Digital Technology’s Positive Impact on Markets for Services
Thesis
By
Adriano Sbroscia
Submitted in Partial Fulfillment
of the Requirements for the Degree of
Bachelor of Science
in
Business Administration
State University of New York
Empire State College
2015
Reader: Tanweer Ali
Acknowledgements
This thesis is simply a byproduct of all the help, inspiration, motivation and
knowledge that professors, friends and family have given me along the way. While
numerous amounts of individuals have aided me from the start a unique gratitude goes out
to Tanweer Ali; my professor for many classes and my thesis mentor. Professor Ali, you
have instilled a passion in me for finance and financial markets that I did not know to have.
You possess a gravitas that is rare to find in individuals while possessing extraordinary
intelligence, kindness and sincerity; qualities many desire but few obtain.
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Table of Contents
1. Introduction……………………………………………………………………….4
2. Economic Background and Theory……………………………………………….7
2.1.
What is a market? ………………………………………………………...7
2.2.
What is a service? ………………………………….…………………..…7
2.3.
What makes a market efficient? …………………….……………………8
2.4.
Components of a market …………………………………………….……8
3. Digital technology on efficiency ………………………………..……………….12
3.1.
Lowering transaction costs …………………………...……………….…12
3.2.
Changing structure of intermediaries ………………………………....…16
3.3.
Falling barriers to exit………………………………………………....…18
4. Digital technology on competition ……………………………………...…….…20
4.1.
New smarter services………………………………………………….....20
4.2.
Decrease switching costs…………………………………………….…..24
4.3.
Economies of scale in the Digital Age…………………………………..25
5. Digital technology on information………………………………………….……27
5.1.
More informed customers……………………………………….….……27
5.2.
Big Data …………………………………………………………………31
6. Digital Technology on Size and Participants …………………………………....35
6.1.
The Internet ……………………………………………………………...35
6.2.
Less informal markets …………………………………………………...38
6.3.
Digital technology creating network effects …………………………….41
7. Alternate Viewpoints ………………………………………………………...….42
7.1.
Winner takes all economics ………………………………………….….43
7.2.
Structural unemployment …………………….....……………………….45
8. Conclusion……………………………………………………………………….47
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ABSTRACT
This thesis explores the significant changes that are occurring in the world today
due to rapid advancements in digital technology. This thesis takes particular attention to
digital technology’s influence on worldwide markets for services. While exploring every
single digital technology development and every single service would be impossible, by
exploring specific cases it is not difficult to see underlining economic trends developing in
the world. This paper combines contemporary research on advancements in digital
technology and its business applications to markets for services to argue that digital
technology has helped markets for services change for the better. Put another way, digital
technology has had a positive influence on global markets for services. This thesis does not
claim to arrive at a definite conclusion, as the 21st century will have many more changes in
store, but aims to show that digital technology, while disruptive, has had remarkable
positive influences regarding many aspects of markets.
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1. Introduction
The economic system that most of the world has become accustomed to today is
capitalism. Under capitalism, people are allowed to own their own factors of production
in pursuit of economic profit. Despite its set of catastrophes, capitalism has flourished, as
it boasts of one of the most effective properties in efficiently allocating resources:
markets. Markets work by being a point of connection between buyers and sellers. Buyers
and sellers meet in order to negotiate terms and prices and to find the best deal possible.
In a perfect market, many sellers compete in order to obtain a greater share of the
marketplace and this competition in turn should drive out the least efficient firms in the
long run (Bannock, G., & Baxter, R., 2003). Markets are also a source and concentration
of information. In a perfect market, investors, buyers, and sellers use markets to obtain
the best possible information to help themselves. Markets also exhibit the property of
“networking effects” which describes the phenomenon of an action or platform becoming
ever more valuable as more people use it.
Technology, or the application of science to improve machinery and production, is the
engine by which markets become more efficient. By constantly pursuing greater output
with the same amount of resources, businesses strive for competitive advantages that will
drive out competitors. Technology is not only used to make firms more efficient, but also
to make markets more efficient as technology can also improve the conditions for market
participants to meet. Recently, digital technology has been one the most significant
catalysts in the enhancements of world trade for its effects on markets (Wolf, M. 2004).
Digital technology differs slightly with the standard definition of technology as it
specifies machinery and know-how that has to do with digital or computerized devices.
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Digital technology can also be associated with information technology, or technology that
focuses particularly on obtaining and understanding vast amounts of useful data
(Schmidt, E., & Cohen, J. 2013).
The purpose of this paper is to try to make sense of all the vast new changes that are
taking place within markets for services by the introduction of truly revolutionary digital
technology. This paper aims to answer the question: how has digital technology impacted
global markets for services? Through much research of contemporary developments and
their application to traditional economic theory, the author sets out to argue that digital
technology has positively impacted global markets for services. Through examples of
new businesses, technological developments and demographic trends, this paper will
strive to show that digital technology has positively impacted markets for services in four
key areas.
Firstly, regarding the efficiency of markets, digital technology has presented means that
lower transaction costs, dramatically changed the structure of intermediaries for better,
and helped lower barriers to exit for participants. Secondly, regarding the internal
competition of markets, digital technology has presented means for new smarter services
which are displacing incumbents, helped decrease switching costs for consumers, and
changed the nature of economies of scale for businesses making internal competition
fiercer. Thirdly, concerning information of markets, improvements in digital technology
have allowed consumers and businesses to access vast amounts of useful information to
make smarter and more effective decisions. Fourthly, regarding the size of markets,
digital technology, through the internet and Internet connected devices, has helped create
truly global market platforms that reach around the world.
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This paper will also briefly mention how the above mentioned developments, while
positive in economic terms, may have undesired short term effects. The drastic changes to
the status quo that technology brings can create significant short term structural
unemployment as well as create “winner takes all” scenarios where economic benefits are
seized by the few, while the majority miss out.
2. Economic background and theory
2.1.What is a market?
In economic terms, a market is simply a point of meeting between buyers and sellers in
order to exchange provisions (Bannock & Baxter, 2003). Markets can exist in both the
physical world, such as a bazar or shopping mall, as well as in the virtual world, such as
an online retail website like Amazon. In the real world, markets are difficult to clearly
distinguish, as at times it is difficult to make out exactly where a market starts and where
it finishes. Markets can be distinguished in both physical space as in domestic,
international or foreign as well as in time; short term, medium term, long term (Bannock
& Baxter, 2003). Markets can also be distinguished by what provisions are being
exchanged. This paper, due to interest of the author, will focus specifically on the global
markets for services.
2.2.What is a service?
In economic terms, a service can be thought of as an intangible product that a business
sells (Bannock & Baxter, 2003). Examples of services are accounting, banking, cleaning,
consultancy, and even medical treatments. While in reality many services are
accompanied with physical goods, for ease of argumentation we distinguish between the
two. This paper will focus on digital technology’s impact on the market for services.
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This paper will also not distinguish between domestic and international markets, as
distinguishing between the two would not enhance the investigations done. Digital
technology has vastly improved global communication and information flows that
distinguishing between domestic and international markets becomes very difficult and
does not necessarily enhance or deter this paper’s main argument.
2.3.What Makes a Market Efficient?
