Tencent Buys Sogou. Plus More Digital and Information Economics (Tech Strategy – Podcast 42)

In this class, I talk Tencent’s recent purchase of Sogou. And go through more digital and information economics.

You can listen here or at iTunes, Google Podcasts and Himalaya.

This is part of Learning Goals: Level 7, with a focus on:

Concepts for this class:

  • Digital and Information Economics
  • Non-Rivalry and Zero Marginal Production Costs
  • Versioning and Pricing
  • Willingness to Pay and Consumer Surplus
  • Bundling and Cross-Selling
  • Complements

Companies for this class:

  • Sogou
  • Tencent


I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.

Note: This content (articles, podcasts, website info) is not investment advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. Investing is risky. Do your own research.

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Welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy. And the topic for today is Tencent by SoGo. And we’re gonna go through some digital economics, digital sort of information economics. Now, first of all, let me apologize for the audio quality. I’m on the road and I’m using a travel microphone, which is not nearly as good as the one I normally use. So sorry about that. I’m up in the north of Thailand in a pretty small little town outside of Chiang Mai, just in the jungle. It’s great, it’s a lot of fun, it’s kind of hot, animals everywhere, thunderstorms every day, I mean it’s the jungle. I keep reading that there’s a huge number of King Cobras, but I have yet to see one thankfully, so it’s been a fun couple days. I’ll head back to Bangkok shortly and the audio quality will be better next week. Now for those of you who are members, the ideas we’re gonna cover today are a little bit of a grab bag on things I think I haven’t gone into enough over the six levels of the course. So 25 sort of learning goals scattered across six levels. Within that, the idea of digital economics, which used to be called information economics, I mean you can read textbooks about this stuff from like 1990. Now I kind of call it digital economics and versioning, pricing, bundling, compliments, things like that. I’ve touched on it a lot, but I think I’ve missed some parts. So I’m just gonna sort of fill in the gaps on that today. So if you’re wondering where this fits in, that’s where it fits into the concept. This all goes under learning goal 29, which is basically digital economics two. And we’ll also talk about SoGo. and you know they just got bought by 10 cents so that’s kind of interesting. I’ll talk about search engines a little bit and just intro that company which we haven’t talked about before but it’s actually a pretty important company. Okay and for those of you who aren’t members feel free to join. You can go over to jefftowson.com. There’s a free 30-day trial. Sign up. See if it works for you. Join the class. It’s I think we’re having fun. More and more people are joining. We’re sort of building out the content I think it’s going along quite well. Well, that’s my opinion. Okay, let’s get into the content. Now, SoGo has actually been around for quite a long time. It’s the number two search engine in China. People don’t really talk about it very much. Everyone talks about Baidu. But it’s a really important company and it’s been sort of behind the scenes and they’ve had an investment from Tencent for quite some time. So it’s been a big deal, particularly on mobile phones. I mean, the way you can think about this is, Baidu was sort of the search champion, very much a clone of Google in the first 10 years on PCs. But then when smartphones came along, they kind of missed the jump to smartphones. And smartphones are problematic for search. When you’re searching on a computer, when you’re searching on a browser, It’s a very natural thing to go to ByDoo.com or Google.com and type in what you’re looking for. And then you search the web and it pulls what it needs from various web pages. It’s basically like a big phone book at the simplest level. It’s a lot more complicated than that now, but it basically started out like a phone book. Okay, when you move to smartphones, one of the problems is you’re not really searching the web in a browser. What you tend to search, you tend to be in apps. And apps are like little walled gardens where the information within WeChat is different than the information in Taobao as two separate apps. So one search engine can’t really search both of those. So it kind of fragmented the search experience instead of searching all the webpages, a lot of the information’s in apps. And then it also… You don’t necessarily go to one app to search. Search sort of becomes something embedded within each app, as opposed to sort of the front door to get onto the internet, basically through a browser on your PC. So when you would go from PC to smartphone, search has always been sort of a problem. And Baidu didn’t really make the jump that