5% 10% 35% Coordination Production Publishing Aggregation Filtering Laptop audio Artist Label Club DJ Blogger bloggers hosting search Bloglines MMOG Developer gamers Mods & plugins Community sites Gaming Open Market
  63. 63. PP Dominant Strategy: Vertical Integration <ul><li>The point: </li></ul><ul><ul><li>Peer production communities are vertically integrated atomized value chains… </li></ul></ul><ul><ul><ul><li>To capture the most value, integrate towards both edges </li></ul></ul></ul><ul><ul><li>… Plus knowledge pools </li></ul></ul><ul><ul><ul><li>Knowledge externalities don’t pool without integration </li></ul></ul></ul>40% 20% 40% Coordination Production Aggregation Platform Peers Aggregator
  64. 64. Peer Production Strategy Competitive Dynamics
  65. 65. Peer Production Model Inputs (Coordination) Means of Production Outputs (Aggregation) Explicitly modifiable by community Sell access to users Competition for access, prizes Wikipedia raw content Open or community regulated access Advertising and sponsorship % Ad revenue Wikipedia CMS Efficient information sharing % Sales revenue % Revenue from outputs Wikipedia entry Knowledge pool grows New aggregated public info Requirements Revenue stream Peer incentive Example Increasing Returns
  66. 66. PP Competitive Dynamics <ul><li>PP model competitive dynamics </li></ul><ul><ul><li>You own a successful PP community facing new competitor entry. What do you do? </li></ul></ul><ul><ul><li>Positioning continuum </li></ul></ul><ul><ul><ul><li>Quality </li></ul></ul></ul><ul><ul><ul><ul><li>Operating model should be partly proprietary. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Tight supplier relationships. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>New peer entry by invitation or referral. </li></ul></ul></ul></ul><ul><ul><ul><li>Quantity </li></ul></ul></ul><ul><ul><ul><ul><li>Operating model should be fully open. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Loose supplier relationships. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>New peer entry open to public. </li></ul></ul></ul></ul><ul><ul><li>What resources and capabilities drive competitive advantage? </li></ul></ul>
  67. 67. PP Strategy Building Blocks <ul><li>Key capability: </li></ul><ul><ul><li>Market-making </li></ul></ul><ul><ul><ul><li>Engineers increasing returns by exploding knowledge pool as user base grows… </li></ul></ul></ul><ul><ul><ul><li>… By creating efficient information-sharing mechanisms </li></ul></ul></ul><ul><ul><ul><ul><li>Which create coordination economies by vaporizing transaction and coordination costs of production </li></ul></ul></ul></ul><ul><li>Results in: </li></ul><ul><ul><li>Economies of speed </li></ul></ul><ul><ul><ul><li>New users are attracted… </li></ul></ul></ul><ul><ul><ul><li>… by accelerating knowledge pool growth </li></ul></ul></ul><ul><ul><ul><li>… which increases productivity </li></ul></ul></ul><ul><ul><ul><li>Or: the faster your throughput is, the faster knowledge pools… </li></ul></ul></ul><ul><ul><ul><li>And reduces unit cost as network grows </li></ul></ul></ul>
  68. 68. How to Make a Market <ul><li>Markets don’t become automatically efficient </li></ul><ul><ul><li>Efficiency emerges from: </li></ul></ul><ul><ul><ul><li>Liquidity : assets are theoretically tradable </li></ul></ul></ul><ul><ul><ul><li>Low transaction costs : assets are actually tradable </li></ul></ul></ul><ul><ul><ul><ul><li>Implications: graininess of information sharing mechanisms is key to minimize information asymmetries between peer producers </li></ul></ul></ul></ul><ul><ul><ul><li>Profit maximizing traders </li></ul></ul></ul><ul><ul><ul><ul><li>Implications: must create incentives/gains for peer producers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Peer producers must be able to internalize those gains </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Only way to avoid prisoner’s dilemma – everyone expects someone else to vote, Bush wins </li></ul></ul></ul></ul><ul><ul><ul><li>Goods traded can’t be purely public goods </li></ul></ul></ul><ul><ul><ul><ul><li>Implication: access to means of production must be restricted to highest valued peer producers: quasi-public goods </li></ul></ul></ul></ul><ul><ul><li>What’s the desired result? </li></ul></ul><ul><ul><ul><li>Information about which inputs used by which means of production most efficiently produce the most desired outputs… </li></ul></ul></ul><ul><ul><ul><li>… is traded and arbitraged, and the best solutions are revealed </li></ul></ul></ul>