According to standard economic theory, a market is efficient when reliable, significant
information is available to all participants at the same time and market prices adjust
immediately to available information (Bannock & Baxter, 2003). In the real world, no
perfectly efficient market exists, as market failures are always present (Bannock &
Baxter, 2003). Market failures are situations in which a market outcome is not efficient as
there is a mismatch between demand and supply of a good or service (Bannock & Baxter,
2003). A market gains efficiency when market failures are fixed and demand and supply
are closer to be in equilibrium. By this definition, the efficiency of a market can be
evaluated by comparing it to a previous state or to another similar market. This paper will
aim to show how digital technology has presented many situations in which market
failures present in markets for services can be fixed or minimalized.
2.4.Components of a market
Efficiency
This paper investigates four components of markets that the author believes technology
has impacted significantly. The first area is efficiency. Efficiency can be defined as the
lowering of waste in a system as well as the achievement of always more output with less
input. A particular market will be used if the alternative methods available are less
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efficient. The markets can be formal, meaning under the supervision of the state, or
informal, meaning not under the supervision of the state. Regarding the real world, less
efficient options could mean more expensive or time-consuming alternatives. The New
York Stock Exchange, for example, acts as a market for the exchanges of stocks, and due
to network effects and concentration makes it the least expensive method for investors
interested in trading NYSE’s particular stocks. The NYSE’s infrastructure, expertise,
strategic location and size makes it one of the most cost efficient methods for investors to
trade stocks.
Efficiency improves in a market when more output is achieved with the same or less
amount of input. In the real world, a prime example is the lowering of transaction costs.
Participants with less transaction costs will have more money and resources to invest in
their businesses or transactions which boosts economic output. Lowering transaction
costs means more output, in the form of greater volumes of trade, can be generated in a
system with less resources being used.
Competition
In economics, competition can be understood as the rivalry between sellers in pursuit of
what they are all aiming for: market share and profit (Hyman, 1997). Competition is not
only restricted to sellers or producers but even to buyers. Buyers can compete amongst
each other in pursuit of obtaining an investment, asset or objective. Markets feature
different level of competition due to many factors, one of them being: entry costs. Entry
costs are the costs incurred for a participant to enter a market (Hyman, 1997). A market is
considered theoretically perfectly competitive when barriers to entry for buyers and
sellers are zero and there are many buyers and sellers in the market(Hyman, 1997). No
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seller can single-handedly change the price of a good or service, as the demand curve is
perfectly elastic (Hyman, 1997).
In the real world, competition is enhanced when barriers to entry for producers are low
allowing more participants in the market. An example of a highly competitive market is
the food industry where opening a restaurant is relatively inexpensive. An example of a
market with few producers are markets for Internet Service Providers where high
infrastructure costs and knowhow make it expensive for new producers.
Information
In economics, information can be thought of as the useful knowledge that is
communicated or obtained that will enhance a person’s actions (Hyman, 1997).
Information is the engine of markets, as buyers and sellers constantly receive and
communicate information to make the best possible decisions. A perfectly competitive
market assumes that all participants have perfect information, meaning that no one has
less useful information than anyone else (Hyman, 1997). A perfectly competitive market
also assumes everyone has equal access to information and information is rapidly
diffused to all participants as fast as possible. This assumption also means that, in theory,
no participant is able to obtain abnormal profits in any operation, as the information of
such a possibility would drive new producers and in the long run all firms would achieve
normal profit, where revenue equals expenses (Hyman, 1997).
Information improvements increase the efficiency of markets, as producers know more
about their buyers and vice versa, improving adverse selection issues. Information
improvements also improve competition, as buyers and sellers are less prone to be
ignorant about occurring and opportunities available. Information also improves sizes of
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markets; as more information is available, more participants will see the economic
benefits of entering a market.
Size and Participants
Size and participants of a market can be thought of as the measurement of the nominal
amount of entities, the aggregate market capitalization of firms present in a market, as
well as the aggregate volume of trade that occurs in the market. Markets with many
producers are more competitive and efficient as more entities are in rivalry with each
other to obtain greater market share (Colander 1995). Markets with few producers that
control the majority of market share are known as oligopolies. A market with only one
producer is known as a monopoly.
The size and number of participants in a market are a function of the entry costs to that
market. Lower entry costs means more producers can enter the market, while higher entry
costs means fewer producers can enter the market and incumbents will face less
competition (Colander 1995).
The size and number of participants is also a function of the information available.
Buyers with better information or better technology to obtain better information will have
greater opportunity to enter the most optimal markets for them.
The size of markets can also be a function of itself as networking effects take place. The
networking effect is the idea that a particular object becomes more valuable as more
people use it (Colander 1995). A large market will be more attractive to producers, which
in turn makes the market even larger. Following this idea, in the long run markets should
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always strive to merge and grow bigger to take advantage of the benefits that come with
larger markets.
3. Digital Technology on Efficiency
3.1.Lowering transaction costs
Digital Currencies-Bitcoin
One area in which digital technology has made the service sector more efficient regards
transaction costs. Transaction costs are the costs and expenses incurred when buying or
selling any security (Colander 1995). Markets try to be a point of intersection between
buyers and sellers in order to make transaction costs as low as possible for all parties
involved. High transaction costs make the entering in an exchange more expensive for an
individual and can potentially deter him/her from entering the market or transaction in the
first place. Transaction costs can also be a barrier to entry for new individuals. High
transaction costs make the market safer for incumbents as there is less than optimal
competition and can make markets less efficient.
One example of how digital technology has helped lower transaction costs and therefore
improve the efficiency of service markets are digital currencies. Digital currencies are
currencies that are completely virtual and independent as they do not belong to any state
or central administration (Fung & Halaburda, 2014). A prime example of a digital
currency is Bitcoin. Bitcoin is digital currency platform that is completely virtual and
works with no intermediaries (Fung & Halaburda, 2014). Bitcoin is completely virtual
meaning it works solely on the internet and all exchanges of money take place directly
between two parties, also known as peer-to-peer (P2P) (Fung & Halaburda, 2014).
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Bitcoin has significantly lower transaction costs for several reasons. Primarily from a
money perspective, Bitcoin makes exchanges of money cheaper (Fung & Halaburda,
2014). As Bitcoin is a virtual currency, it is not registered with any bank or central
administration. Banks and financial institutions demand a fee for their services, and
digital currencies completely rids users of this property. Exchanges of bitcoins are
completely free as there is no central agency to administrate any costs (Fung &
Halaburda, 2014). Exchanges of large amounts of money between banks or transporting
money between countries incur fees, regulations and even different levels of taxes.
Exchanges of Bitcoin do not incur any of these charges.
Bitcoin also lowers bargaining transaction costs. Bargaining costs are costs incurred
between parties in order to come to an agreement (Bannock & Baxter, 2003). As Bitcoins
are an independent currency, in theory, two parties from across the world with different
domestic currencies, by using Bitcoin would be able to avoid any currency exchange
issues while negotiating transactions.
Lastly, Bitcoin significantly lowers the transaction costs of policing and enforcement
(Fung & Halaburda, 2014). All bitcoin transactions are available to see on a public
ledger, with personal information being hidden, which makes it very hard to cheat or con
anyone while using Bitcoin (Fung & Halaburda, 2014). All transactions can be verified
on the Bitcoin block chain, which makes Bitcoin a very transparent payment system and
much safer for merchants.
These benefits are not only theoretical but have already been witnessed in the real world.
A case emerged in which the FBI was able to discover that two of its agents were stealing
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confiscated Bitcoins by simply observing anomalies in the public ledger. These two
agents were duly arrested and prosecuted (Grossman, A. 2015).
All the above-mentioned lowering of transactions costs improve the efficiency of
markets, as users have the possibility of being more productive. Lowering or elimination
of fees means people will have more money for other purchases. Lower bargaining
transaction costs and lower policing and enforcement transaction costs means people will
have more time and money for larger volumes of trade and/or other activities. In all
instances, the aggregate output of the market can increase as money and time are diverted
for more effective purposes.