well. You go back to 2010 when smartphones in China really started to take off. And I think that’s China, Asia, Southeast Asia. I mean, it is a smartphone first world. People don’t use PCs. It’s all about the phone, especially consumers. They didn’t make the jump that well. And back then it was kind of three companies, Alibaba, Baidu, Tencent, and they were all about the same size by market cap revenue. Search also didn’t really keep growing as a revenue model, which is what I wanna talk about today. So when these companies used to be kind of equivalent back then, they really aren’t anymore. I mean, Alibaba and Tencent are so much larger than Baidu that for the most part, Baidu can’t compete with them on a money basis like food delivery, iQiyi. These companies where iQiyi, which is a video streaming video site like a YouTube kind of, it’s a lot about who can spend more money on content. food deliveries, a lot about who can spend more money subsidizing delivery. And Baidu has really had to exit most of those businesses because they simply couldn’t compete financially with Alibaba and Tencent anymore. And all of those businesses were loss makers and they’ve pretty much exited all of them, but iQiyi, which they still are involved in. So when you look at the history of Sogo, I mean, it’s a search engine, founded 2005, although sometimes you read it’s found in 2003, people say different, but basically part of Sohu, which was like, it was your typical web portal from the early 2000s, like yahoo.com. You go there, they have news, sports, search, all of that. And you know, that’s kind of where Google got started as well, that they were the sort of contracted search engine for Yahoo as a portal. Well, within this portal business, Sohu, obviously they created a search engine. PC-based, sort of develops over time. 2013 Tencent invests and basically starts to combine with them to handle their search functions within Tencent’s ecosystem, which we’ll talk about. 2017 Sogo goes public, we can see their financials. Tencent is the major shareholder, but still a minority position. And then in the last couple of weeks. They have about 39% of the company now. Last couple weeks they’ve said, we’re gonna basically take private, buy the whole thing, and I’ll talk about why they’re doing that. But the summary, it’s a search engine, basically the number two search engine in China on smartphones, which is an important distinction. Huge numbers of monthly average users. Some people say top four, top five. I don’t really ever believe these numbers very much. Let’s say it’s comfortably in the top five to 10 in terms of monthly average users, daily active users. Search Engine, let’s say 20% market share. Again, you gotta take all that stuff with a big grain of salt, but it’s clearly in the top tier. All right, what do they do? Various products and services. Their core product is SoGo Search. which is sort of a general search, and that’s an important term, general search. That’s their core product. You know, it puts it into lots of things, type in a question, find a hotel, whatever. What do users want? You know, you pull their 10K, what are you gonna see? They’re gonna say users want relevant, high quality and comprehensive information. Those are important words to keep in mind. Tends to be the default search engine for a lot of 10 cent stuff. So qq.com as well as sohu.com, the mobile qq browser, the SoGo browser. So obviously Tencent is putting, one it’s part of Sohu, but also Tencent has been putting this as the default search engine in a lot of their stuff over the years. That’s why they’re doing it. Tencent is really not a search engine business itself. Search is a very complicated business. I should do a class on search just because it is a whole world in itself. It’s actually very interesting and it’s very complicated. But when you start to take apart the business model of a search engine, it’s like going down the rabbit hole. It’s an entirely different world. It’s really interesting. So anyway, it’s basic search engine. Once you start to do search, let’s say their general search product is the core for them. that immediately tees up things you have to do as a company. You have to start doing translation because the search engine, which is basically a two-sided platform business model, one side of the platform, all the web pages, the other side of the platform, the consumers or whoever’s searching, so two user groups, but a lot of those web pages are not gonna be, and in this case in Chinese, they’re gonna be in different language. So it gets you into the translation business, you have to do it. mobile search, that sort of PC and mobile base, but then it starts to get you into the things like the Q&A business, where a lot of times people don’t type in a question like hotel in Chiang Mai, they put in a more direct inquiry like what is the best way to get from downtown Chiang Mai to I know Lampang or somewhere? Or what is the best medical