Information Rules by Carl Shapiro and Hal R. Varian

Review by Moe Kelley

The basic premise of Information Rules is that the so-called New Economy isn’t so new, that there is fundamentally no change in the way the economy works and there is a great deal of traditional economic research and theory that can be applied to explain the impact of the Internet and other technological developments.

This was an excellent book providing a great deal of insight into the strategies that different companies are taking and should take to deal with the Internet and the proliferation of digitized information. I have written a very brief summary of what I thought were some of the key insights of the book.

Information goods vs. physical goods

The book discusses at length why information goods are fundamentally different from physical goods and have always been so. Information is typically expensive to produce and inexpensive – or virtually free – to reproduce. Old economy examples are books and movies. There is a high fixed cost of writing a book, but it only costs a few dollars to make copies of the book. The internet and digitization of documents, videos and music have simply taken this to the next level. Information is now nearly free to reproduce. How do you price something that is free to reproduce? Information Rules argues to price information according to its value to the end user instead of its cost. Different versions of varying quality can be easily created that have different values to different segments. Segments with low price sensitivity can be given a higher value version for a higher value price. Meanwhile, virtually the same information can be recast in a lower value format and given away or sold inexpensively to those who are price sensitive.

Standards, lock-in and switching costs

Standards wars are everywhere in the new economy and how to deal with different standards and how to understand the impact of competing standards on customers and competition is important. But this is not new. Information Rules presents case after case of standards wars – all the way from railroads to VHS vs. Betamax. The issues and economics are fundamentally the same.

Standards are good for consumers because they make it easier to develop complementary products and make it safer to buy products that fit a standard. They make things more complicated for inventors and innovators, because it becomes difficult to move people from an old standard to a new, non-conforming product.

Customers can become locked-in to existing products and standards and have high switching costs when seeking to move to new products or standards. Often the producer of a new product must pay the customer to switch, but companies should not pay more than they can then recoup by having customers locked-in to their product.

Information Rules goes into great detail about the implications of this, but the most important lesson is to be aware of lock-in and switching costs, be aware of the benefits and disadvantages of a having an open standard and create strategy (both as a buyer and a seller) based on a long term view of the impacts of these things.

Network effects

Another prevailing theme in the book is network effects – how the value of a network grows exponentially with the growth of members. This is now a fairly commonly understood phenomenon with regard to the Internet, but Shapiro and Varian point out many other industries that enjoy network effects. The railroads are a great example. The more cities a railroad goes to the more people can use the railroad AND the more places they can go. A railroad between Boston and Providence has limited use, but a railroad system that goes anywhere in the country is tremendously useful. Fax machines, telephones, MS Office all have similar properties. The more people use Word and Excel the more valuable they are for file sharing and the more comfortable people are in investing time to learn how to use them.

Information Rules was straightforward and informative and gave many cases and examples to support the ideas presented. Shapiro and Varian also did a good job of showing how the rules are interrelated.

The Adobe Acrobat case, for example, contains all the ideas above. The PDF format is a medium for transmitting documents. The software was expensive to create, but is free to reproduce because customers can download it over the internet. Adobe created two versions: A reader and a writer. Anyone can download the reader for free. Giving this away made Acrobat Reader proliferate and the more people that had it the more valuable files in PDF format became because of network effects. Document creators are willing to pay for Acrobat Writer in order to distribute information cheaply to millions of Acrobat Reader users. Because of its widespread use and value, there now would be high switching costs that prevent a new comer from creating a competitive product. PDF has become the default standard for document publishing over the Internet.