Mobile Banking- M Pesa
A subsequent example of how digital technologies have lowered transaction costs and
hence improved the efficiency of markets can be seen through the new financial services
provided by portable electronic devices, known as Mobile banking. Mobile banking is a
term given to generally describe a large array of financial services that one is able to
access through a mobile phone or tablet (Sadana, Mugweru, Murithi, Cracknell, & Wright
2011). A major example of a Mobile Banking platform M-Pesa. M-Pesa is a Kenyan
mobile-phone based money transfer and micro financing service. Users of M-Pesa can
access an array of financial services through their smartphones and most importantly
transfer money to one another directly by SMS technology (Sadana, Mugweru, Murithi,
Cracknell, & Wright 2011).
Mobile banking and in particular M-Pesa come with many advantages, which help
producers and consumers lower transaction costs. Primarily, M-Pesa is a much cheaper
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method for accessing financial services than virtually all alternatives presently in Kenya
(Sadana, Mugweru, Murithi, Cracknell, & Wright 2011). M- Pesa offers much lower fees
than more old-fashioned financial institutions as they operate solely through mobile
devices and leave few operations to their physical banks. This allows low-income
Kenyans with the opportunity of accessing financial services as well as giving them the
opportunity of greater disposable incomes. Mobile banking also lowers transaction costs
for banks as less employee time and less physical bank time is needed for customers
(Becirovic, Bajramovic, & Ahmatovic 2011). Mobile Banking platforms can employ less
people and therefore reduce fees and charges as they have less expenses to cover.
Furthermore, as all transactions are done by phone, the monetary costs incurred by
customers of traveling to a physical bank or ATM are also eliminated. Banks also obtain
boosts of efficiency as they become less crowded with customers and bank staff are
diverted to work on more productive operations. Mobile banking also lowers the
transaction costs of time, as visits to the bank or ATM are no longer necessary. All
transfers of money are exchanged by cellphones, which means they can be done virtually
anywhere. This reduction in time used means people have more time for other activities.
A final advantage is the lowering of risk of carrying cash. Mobile banking eliminates the
need to carry cash, which eliminates the risk of the cash being lost or stolen. This
reduction in risk improves the efficiency of markets as people can partake in more
activities without fear of problems.
Once again the lowering of transaction costs in the abovementioned example improves
the efficiency of markets as people can divert their time and money into more productive
means. Cheaper financial services means Kenyans have more income for other purchases.
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The elimination of the need to travel allows people more time for other activities, and the
elimination of cash allows people to pursue financial activities with less risk. Finally, the
decrease in expenses for banks means banks have more cash to partake in other activities.
With the introduction of mobile banking, banks can increase in productivity as they can
reach more clients and help more people simultaneously while lowering expenses.
3.2.Changing structure of intermediaries
Peer to peer services- Uber
Digital technology has also improved the efficiency of markets for services, as in many
instances it has reshaped the structure of intermediaries. Intermediaries are people or
institutions that bring together two negotiating parties to try to facilitate an agreement
(Colander 1995). Digital technology in the form of vast global communications networks
and widely accessible information has sharply changed the structure of intermediaries for
the better. Due to many advances in Internet connectivity and ubiquitous mobile
technology, for many services intermediaries have been cut off or strongly undermined.
This change has brought smoother operations as both time and money can be saved for
consumers.
The American company, Uber, is an example of the above mentioned development. Uber
is essentially just an application available for smartphones that connects people in need of
transportation with available drivers in the area (Grossman 2015). Uber is a very unique
company as it does not actually produce any service related to vehicle transportation. Its
only purpose is to give consumers the ability to be in direct contact with drivers. Uber
took off by seeing the potential in the vast amounts of smartphones in peoples’ pockets.
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The American company saw the potential of how attractive it could be for consumers to
bypass any one taxi company but instead be in direct contact with all available drivers.
Uber improves the efficiency of markets by, once again, cutting down on time and money
for both consumers and producers. Uber cuts down on a consumer’s time by bypassing
any contact needed with an agency. Traditional taxi services work by needing to first
contact the desired taxi company and subsequently directing the customer with an
available driver. Regarding Uber, as all communication is both computerized and directly
between driver and customer, no central agency with employees is necessary(Grossman
2015). Bypassing any agency reduces risks of mobile congestion with the agency and
time lost.
Uber also takes improvements in efficiency one step further by making all payments
completely digital. Payments are only allowed by credit card or mobile devices and no
cash is ever exchanged, even regarding tips (Grossman 2015). While Uber implements
this policy also for bureaucratic reasons, the underlying principle is to constantly improve
the efficiency of its operations. Simply put, Uber strives to provide the smoothest taxi
service yet. Uber wants all steps of the process, from ordering a taxi, to paying at the end
to be completely digital in order to cut down all possible wastes in time (Davidson 2014).
Many companies are emulating the characteristics of Uber as they are seeing the benefits
of providing a service that “cuts out the middle man”. These companies are emerging so
rapidly that venture capital firms have even coined this phenomenon as the “uberification
of the service economy” (Schlafman 2014). Transportation, home services, delivery and
logistics and many other industries are seeing a rapid emergence of startups. All these
startups are direct products of digital technology, as they all take advantage of the
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benefits of global communications that have emerged from the proliferation of Internet
connected mobile devices.
3.3.Falling barriers to exit
The field of economics and in particular microeconomics takes particular attention to entry
costs when studying markets and its participants. Entry costs are defined as the costs
incurred for a participant, whether producer or consumer, to enter a given market(Colander
1995). A related factor which is studied much less, but is of significant importance, is
barriers to exit. Barriers to exit is just the opposite, as it is the costs incurred for a
participant to leave a market (Colander 1995). Digital technology has positively improved
the efficiency of markets for services as in many instances it has vastly decreased barriers
to exit for producers in particular. There are three main reasons for while digital technology
has made barriers to exit lower.
The first reason is that digital technology services allow companies to operate with
relatively few physical assets. Startups that provide services, which operate primarily by
means of digital technology, have relatively low investments in non-transferable fixed
assets in comparison to companies that would provide a physical good and rely on
manufacturing plants and capital-intensive equipment (Barriers to entry, exit and mobility
2009). The low amount of physical assets allow digital companies wishing to close or be
sold to do so more swiftly and efficiently. Uber is again a good example. Venture Capital
experts believe Uber is worth about $12-40 billion while not owning a single car, driver
insurance or paying any maintenance costs (Bertoni 2014).
Secondly, digital technology is lowering barriers to exit, as in many instances service
companies that are highly digitally technological have relatively few employees.
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Companies with fewer employees are easier to liquidate and close as there are fewer
bureaucratic and regulatory issues (Barriers to entry, exit and mobility 2009). Digital
service companies that rely on the Internet can reach virtually millions of users with
incredibly low numbers of employees. This trait is almost completely exclusive in the
world of business. For example, Skype has almost 600 million users with a workforce of
around 500 employees. About 18 people run Tumbler, which has over 12 million
bloggers. Twitter, with over 175 million accounts, has 300 employees (“Internet
companies” 2011).
A third reason digital technology is lowering barriers to exit is due to the fact that highly
digital service companies have fewer contractual agreements with suppliers and
contractors (Barriers to entry, exit and mobility 2009). Internet companies like Uber,
Facebook, Twitter, have very low or virtually no suppliers as they can deliver their
service directly to clients with no assistance (Barriers to entry, exit and mobility 2009).
