Productive Paradigms in the Digital Era: on two-sided markets and peer production

[From the draft presented at the 3rd Free Culture Research Conference, 8 and 9 of October, 2010- “Productive Paradigms in the Digital Era“]

With the development of information technologies, information has become the centre of production. Because information is frequently both input and output of different production processes there is usually complementarity among markets, resulting in frequent consumption externalities, with extra users positively affecting the value of the product. This “demand-side economies of scale” are commonly referred to as network externalities/effects (see 1). Non-rivalry and low marginal costs characterizes information and exacerbates its relevance.


TWO-SIDED MARKETS AND PEER PRODUCTION

In presence of network externalities across different markets (cross-group externalities) utility is obtained from the matching of elements of these two different markets (hardware and software, for instance), thus each market is positively affected by the size of the complementary market. Markets interrelated in such a manner form an imbricate composite known as two-sided markets. In order to boost positive cross-group externalities one side of the market subsidizes the other one leading to efficiency gains and increased profits. This strategy is “giving away the razor to sell more razor blades”.

While this approach has also been used to study the competition between propietary and open source software (OSS)1 it has been argued that OSS is a different mode of production, peer-production2, that does not rely neither on markets nor managerial hierarchy and is characterized by decentralization among loosely connected self-selected individuals who share resources and outputs. Peer-production would include open software, projects like Wikipedia or E-bay, P2P platforms or even Google searching engine whose page-rank software employs peer-production in ranking pages relevance3 (among other projects).

The cornerstone of peer-production is users´ incentives and the architecture enabling    coordination. Indirect appropriation, hedonic gains are the main incentives. Mechanisms of indirect appropriation include learning effects and reputational benefits which in turn bring in increased future earnings. In the other hand, hedonic rewards can be associated with present consumption: users obtain pleasure from the mere act of creation, physiological rewards and ego gratification. There is thus an exchange production-for-consumption with no strict need of monetary means. Users´ production entails consumption (hedonic rewards) and frequently consumption entails production as well. In peer-production users are indeed both consumers and producers, this is prosumers4. Prosumption implies that an extra user might bring in a contribution to production. This “prosumption effect” is a kind of consumption externality that differently from network effects increases production rather than utility.

Peer-producers consume and produce with no need of monetary means eliminating thus price barriers and transaction costs. By removing these burdens to interaction and scalability peer production boosts interactions among users and hence production, effectively bypassing two-sided strategies and internalizing not only cross-group effects (network externalities) but also prosumption effects.


HIBRIDITY

Frequently not all the costs associated with a certain level of efficiency of the peer-production platform can be peer-ly produced: infrastructure might need to be purchased and some labour employed. The platform will need to acquire them from firms or markets, outside of the peer-production environment. Since the peer-process takes place without need of monetary means, if money is actually needed, (part of the) production will have to be monetized.

Hybrid forms involving peer-production and firms are a possible solution. Complementarity between the firm and the peer-production platform together with differences on the efficiency in the provision of complementary goods or services is the basis of a symbiotic relationship5. Firms can increase the incentives to contribute, improve the design of the architecture enabling coordination, subsidize the peer-production (monetarily or not) yielding efficiency gains and increased production in the peer-production process.

Because direct appropriation of production by the firm would likely lead to a desertion of the peer-production process, firms instead benefit in segments of the market complementary to the peer-production6 such as marketing or customer service. Additionally commercial firms might be induced to collaborate with peer-production processes due to the unsustainability of fully propietary strategies (insufficient market share to efficiently support propietary research and development and increasing buyer demands for open standards)7.

This form of collaboration is a two-sided market: the for-profit firm subsidizes peer-production and sells in the market complementary services and goods whose price can control. These two-sided strategies between firms and peer-processes provides a link between non-monetary and monetary economies and monetizes peer-production. Outputs of the peer-production process are inputs of the goods or services offered, by the firm, in the market: in Google, users create the searching engine and users use the searching engine; similarly, users post and users read the posts in social media. By exploiting this peer-ly generated information the platform is able to use it with for profit objectives, AdSense or AdWords.

In order to foster cross group externalities and prosumption effects these firms lower as much as possible the barriers of entry for new users and even subsidize them by providing services below marginal costs. Increasing number of users attracts more sellers and advertisers and the increasing amount of data to be exploited increases the quality of the advertising service, reinforcing hence two-sidedness.

COMPETENCE AND RELATIVE ADVANTAGES

From this reasoning a simple classification follows: market, non-market and hybrid production models. The efficiency level of each model is related to the costs (labour and capital) faced by the productive entity, existing externalities and the capacity to internalize them. In presence of prosumption effects non-market and hybrid models will enjoy a relative advantage over market production systems, consequently market production might become unsustainable. Conversely in absence of prosumption effects incentives to produce and efficiency gains for peer-production will be reduced and market based production might face a relative advantage given its greater ability to incorporate costly labour and capital to production. Finally when prosumption effects are present and labour and capital requirements are sufficiently low, peer-production will hold a relative advantage over both market and hybrid models.

1Economides and Katsamakas (2005, 2006); and Hagiu (2006) (as far as I am aware of).

2Benkler (2006).

3Benkler (2002, p.192)

4as introduced by Toffler (1984).

5Lerner and Tirole (2004).

6Ibid.

7West (2004).

*Figure source: http://www.hbsp.com Eisenmann (2006), “Managing Networked Businesses: Course Overview.” (via: Wikipedia).


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