  69. 69. Making Markets: Efficient Information Sharing <ul><li>In the real world… </li></ul><ul><ul><li>How do you build efficient information sharing? </li></ul></ul><ul><ul><ul><li>By building incentives to leverage reputation and reciprocity </li></ul></ul></ul><ul><ul><ul><li>By minimizing the risk of contribution </li></ul></ul></ul><ul><ul><ul><li>By imposing punishment costs </li></ul></ul></ul><ul><ul><li>How?! </li></ul></ul><ul><ul><ul><li>By using an implicit or explicit currency </li></ul></ul></ul><ul><ul><ul><ul><li>Links are the currency for link aggregators </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Feedback points are the currency for eBay’s reputation system </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Ratings are the currency for Amazon’s book reviews </li></ul></ul></ul></ul><ul><ul><ul><li>Which is liquid and tradable </li></ul></ul></ul><ul><ul><ul><li>Which creates incentives to profit </li></ul></ul></ul><ul><ul><ul><ul><li>To gain more links </li></ul></ul></ul></ul><ul><ul><ul><ul><li>To get positive reputation feedback </li></ul></ul></ul></ul><ul><li>… and by eliminating transaction costs </li></ul>
  70. 70. A Quick Currency Case Study <ul><li>What is a currency? </li></ul><ul><ul><li>Karma/rating is not an implicit currency </li></ul></ul><ul><ul><ul><li>It’s not tradable… </li></ul></ul></ul><ul><ul><ul><li>… It has use value but no exchange value </li></ul></ul></ul><ul><ul><ul><ul><li>If I give you good karma, what does it cost me? </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Nothing – i have little incentive to reveal my true preferences </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Conversely, if I have good karma, what does it benefit me? </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Generally, I receive more privileges… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>But I can’t trade it to get what I really want </li></ul></ul></ul></ul><ul><ul><ul><ul><li>So I have little incentive to reveal my true preferences </li></ul></ul></ul></ul><ul><ul><ul><li>Your currency has to be more than a ratings system… </li></ul></ul></ul><ul><ul><ul><li>… but not so complicated that peers won’t use it </li></ul></ul></ul><ul><ul><li>What currencies have use and exchange values? </li></ul></ul><ul><ul><ul><li>Links – use value is linking from, exchange value is linking to </li></ul></ul></ul><ul><ul><li>Implication: </li></ul></ul><ul><ul><ul><li>Ratings and karma fail because exchange is unidirectional </li></ul></ul></ul><ul><ul><ul><li>Real currencies succeed because exchange is bidirectional </li></ul></ul></ul>
  71. 71. Making Markets: Sources of Transaction Costs <ul><li>Asset specificity </li></ul><ul><ul><li>Make information sharing objects not specific </li></ul></ul><ul><ul><ul><li>Example: tags </li></ul></ul></ul><ul><li>Frequency and duration </li></ul><ul><ul><li>Make information sharing either frequent and small, or infrequent and large </li></ul></ul><ul><ul><ul><li>Example: playlists (infrequent and large) vs tags (frequent and small) </li></ul></ul></ul><ul><li>Complexity and uncertainty </li></ul><ul><ul><li>Make info sharing mechanisms easy to navigate and predictable in results </li></ul></ul><ul><li>Difficulty of measuring performance </li></ul><ul><li>Connectedness to other transactions in system </li></ul><ul><ul><li>Interdependent transactions can require complex coordination </li></ul></ul>