This feature makes Internet companies much more flexible and easier to close, as there
are very few or no supplier or contractor obligations to meet and therefore less penalties
and legal hurdles to overcome.
Altogether, digital technology has improved the efficiency of markets for services as
barriers to exit are lower. Lower barriers to exit means that companies can halt operations
faster reducing waste as well as diverting capital more quickly with less time wasted.
Lower barriers to exit quicken the legal and bureaucratic issues that arise in closing a
company for whatever reason.
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4. Competition
4.1.New Smarter Services
Mobile Banking/ Digital Banking
Digital technology has introduced a wide array of new services that are aggressively
disrupting the status quo of many industries. Mobile Banking, once again, is a prime
example.
Mobile banking has shaken up the banking industry. It has introduced a service that has
been around for centuries but in a new and unique manner, that traditional finance
institutions were not able to do. By taking advantage of the decreasing costs of
technology and the incredible expansions of mobile devices, companies have been able to
provide financial services through a new medium.
Mobile banking services have the incredible advantage of not needing physical branches
to provide their services and need to invest in virtually zero infrastructure to set up
business. This is equal to saying they have incredibly low entry barriers to the market.
Low entry barriers means more producers can enter the market and increase the internal
competition and drive down prices further.
For Mobile banking to work they only need to take advantage of the already established
telecommunication networks available in the region (Becirovic, Bajramovic &
Ahmatovic 2011). This is physically present everywhere in developed nations and
growing very fast in developing nations. The absence of physical branches and low
investments lowers drastically company expenses, which transform into lower fees for
customers. Subsequently, the low costs that mobile banking offers for customers means
that a whole new demographic of lower income individuals can be reached. There is
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strong evidence for growth from all around the world. In 2010, Mobile Banking grew in
Kenya, China, Brazil and USA, 200 percent, 150 percent, 110 percent and 100 percent
respectively (Bul 2012).
While mobile banking will not wipe out traditional financial institutions overnight, they
do offer the possibility to threaten the historically stable customer base of the oldfashioned banking (Denecker Gulati & Niederkorn 2014). Mobile banking offers a
comfortable and safe service to anyone with a mobile device, which in this day, is a
monumental figure. Traditional banking behemoths do not only need to worry about
losing potential customers in developing countries but at home in their own developed
economies (Denecker Gulati & Niederkorn 2014). While there is much talk of the
potential of mobile banking in the developing world, developed nations are adapting very
quickly. South Korea with 47% leads the world with highest percentage of people using
mobile banking services, followed by China with 42%, Hong Kong with 41%, Singapore
with 38% and India with 37% (Bul 2012).
All the competition that mobile banking is bringing to the market for financial services
does not have to necessarily be a danger for incumbents but an opportunity to restructure
in order to keep the pace of technological change. 90% of US Bankers surveyed expected
a decrease of at least 10% in branch numbers over the next 5 years (Brand 2014). The
Federal Reserve reported that 48% of smartphone owners have used mobile banking
services in 2013 and “while the growth of smartphones will slow, the adoption of mobile
banking is about to take off” (Mitek 2013).
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Digital technology has been able to aggressively disrupt an historically stable industry by
offering a simple and already existing services through innovative and always changing
mediums.
Uber
A second example of digital technology increasing competition in service markets is once
again Uber. Uber, and other companies like it, are introducing a extremely simple but
monumentally effective services that are catching incumbents completely off guard.
Uber has increased competition in the taxi industry all around the world by simply
introducing a system for which customers can find a huge array of new drivers. Uber’s
competitive edge is that it is not responsible for any physical taxi but only acts as the
matchmaker between customers and drivers through its mobile service. In many cities,
Uber can offer lower prices than its competitors can. This is due to the simple strategy of
lowering prices while making it up with larger market share. By not being restricted to
any geographic area, they have been able to expand aggressively all around the world.
Uber is present in 57 countries and over 240 cities and growing every year (Uber). Uber
also competes with the traditional taxi industry by using digital technology to make the
customer’s experience better. Besides using the application to order a ride, the Uber app
allows you to see the details of your driver, can give an estimate of your fare, allows you
to pay through your smartphone and even allows you to rate your driver and leave
feedback (Uber Features).
Uber has been disruptive by simply bringing “competition to an industry which hasn’t
been shaken up in years” (Mulgrew 2015). By simply bringing to the market more drivers
and easier access to information Uber has been able to greatly disrupt Taxi cartels or
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monopolies that have been present in cities worldwide. This competition in turn, has
forced inefficient taxi companies to rightfully see a decrease in sales. San Francisco has
seen a 65% decline in taxi services since the start of ride sharing services (Ferenstein
2015,).
The Uber model of independent drivers and constant feedback also increases internal
competition between drivers. This in turn has made the standards for ride sharing services
much higher than the regular taxi industry. A Seattle Taxi report found that, nearly 70%
of TNC (Transportation Network Companies) drivers arrived within 5 minutes compared
to less than 40% for normal taxis (Phillips 2015). 80% of customers rated TNC services
as “very good” compared with 10% of normal taxis (Phillips 2015). 90% rated the
payment system of TNC as “very good” compared with 10% of traditional taxi customers
(Phillips 2015).
Uber is forcing regular taxi companies to finally get their act together and provide better
services, but in the end this may not be enough. Being much more flexible in terms of
regulation and infrastructure, Uber could potentially “eliminate the entire infrastructure of
the regulate taxi cartels” as one report claims (Corcoran 2014).
Uber’s success has inspired even more competition as other ride sharing services have
emerged to claim a piece of the pie. While Uber’s position is still dominant rivals such as
Lyft, Curb and Sidecar are catching up. These ride sharing services will all compete for
market share and profit and the ultimate winners will be the customers. Digital
technology has brought positive change by ultimately improving a service that has been
stagnant for decades.
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4.2.Decreasing Switching Costs
Digital technology has been able to increase competition in markets by lowering the
switching costs for consumers. Switching costs are the costs incurred when changing
provider, brand or product (Hyman, 1997). These costs could be monetary, such as a
change in expenses, or psychological, such as time and effort based switching costs. High
switching costs allow companies the privilege of dissuading customers from leaving their
services (Hyman, 1997). For example, cell phone providers charge high cancellation fees to
incentivize customers to finish a contract. Digital technology, in many instances, has helped
lower switching costs for consumers, which makes the market more competitive as holding
on to customers becomes more challenging for firms.
Evidence of this can be seen in the radical changes in usage of social networks and social
platforms. In 2008, Myspace dominated the social network industry and attracted 75.9
million unique visitors per month (Jackson 2011). In 2006 it surpassed Google as the
most visited website in the United States (Jackson 2011). Myspace’s success was shortlived, though; since the rise of Facebook in 2008, Myspace has lost users every month
(Jackson 2011). As of March 2015, Facebook reached over 1.4 Billion active users a
month and Myspace had less than 50 million (Jackson 2011). Many more narratives exist,
such as MSN messenger taking over AOL Instant Messenger only to be later taken over
by Skype; or Tinder aggressively taking over the online dating industry. All share a
similar factor. A crucial feature that made these businesses successful was their low
switching costs.
Skype, Tinder, Facebook and more provided a service that already existed, ameliorated it
and toiled with it to make the switching costs as low as possible. The internet and mobile
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devices allowed people the freedom to easily access alternative services with no change
in infrastructure. Furthermore, tech companies knowingly pursued courses of action to
make switching costs as low as possible. Rather than create a whole new profile, to
access Tinder one must connect their already existing Facebook Profile. Facebook
pursued the same audience of Myspace but made the user interface much more user
friendly.
