Web 2.0, Copyright, & Intellectual Property Economics 

     In the age of Facebook and Flickr, in the global mushrooming of the Web 2.0 battlefield, the world has shifted from material, product-oriented businesses to intellectual capital industries. In contrast to the usual physical production process, this proliferation of expansive social and economic platforms is characterized by a unique “networking effect”: namely, as the size of the user base grows, the utility of such technological networks rises, not falls.  So-called “increasing returns” products do not behave according to classical economic precepts on either the supply or demand side.

     On the demand side, increasing returns goods differ from traditional market goods in terms of their social value. For traditional goods, an increase in supply decreases the utility of the good. An increase in the supply of diamonds, for example, decreases the perceived value of each diamond already in the marketplace. Goods that express increasing returns, however, gain in value as the supply of the good rises. For instance, one fax machine has very little value, but as more and more fax machines are produced, the value of each fax machine in the marketplace increases because each fax machine becomes more useful.
On the supply side, products with increasing returns also behave differently than traditional goods. Conventional product-based processes are subject to the law of diminishing marginal returns. That is, for each additional unit of input, one receives less and less additional output with all other factors held constant. According to diminishing returns theory, eventually it becomes impossible to continually decrease the average cost of production no matter how large the scale of the enterprise. While early increases in production run size lead to falling average costs through a variety of factor inputs (e.g.: higher bargaining power over inputs, learning curve efficiencies, etc.) at some point producers run into administrative and communicative problems that effectively stymie further increases in production efficiency.

     However, in an information economy – one where the primary output is an intangible idea, design, service or website, not a physical product – industries that experience increasing returns occur regularly. This dynamic causes those who have an advantage to get even further ahead because declining average costs and/or increases in perceived value amplify the benefits of scale; success is, in essence, self-reinforcing. The marginal cost of production for information goods is often negligible: the first copy of Microsoft Windows costs millions of dollars, but the second costs only a few cents. Those companies that obtain a lead, irrespective of the cause, can more easily become a staple in the marketplace and eventually become the technological standard.

     Until very recently, goods have almost exclusively been physical and trade has been rooted in productive competition. Trade was either based on the harvesting of raw materials – coffee, cotton, and coal – or on the marketing and circulation of finished goods – cars, clocks, and crayons. With rare exceptions, no one company could dominate the marketplace because that given company faced decreasing returns to scale, and the price was forced down to the average cost of production for all firms. Even if only a select few companies dominated the market, these companies inevitably ran into barriers such as limited demand or limited access to resources when they sought to expand. Diminishing returns existed in some form, and the marketplace for material goods could be considered more or less perfectly competitive as a whole.

     And yet, the rise of the intellectual property and the services-based economy has generated a new species of increasing returns businesses that leverage the network effect. Many electronic devices, operating systems, and software applications have become standard platforms that mature in benefit as they achieve scale.
For example, in the well-known Betamax-VHS videotape format war, VHS took the initial lead, as it was easily available to rent in popular chains like Radio Rentals and DER while Betamax was confined to upscale providers. Since VHS machines were easier to rent, more consumers utilized the device; because there were more consumers renting VHS machines, more movies were produced for the platform; and, as more movies became available in-turn, more and more consumers turned toward the existing VHS platform. Experts acknowledged that Betamax offered the technically superior platform, but VHS emerged as the ubiquitous standard. An initial lead – and the insurmountable amplification effects of the network – allowed VHS to prosper.

     In a networked system, achievement, no matter how small, is self-reinforcing, and in practice, fosters future prosperity. The traditional product-based economy has depended upon rival goods (i.e. the consumption of the good by one consumer prevents simultaneous consumption by others). However, in the rapidly expanding intellectual property economy, the product becomes ideas – in terms of operating systems, development platforms, and electronic marketplaces – and these non-rivalrous creations may in turn encourage more innovation in the forms of modifications, applications, and even new material products.
Businesses with increasing returns, an outgrowth of the new intellectual property economy, challenge the conventional wisdom that competition always reduces social costs. Admittedly, the progress from product development to marketplace dominance is unclear and the winner is more randomized: whoever captures the early adopters seems to have a very substantial advantage going forward. Moreover, as the number of linked nodes expands, value is created as a result of the interface between individuals and companies, not necessarily as a result of productive competition between these parties. Externalities created by the network are, consequently, positive social benefits. The natural evolution of firms in such circumstances is to develop into consolidated monopolies, ones that maximize the utility of interaction.

     This networking phenomenon is ideally adapted to the free, amorphous, and interactive nature of the Web. The augmented utility provided by increasing returns is the driving engine behind the success of Amazon.com as a universal retailer, eBay as an evolved form of a local pawnshop, and, of course, social and job-networking sites such as Facebook and LinkedIn. To some, this interactivity applied to the Internet has merited its own distinction: “Web 2.0” is defined as the shift in the Internet from a mostly one-way information flow to an evolving interactive platform, deriving its efficacy from inter-human connections and other network effects.
Tim O’Reilly, a highly respected Internet specialist and pioneer of the Web 2.0 term, cites the emergence of Craigslist, Skype, and Digg – websites that are founded upon peer creation and thrive upon interactivity – as prototypical examples of Web 2.0. He claims, “Understanding the dynamics of increasing returns on the web is the essence of what I called Web 2.0. Ultimately, on the network, applications win if they get better and more people use them.”
And yet, while O’Reilly and other technocrats may have recognized the emerging trends, few besides high-tech insiders have acknowledged and adapted to the shifting nature of the economy. Adjustment will require policymakers, entrepreneurs, and common citizens alike to reevaluate the conventional societal roles of creation, competition, monopolies, and standardization.
The evolution of increasing returns businesses challenges conventional competitive theory. Traditionally, monopolies have been considered to decrease social surplus and therefore faced regulatory control. However, in the emergence of technological increasing returns situations, where larger networks provide increased social utility, the mere existence of a monopoly may not necessarily be deleterious to the consumer. And yet, the self-fueling cycle of current success feeding future expansion may also result in the long-term favoring of inferior technologies that possess only the short-term advantage and spiral into a “popularity contest” — for example, the history of the VHS. That is, under said circumstances, displacing entrenched technologies at a later time, even with superior ones, may be highly impractical or even impossible.

     The solutions to this shifting structure are currently unclear. However, technical standardization – either through the government or privately agreed upon through industry – may provide a key role in avoiding the costly format wars brought on by competing platforms, e.g. BluRay v. HDD. Due to the interdependent nature of information-based businesses with increasing returns, the traditional regulatory mechanisms of market-based competition may fail. Competitors may gain profit from the existence of peers such that they are willing to float inferior technologies for a prolonged period of time, even when common standards would increase social surplus.
On the other hand, maintaining open platforms, for example, by reforming current copyright law, may be essential in order to preserve the positive social networking effects of collaboration and creation. Professor Lawrence Lessig at Harvard Law School asserts that current copyright laws are outdated and restrict the collective benefits of collaboration. He suggests, “The danger in media concentration comes not from the concentration, but instead from the feudalism that this concentration, tied to the change in copyright, produces.”

     The best modes of transition from the current material-based economy to an information-based economy remain to be debated. What has become increasingly clear, however, is that the shift from primarily material to primarily intellectual capital industries will require us to rethink the role of the individual, business, and the human network.