  72. 72. PP Strategy Building Blocks <ul><li>Key resource: </li></ul><ul><ul><li>Peer network </li></ul></ul><ul><ul><ul><li>Owning the largest user network realizes increasing returns </li></ul></ul></ul><ul><ul><ul><ul><li>… .but only when knowledge pool explodes, attracting even more new users, increasing productivity </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Knowledge pool explosion depends critically on market-making capability creating efficient information sharing </li></ul></ul></ul></ul><ul><li>Results in… </li></ul><ul><ul><li>Economies of scale </li></ul></ul><ul><ul><ul><li>Speed and scale are interdependent </li></ul></ul></ul><ul><ul><ul><ul><li>If you can build both, you will achieve increasing returns </li></ul></ul></ul></ul><ul><ul><ul><ul><li>… efficient information sharing mechanisms drive speed… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>..and supply-side viral and network effects turn speed into scale </li></ul></ul></ul></ul><ul><ul><ul><li>Unit cost falls as marginal productivity increases in network size </li></ul></ul></ul><ul><ul><ul><ul><li>many specialized hands make production more efficient </li></ul></ul></ul></ul>
  73. 73. PP Strategy Building Blocks <ul><ul><li>And economies of scope: </li></ul></ul><ul><ul><ul><li>Scope is a secondary economy </li></ul></ul></ul><ul><ul><ul><li>Production set explosion means unit costs can fall in network size… </li></ul></ul></ul><ul><ul><ul><li>… but only if means of production are flexible </li></ul></ul></ul><ul><ul><ul><li>… and inputs are tradable </li></ul></ul></ul><ul><ul><ul><ul><li>It’s no good having a community of diamond miners when DeBeers owns all the mines </li></ul></ul></ul></ul><ul><ul><ul><li>Drivers: Knowledge network size </li></ul></ul></ul>
  74. 74. Relative Advantages Efficient Info Sharing Peer Network Public Knowledge Productivity New Users Without a market making capability… … public knowledge doesn’t pool … new users aren’t attracted … marginal productivity doesn’t grow … increasing returns fail
  75. 75. Peer Production Revenue Sharing <ul><li>PP is not about getting others to make your stuff for ‘free’ </li></ul><ul><ul><li>PP is way to create more value via coordination arbitrage </li></ul></ul><ul><ul><ul><li>… But there’s no such thing as a free lunch </li></ul></ul></ul><ul><ul><li>Revenue sharing will emerge as supply-side price competition </li></ul></ul><ul><ul><ul><li>Peer producers will appropriate more value as communities grow </li></ul></ul></ul><ul><li>Should you share revenues? Yes! </li></ul><ul><ul><li>Sharing creates incentives for productivity and knowledge growth </li></ul></ul><ul><ul><li>But share strategically – not as margin-eroding price competition </li></ul></ul><ul><ul><li>Strategic revenue sharing targets constant margins and revenue growth in network size </li></ul></ul><ul><li>Strategic revenue sharing </li></ul><ul><ul><li>What determines the peer producer revenue share? </li></ul></ul><ul><ul><li>Rivalry for peer producers within your industry </li></ul></ul><ul><li>Pre-empt margin erosion… </li></ul><ul><ul><li>By limiting rivalry for peer producers </li></ul></ul><ul><ul><li>The more effectively you limit rivalry, the more you can share without margin erosion </li></ul></ul><ul><ul><li>What limits rivalry for peers? </li></ul></ul>
  76. 76. Peer Production Industry Structures & Rivalry Suppliers & Buyers: Control access to key technologies, inputs, and distribution channels – vertical integration Control buyer/supplier scope economies by controlling high-value complements Fragment/commoditize key technologies or inputs if you can’t control them Example: Amazon – Fedex deal
  77. 77. Peer Production Industry Structures & Rivalry Suppliers: Control access to key technologies or inputs – vertical integration Fragment/commoditize key technologies or inputs if you can’t control them EG: Complements: Create larger numbers of higher quality complements than competitors Raises switching costs by lowering relative value of substitutes Example: lightweight, open standards (RSS) drive cheap complementarity Anti-example: Apple closing off iPod/iTunes platform kills complementarity Buyers: Control distribution channels – vertical integration Fragment/commoditize distribution channels if you can’t control them EG: New Entrants: Vertical integration creates strong entry barriers Scale and speed economies in network markets create strong entry barriers Other sources: first-mover advantage, preemption, deterrence, complements, nonlinear pricing, differentiation Example: eBay’s user network