These low switching costs have given rise to large swings in customer loyalty. What may
seem as a strong and stable business could be very short-lived. The social network
industry has already coined a term called the “Myspace effect” to describe these drastic
changes (Wlodarz 2012). According to a Princeton research, Facebook will lose 80% of
its users by 2017 (Du 2014). These swings of customer loyalty are making the
competition between firms much more fierce as customer loyalty is much harder to hang
onto. Firms will have to constantly consider new and creative ways in order to maintain
customers as customers will have much lesser costs in switching services.
In the end, the beneficiaries are consumers and the overall market. With lower switching
costs, consumers have more choice and more ease at changing service provider. The
market will benefit as new entrants will have a greater edge at fighting incumbents and
maintaining a monopoly will be ever more difficult.
4.3.Economies of Scale in the Digital Age
While the impact of traditional technology has been moderate in some instances, digital
technology has also brought about drastic changes to market fundamentals that were not
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questioned for years. One example of how digital technology has surprised economists is
by the changing nature of economies of scale in regards to digital products or services.
Economies of scale is the name given to the phenomenon of falling per unit costs when
quantity of produced goods increases (Hyman, 1997). As a firm produces more goods the
per unit costs decrease as expenses can be spread out on more units. Economies of scale
give firms a competitive advantage as larger firms can produce greater amount of goods
while simultaneously decreasing their per unit costs. Economies of scale also act as a
barrier to entry as new firms with less output will have a higher average cost which can
deter entry.
Digital technology is challenging this classic theory, as it is bringing situations that do not
follow this principle. Simply put, many digital products and services have the unique
characteristic of while having an initial production cost, the costs of reproducing are
virtually zero (Brynjolfsson & McAfee 2014). Furthermore, the Internet has made the
distribution costs significantly lower.
Itunes is a good example of this occurring phenomenon. Before Itunes or any digital
media outlet existed, music was sold through physical CDs, through a supply chain of
record labels, manufactures, retail stores and distributors. Itunes has virtually eliminated
all physical aspects of the distribution process, as it sells music directly to customers
through the internet. A record label which may have had an economies of scale advantage
in large scale production, distribution and bargaining power will have lost a significant
edge through the advent of Itunes. Through the use of Itunes there is essentially no limit
to how much music one can sell as copying a digital product incurs virtually zero costs.
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Itunes has made the market more competitive by leveling the playing field between
incumbents and new entries in the field of music.
Another example are digital newspapers. Digital newspapers are simply newspapers that
can be directly delivered and downloaded to digital devices such as computers or
smartphones. Digital technology in this case has again digitalized what was once a purely
physical product. Digital outlets such as application stores are allowing producers to sell
directly to customers. Economies of scale that may arise from production capabilities,
distribution know-how, location and others are completely wiped out by the new digital
economy.
In this example, digital technology has made the market more competitive as it has wiped
out many advantages that historical incumbents may have had due to economies of scale.
This reduction in advantage simultaneously decreases entry costs, as new producers will
be less reluctant to forego the initial investment required. Overall, markets have been
made more competitive as incumbents face lesser advantages vis-à-vis new participants.
5. Information
5.1.More Informed Customers
Trip Advisor
Digital technology has helped enhance markets for services by improving the flow of
information throughout markets. Market information that is more accurate, reliable and
timely helps consumers make better-informed decisions about how to spend their money.
Market failures exist when there is imperfect information or information asymmetry
between producers and consumers (Colander 1995). This lack of perfect information makes
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that customers or producers do not make the most optimal decisions of how to allocate
resources.
One area in which digital technology has improved the flow of information in markets
can be seen by the emergence and popularity of online review websites. A prime example
is Trip Advisor. Trip Advisor is a website company that provides reviews and comments
on wide range of travel related services. Trip Advisor has over 200 million reviews
spanning over 4.5 million accommodations and reaches 315 million unique visitors a
month (About TripAdvisor 2015). Trip Advisor is able to generate these huge amounts of
reviews due to its user-generated information. The website acquires its information from
users who rate and review travel related services. As Trip Advisor grows, it becomes
easier to acquire new users and increase reviews due to its “network effect”.
Trip Advisor has vastly improved markets by creating a platform in which people can
easily access information about services. Trip Advisor acts only as a platform, and does
not involve itself in the reviewing process. The final rating given to a service is merely an
average of all the reviews submitted and is always up to change.
Trip Advisor has helped improve markets by allowing potential consumers to make
better-informed decisions. The information allows customers to better target services
based on their exact desired criteria, whether it is price range, geographic location, or
more. Increasing the precision of every choice increases the economic benefit derived
from every purchase. This makes people happier and better off.
On the other hand, Trip Advisor has improved markets by decreasing the advantage of
ignorant customers that may have allowed many services to continue operations. Trip
Advisor allows consumers to avoid “bad” services without having to try them for
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themselves. Companies that may have had a geographic or strategic advantage but
produced low quality services will face fiercer competition as consumers are less ignorant
of alternatives to choose from. Similarly, a small and unknown business can flourish and
gain recognition very quickly due to Trip Advisor.
Finally, Trip Advisor and other forums of user-generated content have allowed producers
to have access to huge amounts of feedback without any of the costs of conducting own
surveys or research (“TripAdvisor Now Offers” 2014). Trip Advisor can allow hotels and
restaurants to work on precise complaints and criticisms that may have not been aware of.
Producers with better information can make better choices on how to improve their
services. Better information allows producers to allocate resources most optimally. Trip
Advisor also allows producers to compare themselves to competitors in pursuit of
improving their business.
Trip Advisor has created a monumental platform of information that has improved
markets by creating better-informed participants, whether consumers or producers.
Travel Agency Websites - Expedia
A subsequent example of a website that has vastly improved information flows in the
markets for services are travel agency websites like Expedia and Travelocity. Expedia
and websites like it are virtual travel agencies, which facilitate travel operations for
customers and service providers.
Expedia works by taking request from users online and tapping into partner hotel, airline
and other management systems to find the best possible deals and transactions for
customers interested in making travel arrangements. Arrangements can be made with any
combination of flights, hotels, cars and more. Digital technology has allowed internet29
based travel agencies to flourish by taking advantage of the huge amounts of data
available through the internet. Expedia obtains a request and automatically finds the best
possible deals with partner providers to facilitate and quicken operations.
Travel Agency websites have improved service markets by offering a means to better
information for customers as well as a mechanism for hotels and other services to obtain
faster information on potential clients.
By connecting to hundreds of thousands of hotels worldwide as well as hundreds of
airlines, these websites can process more information than any human could. Customers
save vast amounts of time as requests are processed in a matter of seconds. Subsequently
requests can be constantly toyed with to increasingly pin point specifications. In the end,
these results all allow customers to make better economic decisions, which in turn allow
them to obtain a higher benefit from their purchase.
These websites not only help customers improve their travel specifications but also
improve hotels’ and airlines’ ability to reach customers. Rather than spend millions of
dollars on advertisements, hotels and airlines can submit their details to travel agency
websites which will automatically display them to clients.
Furthermore, Expedia helps hotels and airlines reserve rooms and seats. Expedia and
travel agency websites can send your details directly to the hotels computer systems as a
means to facilitate and automate operations. By using Expedia, a client can purchase and
reserve a hotel room across the world quickly and completely computerized.
