Why You Love the Internet

I still remember when I got my first adult library card, & could take out books from upstairs without my mom signing. It was an oaktag card with a little sheet metal plate bent around two slots in the card. The metal plate had my number on it. The ka-CHUNK as the machine stamped the card was musical to me. My greatest disappointment was that I could not sign out the Encyclopaedia Britannica & instead had to sit and read it in the library.

The library is much bigger now. Google, the Gutenberg Project, Wikipedia, Blogger, … Even better, if I had wanted to read a foreign newspaper, or even one from out of town, I would have had to go into the nearest big city (Hartford at the time) and use their library. Of course, I would never have known if there was something I wanted to read until I got there. When Apollo 11 landed on the moon, the New York Times retracted an editorial from 1920 that had said that Dr. Robert Goddard’s invention would never work in space because “there was nothng to push against.” I was such a fan of space exploration that I took a bus into Hartford just to read it myself. Now, except for the squishy brown rotten parts of the New York Times, I can read the whole thing online for free. The cost of information has plummeted.

Why do you care?

You care about this because it is going to make your life better. You will have more money. Your children will have a library card that is close to the one the angels have in their wallets.

The second portrait from the right on our masthead is Ronald Coase. He is perhaps best known for the “Coasean bargain” (more on this subject when I get around to it), but his wonderful short essay, The Nature of the Firm, injected some reality into economic analysis. As he pointed out, information is not free. From the 1991 Nobel Prize award announcement:

Coase showed that traditional basic microeconomic theory was incomplete because it only included production and transport costs, whereas it neglected the costs of entering into and executing contracts and managing organizations. Such costs are commonly known as transaction costs and they account for a considerable share of the total use of resources in the economy.

Ronald Coase’s greatest contribution was to show not only that reality is different from theory, but how and by how much.

It costs money to find out what the market is willing to pay for your product. It costs money to find out what vendors are charging for the materials you need, and where you can get the best price. Most vendors will charge you less per unit for a large order than for a small one because their set-up and transportation costs are less. In other words, the real world has friction, and it matters. On the other hand, while trying to overcome these external costs of getting information, a firm is creating internal costs. More people must be hired, and information is distorted as it percolates through the organization. At a certain point, the value of information equals the cost of obtaining it. This is the equilibrium point. The firm has reached its maximum efficient size.

What the internet has done has moved the equilibrium point. The cost of information has fallen off the table. This means that the firm can be much smaller and still obtain the information needed to function efficiently. I recently spoke to a game developer who has been earning a meagre living from an online game he wrote. He did the original design, wrote the logic, designed the databases that lie beneath everything, etc. He has the artistic sensibility of your average mollusc, so he outsourced the graphics to some friends he has never met in Japan and the Netherlands (they love anime in the Netherlands), gave some free licenses to more friends in Russia and India to get more server space, swapped some other goodies for some games he wanted (they did the same & gave some valuable word of mouth), and basically earned enough to stay in bed an extra hour each day and play more games. He still works late, but this firm is a messy bed and a kitchen table with access to every time zone.

What is the optimal size of a firm now? Small, and getting smaller. Friction has met Teflon. If you can get marketing information from Google and sell your stuff on e-Bay, there are a lot of salaries you don’t have to pay. Luckily, the people you didn’t have to hire have internet connections themselves and are selling stuff you want to buy. Somewhere out there is a one-bedroom apartment with empty pizza boxes and a great idea. This time, they don’t even need a garage.

17 thoughts on “Why You Love the Internet”

  1. Interesting post. While it is true that the Internet reduces transaction costs, the costs involved in “entering into and executing contracts” do not go away. You may exchange contract verbiage with the other party electronically, but you still have to think out and debate the terms of the contract.

  2. The search part of transaction costs is less with the Internet, and for some types of transactions it’s much less. Thus eBay serves an entire industry devoted to buying and selling items that previously weren’t even worth taking the time to discard. Google has created an enormous new advertising market. And search engines make it much easier to find and compare service providers of all types. So while some of the costs of entering into and enforcing contracts remain, significant parts of those costs — the shopping-around parts — have become cheaper in many cases.

  3. When you get into business-to-business deals, though…let’s say, outsourcing the manufacturing of your new product…the contracts are going to be customized to at least some extent, and very complex. The Internet will help more with other transaction costs…sharing of design data, for example…than with the contractual aspects per se.