  78. 78. Where PP is Inferior <ul><li>PP is an inferior way to organize the production & design of goods </li></ul><ul><ul><li>For which access to means of production is unavailable </li></ul></ul><ul><ul><ul><li>Tightly controlled by suppliers </li></ul></ul></ul><ul><ul><ul><li>Aggregate peer network learning costs higher than opportunity cost of production </li></ul></ul></ul><ul><ul><ul><li>Capital and connectivity intensive </li></ul></ul></ul><ul><ul><li>For which sharing isn’t viable </li></ul></ul><ul><ul><ul><li>No learning externalities </li></ul></ul></ul><ul><ul><ul><li>Connectivity issues </li></ul></ul></ul><ul><ul><li>Inherent properties of goods </li></ul></ul><ul><ul><ul><li>Goods not lumpy </li></ul></ul></ul><ul><ul><ul><li>Durable goods </li></ul></ul></ul><ul><ul><ul><ul><li>These properties limit rate of knowledge pool growth and kill increasing returns… </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Or limit ultraspecialization gains and kill distributed economies of scale </li></ul></ul></ul></ul>
  79. 79. Where PP is Superior <ul><li>PP is a superior way to organize the production & design of goods </li></ul><ul><ul><li>For which real-world production transaction costs are high </li></ul></ul><ul><ul><li>For which real-world production coordination costs are high </li></ul></ul><ul><ul><ul><li>But for which , virtually, production and consumption information can be efficiently shared, realizing coordination economies </li></ul></ul></ul><ul><ul><li>For which ultraspecialized knowledge is dispersed throughout the larger population </li></ul></ul><ul><ul><ul><li>Which can realize distributed scale economies </li></ul></ul></ul><ul><ul><li>For which inputs are divisible </li></ul></ul><ul><ul><li>For which the means of production are accessible </li></ul></ul>
  80. 80. Summary: Peer Production Economics <ul><li>Assigning coordination rights is costly in the real world </li></ul><ul><ul><li>But virtually, coordination economies make atomized microproduction viable </li></ul></ul><ul><ul><ul><li>By efficiently sharing information about about who and what should have access the means of production </li></ul></ul></ul><ul><li>Atomized microproduction… </li></ul><ul><ul><li>Yields ultraspecialization gains </li></ul></ul><ul><ul><li>Reusing modular microchunks of production create increasing marginal productivity </li></ul></ul><ul><ul><ul><li>Distributed economies of scale result </li></ul></ul></ul><ul><li>Knowledge pools </li></ul><ul><ul><li>When goods are produced, and new shared information is stored </li></ul></ul><ul><ul><ul><li>Increasing the future productivity of the community </li></ul></ul></ul><ul><ul><ul><li>Attracting new users, who make it more efficient to produce more goods… </li></ul></ul></ul><ul><ul><ul><li>… sustainable supply-side increasing returns </li></ul></ul></ul>
  81. 81. Summary: Peer Production Economics <ul><li>Disintegrated value chains will atomize </li></ul><ul><ul><li>Cheap coordination will atomize and explode the center, where production of goods generally happens </li></ul></ul><ul><ul><li>… and value will migrate to newer and newer edges </li></ul></ul><ul><li>The dominant peer production strategy </li></ul><ul><ul><li>Is to vertically integrate across the entire value chain </li></ul></ul><ul><ul><ul><li>To capture the most value by providing infrastructure, inputs, and marketing/aggregation/filtering of outputs </li></ul></ul></ul><ul><ul><li>This can be seen as a shift from goods to services in many industries </li></ul></ul><ul><li>In order to achieve this strategy, you need… </li></ul><ul><ul><li>Key resources and capabilities in market-making … </li></ul></ul><ul><ul><ul><li>In order to enable efficient info sharing and engineer increasing returns </li></ul></ul></ul><ul><ul><li>… and a sufficiently large and productive peer network… </li></ul></ul><ul><ul><ul><li>In order to realize distributed economies of scale </li></ul></ul></ul>
  82. 82. Summary: Peer Production Models <ul><li>Open or community-regulated access to the means of production </li></ul><ul><li>Open or community-regulated access to modify inputs </li></ul><ul><ul><li>Low level inputs require little technical knowledge </li></ul></ul><ul><ul><ul><li>content, designs, ideas, proposals </li></ul></ul></ul><ul><ul><li>High level inputs require complex technical knowledge </li></ul></ul><ul><ul><ul><li>product architectures, interfaces, features </li></ul></ul></ul><ul><li>The catch: </li></ul><ul><ul><li>Supply-side productivity gains depend critically on information sharing to create knowledge externalities. </li></ul></ul><ul><ul><ul><li>How do you know how to modify inputs? </li></ul></ul></ul><ul><ul><li>Without knowledge externalities, the PP model can’t reach hyperefficiency. </li></ul></ul><ul><ul><li>Supply side effects alone are not enough </li></ul></ul>