Besides all the special features Expedia has to offer, one of the most simple ways it has
vastly improved markets for services is by displaying all possible prices that are available
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for a customer and his/her special requests. By providing a vast list of prices, customers
can most accurately choose the combination they are willing to pay. By offering different
prices for different services, markets improve by appealing to as many customers as
possible. If only few or just one price were offered, customers who could not afford the
minimum price would not enter the market and producers would lose out on potential
sales. Subsequently, with less price variability, producers miss out on the potential of
people whom are willing to pay more but don’t have the chance. Furthermore, by
comparing and contrasting prices and services, Expedia can help more efficient firms to
be noticed and outcompete less efficient businesses. This in turn should create a more
productive and efficient industry.
5.2.Big Data
A final way in which digital technology has improved markets for services is through the
creation and interpretation of “Big Data”. Big Data is a term coined to describe
monumental amounts of data generated by digital technology that can be captured,
communicated, aggregated, stored and analyzed (Manyika, Chui, Brown, Bughin, Dobbs,
Roxburgh & Hung Byers 2011). As more people use smartphones, the Internet and
practically any digital devices monumental amounts of data is constantly created and
stored. The interpretation of this data into useful information is proving to be an
incredible tool for enhancing businesses and improving information flows within
markets.
Digital technology has improved markets for services as it has created the tools to create
and interpret vast amounts of data, which businesses can turn into useful information.
Greater information in turn allows managers to make more optimal decisions, which lead
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to outcomes with bigger gains. The analyzing of data, or data analytics, is proving to be a
new competitive advantage which allows firms to outcompete rivals.
Digital devices, whether online or not, have created the means to create vast amounts of
data. This data ranges across many areas from Facebook photo uploads, to twitter
comments, to purchasing preferences, all decisions and actions done on digital devices
have the potential to be recorded and stored. As millions of operations occur every day,
data is being created at an incredible pace. On the other hand, advancements in digital
technology, in particular Super Computers, have finally given us the means to convert
these vast amounts of data into something useful. Through massive computational power
and speed useful information can be created from these huge reservoirs of data. The
information provided can help businesses and the overall market in the following ways.
While there will be evident issues of privacy and accountability regarding the recording,
storing and analyzing of data that governments and business will have to resolve, there is
a wide agreement that if used properly and in good faith Big Data could truly
revolutionize for the better markets and the world of business.
Improve Internal Operations
The first way Big Data has improved markets for services is by creating the means for
businesses to conduct more efficient operations. As data is constantly stored from all
operations, businesses are able to find out much more about their own operations than
any time before. Inefficiencies can be discovered and productivity can be enhanced by
simply discovering patterns and clues from internal data. As more data is digitalized,
more data can be interpreted. Businesses can collect information on virtually anything
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that can be digitalized. Businesses can collect data ranging from product inventories, to
personnel sick days and in turn analyze this data to cut down on inefficiencies and
increase productivity (Court, 2015). Businesses, through data analytics, can also
experiment with theories and hypotheses. Data modelling allows businesses to create
theoretical models and can prove or disprove raised hypothesizes. A report by McKinsey
estimates that retailers can increase their operating margin by more than 60% by simply
analyzing internal data better (Court, 2015). Firms such as Tesco in the UK have already
been able to gain market share and beat competitors by simply improving operations
through better understanding of internal data (Court, 2015). There is growing evidence of
financial and insurance companies that are following this pattern (Court, 2015).
Better Forecasting
Furthermore, all this useful information that is created can help businesses make better
forecasts of the future, which allow managers to make better decisions. As more amounts
of data and greater computer capabilities come together, models that are more accurate
are created. Models that have greater accuracy and take into account more variables can
help managers make better forecasts about the future. Big Data also allows managers and
anyone concerned to toy with particular variables in a model. By manipulating only
particular variable managers can better understand relationships between different factors.
Businesses have the potential to model practically anything that can be digitalized. Avvo,
the online legal marketplace, was able to better price its online advertisements due to data
analytics. Before using data to base its decisions Avvo, like many other companies,
would price its advertisements based on feeling rather than solid mathematics (Google
Analytics 2014). The outsourcing of data analytics allowed them to thoroughly study the
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behavior of users on its own site, which in turn made it possible to price more accurately
advertisement space. This in turn improved their finances and business.
Segmenting customers
Big Data has also benefited customers directly and indirectly. Customers have benefitted
directly as businesses can use large amounts of data to better segment customer groups
and tailor services specifically for particular groups of people. As services are tailored
ever more specifically to the needs and desires of customers, businesses improve business
relations and customers receive higher consumer surplus from their purchases. Customers
benefit indirectly through lower prices, better customer service and greater transparency,
which are all a byproduct of data analytics. Travelocity, one of the largest travel
companies in the world, obtains vast amount of data from its millions of users and in turn
uses this data to help improve its website. By knowing more about how users interact
with their website, they have been able to restructure it to optimize performance and user
experience (Think with Google 2012). Travelocity, through data mining, has improved
their website by discovering how people responded to slight changes in variables such as
wallpaper design, size of icons, text format and others (Think with Google 2012). The
website in turn, tailored the website to the most desired specifications of its users.
All new services or business models
Lastly, Big Data has the potential to create all new services and business models. As
computers can make more accurate models, which lead to more accurate forecasts,
businesses can predict with greater certainty future buying habits and consumer behavior.
New information can help pave the road for entirely new creations. Digital technology in
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this example helps spur creativity and entirely new products or services. Satellite TV
provider Sky Italia, was able to use data from its digital platforms to discover details of
what its customers viewing behaviors were like and would be like in the future. The TV
provider was able to predict future viewing habits by simply modelling customer
behavior throughout time (Angelucci). With all this new information Sky Italia, created
all new on-demand shows and programs that did not exist before (Angelucci). Sky Italia
continues to create new services and business models by constantly observing and
modelling social networks and user comments to try and find clues on what the future
will look like (Angelucci).
6. Size and Participants
6.1.The Internet
A final way in which digital technology has improved market for services is by making
markets larger in both amount of participants and in global reach. Digital technology has
made markets larger by eroding both physical and transaction barriers and helping merge
previously separated markets as well as creating greater incentives for markets to become
larger. The greatest influence on creating ever larger markets for services is by far the
Internet.
The Internet is merely a global connection of computers that are able to communicate
with one another. The Internet has radically changed the nature of markets by creating a
platform for communication and exchanges that does not take place in the physical world
but in the virtual. Any person that connects itself to the global computer network gains
access to millions of potential producers and consumers. The Internet acts a gateway to a
virtually global market place. In this sense, the Internet has created a literal global
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marketplace as the internet can transcend national political borders and can be accessed
virtually anywhere.
The most obvious examples of businesses that have flourished from the vastness of the
Internet are website companies. Google, the most visited website on the planet, receives
1.1 billion unique visitors every month (Smith 2014). Youtube, in second place, receives
1 billion unique visitors and Facebook in third place, 900 million unique visitors (Smith
2014). These website companies were able to flourish as the Internet allowed them access
to a marketplace that did not exist before. The Internet allowed businesses that produce
virtual goods and services to reach out to the world rather than to one particular domestic
or national market. These companies became behemoths by tapping into a market that
allows almost speed of light transfers of information and universal access. As Internet
penetration is set to expand these companies are likely to become even larger.