  4. Not Mitch’s main point but his lead in is also interesting:

    I, too, have been struck by how much the newest technology on the internet has led to domestic practices that are more thrifty, more respectful of “things”–we are less a throwaway society. And those old quite ordinary things we loved for some reason can be found again.

    And about the library at our fingers: now when my memory fails me & facts or words are just beyond my grasp, I google; I’m sure it’s in my imagination but it is like the synapses in the head are firing again, alive again.

    By the way, how does inventory fit into this? It seems to me that slimming down the route may lead to less waste & loss.

  5. Interesting post, but I live in a world where at times I feel as I am doing the same thing that was done 30 years ago. That is the world of heating and air conditioning distribution. I own a business that is a wholesaler of parts and equipment to service techs and facilities. Yes, CAD drawings and other technical information is at our fingertips now where it was not even 10 years ago. And my processes are far better and more streamlined than they used to be. However, if a belt on a piece of equipment breaks, the routine is the same as it was back when newspapers mattered. The technician has to drive to the job, see what is wrong, drive to a wholesaler, pick up the belt and drive back to the job and replace it. I find it an interesting duality that in this day and age of virtually free information at your fingertips on anything from Flemish painters to nanotechnology, you still have to find someone to go out and fix the bloody machine with tools that are no different than they were thirty years ago. Wrenches, screwdrivers, pliers.

  6. Sure, for negotiating big or complex deals or searching for or providing many types of services the Internet may be irrelevant.

  7. Mitch’s post is correct — and David’s and Dan’s comments on its limitations are also correct. For a game company that started to have enormous revenues, all the parties involved would want to formalize their relationship, which could not be done on the very cool free and easy program Mitch describes. When you start scaling up, details start to matter, and you will want a negotiated contract which will mean lawyers and expenses and less informality. Still, the business could not have gotten started in the first place without the Internet. Dan’s point is also important. One of the things that has been noticed is that the loss of blue collar manufacturing jobs is being to some degree offset by jobs maintaining and repairing and upgrading the enormous amount of fixed capital we have all over this densely built-up ocuntry. Site-specific work has to be done in person by someone with a screw driver, or whatever tool it may be. There may be ways to streamline this, but it cannot be done “online”. There really is a there there underlying all this virtual stuff, and sometimes it breaks and has to be fixed. No getting around it.

  8. Well, one good thing is definitely that I don’t have late fees. I always ended up owing the library more than it would have cost for me to buy a new book. But, the cost of buying a nice computer, printer, and paying for high speed is a big chunk of change!

  9. Dan from Madison,

    I don’t want to ruin your day but I think the internet has changed your business in a way you can’t see from your perspective. Speaking from personal experience, it is easier for non-specialist to use the internet to affect their own repairs.

    Pre-internet, one had to spend a lot of time finding a hardcopy resource that could even begin to point a beginner in the right direction to start repairing something like an AC. Now it takes just a few minutes. Finding parts was also a challenge but the internet has solved that pretty much as well. I have repaired several major appliances around my house. It started mostly just for fun but I ended up saving a lot money.

    I would guess that the next innovation in onsite service might come with the wide availability of web cams and smart appliances. Appliance repair might start to look more like computer technical support where a remote technician troubleshoots the problem over the phone before the onsite guy goes out.

  10. Dan, you have a job that can never be outsourced to India. There will always be a need for a guy who can handle a screwdriver and a wrench (or, on a bad day, a cold chisel, a screw extractor, and Liquid Wrench).

    That said, the Internet is doing for knowledge-based jobs what the introduction of electric motors did for manufacturing. Instead of the array of pulleys and belts that were needed for a water-powered factory, each individual machine could have its own motive power. Smaller installations and stand-alone machines would not have been possible without this.

    Now each of us has the equivalent of a research staff and marketing department of a large company of the 1960’s. It’s making a difference.