  83. 83. Summary: Peer Production Models <ul><li>Demand-side sharing mechanisms make private info and preferences about inputs and outputs public </li></ul><ul><ul><li>Playlists, tags, votes, ranks, values, reputations… </li></ul></ul><ul><li>Aggregating sharing mechanisms reveals: </li></ul><ul><ul><li>Utility functions & preferences – most efficient outputs </li></ul></ul><ul><ul><li>Private technical expertise & info – most efficient inputs </li></ul></ul><ul><ul><li>The cream will rise to the top - the most efficient inputs and outputs become transparent </li></ul></ul><ul><ul><ul><li>Assuming search costs are low </li></ul></ul></ul><ul><li>Efficent sharing pools knowledge </li></ul><ul><ul><li>Which creates sustainable supply-side increasing returns </li></ul></ul><ul><ul><li>No sharing without market-marking </li></ul></ul><ul><ul><ul><li>Leverage implicit or explicit currencies to build incentives </li></ul></ul></ul><ul><ul><li>No productivity gains without sharing </li></ul></ul><ul><ul><ul><li>Knowledge must be a public good </li></ul></ul></ul>
  84. 84. Thank You
  85. 85. Heuristics
  86. 86. Peer Production Advantage Dot Com 1.0: Search engines, portals, networking services Peer Production Yellow Pages Fabs Low Search Economies High Coordination Economies Low High
  87. 87. Coordination Arbitrage Criteria Hedge Funds, VC Ford, GM Lifestyle goods Peer Production Sweet Spot Media… Low Input Indivisbility High Coordination Diseconomies Low High
  88. 88. Relative Advantages in… Amazon Peer Production Community Out of the Game Vital point eBay No Community Size Yes Market Making Capability No Yes
  89. 89. Who’s Attracted? Slackers: Inefficient info-sharing Restrict peer entry by invitation/referral Shift to part-closed model Control quality of complements Everyone : Sweet spot No one: Vital point Geeks: Expand scope Shift to fully open-access model Leverage viral effects & complements to win peers Low Knowledge Pool Size High Knowledge Pool Quality Low High
  90. 90. Productivity Explosions Productivity Implosion Real-World Productivity Real-World Productivity Productivity Explosion Low Community Size High Knowledge Pool Size Low High
  91. 91. Peer Production Cost Advantage Disintegrated Gains to Specialization Size of Production Set Atomized Integrated
  92. 92. Notes
  93. 93. Peer Production - Resource & Capability Dynamics Speed Effects User network Knowledge pool Action Coordination Information Exchange Knowledge Externalities Increasing returns Productivity Output Scale & Scope Effects
  94. 94. Analyzing Network Economics 2.0 <ul><li>3 dimensions of next-gen b-models: </li></ul><ul><ul><li>Horizontal scope (products) </li></ul></ul><ul><ul><li>Vertical scope (features) </li></ul></ul><ul><ul><li>Peer productivity (knowledge network size vs user network size). </li></ul></ul><ul><li>3 economic variables: </li></ul><ul><ul><li>Scale, scope, and speed drive positioning on the above dimensions. </li></ul></ul>
  95. 95. 2.0 Strategy Space Vertical Scope (Product Depth) Horizontal Scope(Portfolio Breadth) Peer Productivity Scope Scale Speed
  96. 96. Scale, Scope, and Speed Economies <ul><li>Scale </li></ul><ul><ul><li>Reduction in unit costs due to increase in operational size </li></ul></ul><ul><li>Scope </li></ul><ul><ul><li>Reduction in unit costs due to increase in number of products marketed </li></ul></ul><ul><li>Speed </li></ul><ul><ul><li>Reduction in unit costs due to increase in number of products put through supply/demand chain </li></ul></ul>
  97. 97. Coordination and Transaction <ul><li>Coordination </li></ul><ul><ul><li>Search </li></ul></ul><ul><ul><li>Matching </li></ul></ul><ul><li>Transaction </li></ul><ul><ul><li>Negotiation </li></ul></ul><ul><ul><li>Bargaining </li></ul></ul><ul><ul><li>Enforcement </li></ul></ul>

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