A second group to have exploded due to the internet are online retailers. Amazon started
as a online bookstore in the United States and has grown to an online e-commerce
website that has over 200 million users (Smith 2014). Amazon sells directly in over 100
countries and indirectly in 185 (Smith 2014). A company that started in 1994, last year
had revenue boarding 90 billion dollars (Smith 2014). Alibaba, another e-commerce
website, founded in 1999, last year was subject to the biggest IPO in history, raising 25
billion dollars (Smith 2014). Alibaba is bigger than Amazon and eBay combined and has
total merchandise value at over 270 billion dollars with close to 300 million users (Smith
2014). These two extremely young companies grew monstrously in a short period of time
due to the Internet. These two companies took advantage of the growing popularity of the
Internet and globalization to create a website which acted as a gateway to merchandise all
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around the world. Amazon and Alibaba, seldom sell anything directly, but act
predominantly as an online retail space for the whole world.
A third group, that is even younger but is striving in the information age are “sharing
economy” companies such as Uber, AirBnb, couchsurfing and more. These companies
are growing incredibly quickly due to the open nature of the Internet. Uber, starting in
2009, now operates in over 55 countries and 290 cities while being estimated to be worth
over 40 billion dollars (Smith 2014). These companies once again took advantage of the
unique nature of the Internet to create businesses that could quickly expand all over the
world in incredibly short period of time.
These developments due to digital technology benefit markets for services by creating a
marketplace that is larger in both global reach and participants. The Internet allows an
inflow of online businesses that can quickly tap into new markets. While previously a
multinational company may have had to invest significantly in order to enter new
markets, Internet companies can expand aggressively by simply taking advantage of
telecommunication networks present around the world. Furthermore, Internet penetration
is set to expand further throughout developing countries which will only help online
companies even further.
Markets benefit as businesses can reach larger amounts of consumers. Businesses can
raise larger amounts of revenue that would not have been possible solely in their domestic
market. Having access to a vast customer base allows companies the privilege to
specialize more and reach niche markets that may not have been possible at home. A
company based in any part of the world can easily provide a service over the Internet to
any area with equal access to the Internet.
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The increase in size of markets benefits consumers as their choice of service providers
grows. Consumers with more choice can choose services that suit them best increasing
the economic benefit acquired. The larger amount of choice that consumers have in turn
increases competition within markets between firms as maintaining market share
becomes harder. The Internet allows consumers to access monumental amounts of new
services which incumbents will have to fight off. In all, this competition improves
markets as the least efficient firms should close and give room to the best performers.
A final area in which digital technology and in the internet help improve markets for
services is through the act of specialization. The vast market of globally connected
computers allows producers from different parts of the world to specialize in areas in
which they have a comparative advantage. One way companies in the digital age
specialize is by outsourcing work others can do better. A good example of this
phenomenon is the outsourcing of data analytics. Businesses, regardless of the industry,
are realizing the benefits of “big data” as mentioned in the previous section and recognize
that the work can be best done by outsourcing the task to other companies. IBM, Hewlett
Packard and Dell all offer data analytic services in addition to their physical goods.
6.2.Less Informal Markets
A second way digital technology has made markets larger is by its role in helping drive
more activity into the formal economy. In this sense, markets appear larger as more
activities move from the informal economy into the formal economy.
Informal economic activity is all activity that is not monitored by any government and
hence not taxed or subject to any regulation (Colander 1995). Informal sectors are found all
over the world but prevalent in developing countries where governments may not have the
38
resources to oversee all economic activity formal economy. (“Formal Economy” 2014).
Informal sectors also prevail in situations in which the entry costs to the formal sector are
too high and/or weak political institutions prevail (Colander 1995).
A prime example of how digital technology has helped increase formal economic activity
is through the expansion of mobile banking and microloans as was mentioned in the
previous sections. Through the expansion of ever cheaper mobile devices and
internet/telecommunications connectivity new financial services have sprung up in many
developing countries that have allowed people to enjoy financial services from formal
sources. These financial services are not necessarily new in nature but have become
cheaper to access due to the lowering costs of digital technology. In many developing
countries, access to credit is one of the biggest restraints to economic activity and for
many the only source of loans is through unregulated and unlicensed lenders (“Formal
Economy” 2014). Microloans and mobile banking services have allowed people to access
financial services from regulated, licensed and state monitored providers. Microcredits
and microloans will not resolve informal markets over night and are not expected to be a
long term solution, as many evident problems have emerged, but are definitely a step in
the right direction for nations which dream of growing their formal economies.
These mobile financial services have lowered entry costs to the formal economy for
consumers by providing cheaper services than previous financial institutions could.
People who could not afford the interest payments or fees of formal banks and had to
resort to informal providers can now access cheaper financial services from formal
sources. Smartphones and telecommunications made formal markets larger not only by
lowering entry costs but by also in some instances bringing services to people whom had
39
no access to it at all. By using a smartphone and telecommunications people whom were
too far from any formal services or could not afford the travel, have been able to access
them equally. Digital technology has helped increase the reach of formal providers.
Increasing the formal economy has several benefits. Firstly, the formal economy is safer for
both consumers and workers. Activities in the formal economy will be subject to
regulations, scrutiny and to laws factors that may not apply to informal providers of
services (Colander 1995). Workers in formal economies benefit from having greater legal
protection and social benefits from the government, services that cannot be provided if the
government is not aware of the activities. Workers in the formal economy can also be part
of unions and have a greater political voice (Colander 1995). Subsequently, more firms in
the formal sector also improve competition as firms will have to pay all the fees and
charges required (Colander 1995). Informal providers can make abnormal profits and
distort fair competition by making it harder for honest businesses to compete. Informal
providers can free ride on infrastructure and logistics paid by others while not paying any
participatory costs. Governments also benefit from increases in size of the formal economy
by having more tax revenue as well as more information on the health of their economies
(Colander 1995). With more observable activity more data can be collected on their
economy. With more data available greater information can be generated which can lead to
more effective policy decisions being made. Digital technology in this example has helped
markets for services by providing the means for people to enjoy critical services while also
doing so in the formal economy. A larger formal economy improves markets by creating
greater opportunities for governments and people.
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6.3.Digital Technology Creating Network Effects
A final way, digital technology has helped create larger markets is by creating situations
in which network effects are augmented.
In economics, network effects describe situations in which a good or service becomes more
valuable as more people use it (Hyman, 1997). Network effects are present when the
benefit from a particular activity is directly dependent on how many other people are also
partaking in the same activity. A historical example is the telephone. The first person with
the telephone derived no benefit from it as there was no one else to call. As more people
acquired the telephone the benefit for the next person grew as well. Nowadays fixed line
and mobile phones are present all around the world.
Digital technology has introduced scenarios in which new services can be subject to very
drastic network effects and create very large markets in very short periods of time. The
global expansion of the internet as well as the penetration of Internet connected devices
has created scenarios in which website companies can grow very rapidly in market share
by simply allowing network effects to play out. Many of these website and online
companies, due to the global nature of the Internet, can acquire a critical mass in a very
short period of time.
A prime example of this phenomenon can be seen with social networks such as Facebook
and Twitter. Facebook and Twitter created enormous platforms of social communication
that transcended political borders within few years of their launch. Facebook and social
networks like it had the double benefit of becoming more valuable as more people started
using their services as well as the fact that internet penetration worldwide was increasing.
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A subsequent example are user-generated websites such as Trip Advisor. Trip Advisor
acquires its website information from users who register and comment on their travel
experiences. As more people join, their website becomes more reliable, known and useful
for the subsequent person. Trip Advisor is now the largest travel website in the world
(Colander 1995).