  11. Shannon, Don’t worry, my day isn’t ruined. There are some simple appliances that a homeowner can repair if they want, but most are thrown away. The company I work for used to be heavily involved in appliance parts but the market is just going away – so now we are 100% HVAC. To this day for heating and a/c only the most elementary repairs as far as the homeowner is concerned can be made (a contactor, motor or ignitor) and the rest are “out of bounds”. Not only out of bounds as far as technical knowledge goes, but as far as part availability goes. Most brands only sell through wholesalers such as myself and most wholesalers protect our customer base (contractors) by not selling to the general public. You may see a lot of Carrier or Trane ads on TV, but you never see ads for Carrier or Trane wholesalers. Sure, you may be able to procure a printed circuit board on the internet somewhere, but good luck if you need warranty support of any kind. There are resourceful types such as yourself that will spend the time and energy to seek out other channels of distribution, but that is time consuming and may end up costing the homeowner more in the long run. It is getting more rare for anyone to want to sell furnace parts to the general public for liability reasons as well (combustibles). So the vast majority of residential heating and a/c applications are done the old fashioned way – and all commercial applications are done through one or two step wholesale distribution. I guess my comment was more intended to show how far we have come in distribution (my side of the business is heavily automated and web based) but how much we have stood still on the mechanical side.

  12. Dan from Madison, I dont’ want to ruin you day either, but your “day” is sometime next month.

    Houston TX is already installing a system of “internet over power lines” that routes TCP/IP packets as UltraWideBand signals over the local electrical grid. So the generators and house-hold eletrical meter can start talking to each other and pricing for a watt of electricity can vary based on the moment-to-moment market. So next your HVAC system will be checking not only the inside thermostat before starting up a heat or cool cycle, but the current meter price for a watt of electricity, and a onboard computer will do some consumer-option’d algorithim to decide whether or not to buy that watt right now. NEXT, of course, the ob-board computer will track the performance of the compressor, motor, exchanger — just like the chip in your auto hooked up to the “SERVICE ENGINE SOON” light does for gasoline engines. And so about the end of March this year somebody will be offering you to hook up your dispatcher’s call board a system that will schedule service calls to modern HVAC systems whose onboard systems have reported over the powerlines that the belt is slipping and needs to be replaced … You will know that sometime the first week of April to have laid in an inventory or parts to take on a pre-plannned route to service all the HVACs in an area BEFORE they go wonky.

    Oh wait — that’s Houston. Wisconsin? I think that future won’t arrive up there until, oh, maybe about September …

  13. “Dan, you have a job that can never be outsourced to India. There will always be a need for a guy who can handle a screwdriver and a wrench (or, on a bad day, a cold chisel, a screw extractor, and Liquid Wrench).”

    Never say never. Get some more bandwidth on line, and people will start getting remote controllable robots to do things for them.

    Then an HVAC tech in India will hook into your customers’ robot and have it fix their air conditioner.

  14. Pouncer: “So next your HVAC system will be checking not only the inside thermostat before starting up a heat or cool cycle, but the current meter price for a watt of electricity, and a onboard computer will do some consumer-option’d algorithim to decide whether or not to buy that watt right now.” Last time I checked, you need heating or air conditioning NOW, not at some favorable time in the future. And last time I checked the power grid that runs Texas was independent from the others, which is a good thing but makes shopping for electricity a bit more difficult. But I am no utility expert, that is left to my comrade Carl on my blog. That aside, the diagnostics are interesting. Many hotels use something like this already in their PTAC units (PTAC stands for Packaged Terminal Air Conditioner). That doesn’t mean that the facility stocks more or less parts, just tells them that they have a unit down and have to procure a part. And not all parts show wear – some failures just happen instantly – that is life. The belt or other part still has to be replaced. The wrenches still have to be brought out of the tool bag. That is my point – that you can “high tech” your way through some things but not others.

  15. I am a co-poster with Dan from Madison and an (unfortunately) relative expert on the energy industry.

    It is very cool that Houston is doing some “time of day” metering that sends real-time pricing signals to houses. Generally these residences get some sort of “fixed” discount off their utility bills (maybe 20%) for participating in the program. These programs move up or down the thermostat and cycle some air conditioning (I’m not an expert) at peak times. Managing the peak is critical for the energy markets since their peak determines total capacity needs which has an outsized impact on capital spending.

    Back to the subject at hand, I am not an expert in the world of manufacturing products but from a services perspective we seem to be a long way before the day when the internet brings down costs and dis-intermediates the supply chain. Under Sarbanes the needs for accountants and financial people has exploded and these tasks can hardly be outsourced (on a mass scale). There also is a big run on programmers – a while back there were a lot of people chasing jobs but in general if you have up to date credentials there are a million opportunities in cities like Chicago right now.

    I still can’t fix any appliances, though, I am a hopeless mechanic :)

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