A final example of online intermediaries such as Uber and AirBnb. Uber, for example,
gains momentum as more people register to use Uber. As more people join Uber and
desire rides, more private drivers see a market opportunity. This positive feedback loop
has allowed Uber to expand worldwide in a very short period of time.
These developments have improved markets for several reasons. A larger unified market
can take advantage of greater information flows than smaller segmented markets (Colander
1995). One large market rather than many smaller markets will have larger pools of talent
and will make competition more fierce between firms. The Internet presents this kind of
worldwide platform. Excluding Internet restrictions that some governments pose on their
citizens´ internet access, the Internet presents the first truly global marketplace. These
network effects are also beneficial as it allows new emerging firms to gain a critical mass in
shorter periods of time. Incumbents will find doing business in larger or growing markets to
be more competitive and this should allow best performers to win out in the long run.
7. Alternate Viewpoints
While this paper has presented different pieces of evidence to argue that digital
technology has improved market for services, it would be unwise to suggest that everyone
benefits from these drastic changes equally, at least in the short run. While the theoretical
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positive aspects of digital technology are almost universally accepted, in the short term,
not everyone is made a winner from drastic changes within markets. This paper will look
at two issues which may significantly undermine the benefits that digital technology
brings.
7.1.Winner Takes All Economics
Advancements in digital technology have created scenarios in which historically stable
economic assumptions may have to be reinvestigated. While in economic theory,
competition within markets is good as it leads to the elimination of least efficient firms,
there may be scenarios in which a drastic increase in competition cause greater volatility
and changes than people are able to respond to. Decreasing barriers to entry, decreasing
switching costs and the changing nature of economies of scale can create “winner takes all”
scenarios (Schmidt & Cohen 2013). Winner takes all economics are situations in which a
best performing firms are able to capture very large shares of markets and/or rewards while
remaining competitors receive very little (Colander 1995).
The Amazon platform is one area in which winner takes all scenarios can occur. Amazon,
the online retailer, has allowed best performers to make monumental amounts of revenue
that were virtually impossible beforehand. JK Rowling, with her Harry Potter series, was
the first author to break the $1 Billion dollar worth and Amazon was certainly a
contributing factor. While her fame and fortune are definitely merited, it is significant to
realize that this monumental acquisition of money is a very recent phenomenon. The
global reach of Amazon as well as the digitalization of her books into E-books were very
significant factors. J.R.R Tolkien and other renowned authors never made it close to such
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monumental figures in their lifetime as their lack of access to such a global marketplace
was not present.
Other examples of this winner takes all economics can be found in Facebook, Instagram,
Uber and other companies that exploded due to digital technology and the digital age.
These monumental companies were founded and started by very few people and have
been able to gain monumental market capitalizations in relatively short periods of time.
All these developments are not negative per se but can have undesired effects relative to
others. All these vast and very fast accumulations of wealth have benefitted many people
but not the majority of people. While these monumental expansions have benefited
founders, CEOs or investors the average members of society have not grabbed a piece of
this pie. This mismatch in peoples´ gains can have harmful effects on an economy as well
as a nation (Stiglitz, 2012).
A more economically unequal society can make a nation more unequal politically
(Stiglitz 2012). People of different income levels will have access to different quality of
resources, whether medical, educational or living quarters. These differences in quality of
life can manifest itself later on in differences in quality of citizens. Citizens who are less
healthy and less educated will be less effective political citizens than their more healthy
and educated counterparts.
High income inequality can also cause positive feedback loops that make a situation
worse. People with access to worse education and medical resources will be less effective
employees and be less attractive to employers. Employers will prefer more educated and
healthy potential employees, whom most probably already come from higher income
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families. High income inequality could potentially create vicious cycles where the
barriers between poor and rich reinforce themselves and helps to create even more
segregated societies.
7.2.Structural Unemployment
Digital technology and all its implications have not only improved markets but also
changed their structure greatly. The latter factor is where many issues may arise.
Introductions of new technology and new business practices seldom have not been
destructive to the status quo. Digital technology is no different. If anything digital,
technology has been more destructive than any kind of technology before. Digital
technology has introduced rapid changes to the needs and requirements of businesses that
have proven much too fast for people or governments to respond to.
Loss of Jobs
The first clear example is through the loss of jobs. Digital technology through the advent
of computers from smartphones to super computers have automated many tasks that can
be done more cheaply and effectively by computer than by humans. People in virtually all
industries have been displaced by digital technology. This displacement has taken the
form of lower salaries, actual layoffs or hesitance in hiring new employees.
This displacement once again is not an evil per se, but the short term repercussions for
people and society may be very difficult to deal with. People who are laid off are a
burden for governments as they will have to survive on social benefits and are a loss in
potential economic activity for a nation until they find a new job. Jobs that are automated
will hurt the youth who will not be hired as well as old citizens who are too old to learn a
45
new skill in time. Higher youth unemployment can lead people to accept jobs that are less
than their potential or choose wages which are less than they could possibly earn.
Jobless Growth
A second challenge presented by digital technology is through the phenomenon of
“jobless growth”. Jobless growth is the growth of an economy without actual or
significant growth in employment (Wagner 2010). This phenomenon is present across
many industries but is most significant in technology intensive sectors. Once again,
website companies are an evident example. Websites and social networks can create
billions of dollars of value by employing very few employees. This contrast can create
tricky situations for governments who can witness actual economic growth in terms of
GDP while no significant increase or even a decrease in employment.
This jobless growth once again can be harmful for societies as it can contribute to greater
inequality in income and wealth between members of a society. The growth of an
economy can benefit very few members while the majority do not reap any of the benefits
or are actually worse off. This diversion can be harmful again for the reasons mentioned
previously.
This paper does not suggest policies or measures to be taken to offset these potential
dangers but aims to make obvious that the benefits digital technology brings does not
come without short term risks. In the end, old fashioned legislation and government
policies will be the tool to offset the challenges that digital technology can bring.
Governments and administrations will have to have to balance the tradeoffs that come
with intense digital disruptions and economic growth.
46
8. Conclusion
The underlying question that gave rise to this research paper was simply: how has digital
technology impacted global markets for services? While it is not difficult to be aware of
new technological developments and new world trends, the aim of this paper was to
investigate how all these developments have impacted and are influencing the interaction
between consumers and producers around the world. In other words, what impact are
developments in digital technology having on global markets for services?
This paper aimed to argue that digital technology has positively impacted global markets
for services as it has improved many underlining conditions that make markets function.
This meaning, the current wave of digital developments that are sweeping across the
world are positive and constructive for both consumers and producers all around the
world as they are enhancing positively the underlining pillars that make markets function.
This paper strived to prove this point by investigating current technological developments
happening in the business world and combining them with traditional economic theory in
order to show that in many accounts digital technology has created conditions for markets
to work better.
The paper restricted itself to markets for services due to time and research constraints.
Nonetheless, many of the same arguments presented could be applied to markets for
goods. The paper was divided into four key parts in order to better lay out the author’s
argument. The author doesn´t try to argue that these four areas are in any way exclusive
as it is clear that many of these developments in each area overlap with each other.
47
Finally, a chapter has been dedicated to exploring how all these developments may be
positive for markets around the world but by no means guarantees absolute gains, at least
in the short run, for all participants. In the future, greater research must be conducted on
how the rapidly changing landscape of business is affecting all people and not just the
few whom are gaining. A world in which markets work theoretically perfectly but the
majority do not reap the benefits is both unsustainable and a recipe for disaster. In the
end, governments and policy makers will have to value the tradeoff between
technological progress and its threats to the status quo in order to reap its benefits while
minimalizing the risks.
48
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