treatment for this? Well, that’s a very almost professional level question. So it starts to get you into the Q&A business, which is a lot of like Juhu or Quora. So it kind of pushes you into that type of business as well. And it immediately starts to push you into what we call multimodal inputs. Because a lot of search was based on searching text on web pages, that’s where it began. then it became searching text on a smartphone. But very quickly it becomes, well, what about stuff that’s not text? What about images? Can I search for an image? Well, that gets you into the computer vision business and the AI business. What about searching for spoken language? That gets you into speech to text and natural language processing. So you start to get into text, images, sound, voice, music. Suddenly… You know, your search engine has to do a lot more than just scour webpages for words in text form. Audio response, things like that. So even the core business starts to move in these funny directions. And then they have what we call vertical search services, which are sort of specialized areas like healthcare search. Now that’s a very different animal than just general search. If you’re searching healthcare questions… you’re gonna start to have collaborations with doctors, with hospitals, with medical information providers, because the questions are more difficult. English search, which SoGo offers English search. Well, they’re gonna have a partnership. In this case, they have a partnership with Bing.com. Cross language search, they have a deal with Jihoo Q&A. Encyclopedia business, image search, video search, image search. It kind of gets you into a lot of these other businesses by necessity. And then they have a browser. So I mean, these are not unlike the questions that Baidu and Google are dealing with. All these companies tend to be getting pushed into same directions in terms of the products they offer and the types of texts they have to really pioneer. There’s a reason why Baidu is big into AI, because it had to go there. It’s obvious why they’re in computer vision. because they have to do computer vision search, why Google offers Google Translate, because it has to be able to search all the world’s websites regardless of what language they’re in. So it’s kind of a really fascinating business when you start taking it apart. So if we look at the financials for SoGo, I mean, they’re pretty basic, not hard to understand at all. The revenue is fine. They’ve been slowly moving up $300 million revenue. 2014, 15 is 500 million more or less. By 2018, they’re at a billion dollars in revenue. I mean, it’s just generally stepping up, stepping up, stepping up. Their gross margins, their sort of gross profits, roughly about 40% off that, which is quite nice. And this revenue is all advertising-based. I mean, there’s not much else here going on. They’ve got a little other revenue, but it’s all ad-based. 40% gross profits overall, they’re spending about 20% on R&D, about 15% on sales and marketing. And you know, so overall they end up with about 10% net profit, more or less. And it’s fine. I mean, it’s just a pure digital business. And you know, the economics are nothing like the Alibaba economics. They’re nothing like the Tencent economics. I mean, we’re not even close to that scale. We’re down at the billion dollars. Okay, fine. But the gross profits are good. And one of the benefits of being a search engine is we don’t see the massive sales and marketing expense that so many of these digital companies have to do because they are dependent on getting users all the time. Please come to my hotel site, Ctrip. Please come to my food delivery site. They don’t have that because they are all sort of, by definition, they are the front end of the whole consumer experience. You know, it’s like WeChat. I mean, the very first engagement with a consumer is really either messaging or search. They are kind of the gatekeepers in a lot of stuff. They do spend on their sales and marketing, but it’s nothing like we see in other places. And it also helps if you’re sort of trying to be the front door to consumers. It also helps if your strategic partner is Tencent, because they have WeChat and all the others. So between the two of them, they are really in an unbelievably good position. You look at their cash flow and things and it’s fine. $150 million per year. Some years 180, some years 140, but you know, cash flow positive and… Then they’re basically doing some financing. They went public, they raised some money, and they’re putting a lot of money in sort of CapEx and R&D and things like that. So sort of investing for the future. But yeah, I mean, it’s a fine, it’s a very easy company to value, unlike these other digital companies we talk about. It’s pretty straightforward. Now, if you kind of look at what they’re working on tech wise, it’s a long, long list of tech investments. It is really pretty interesting, you know. Search engines start with this idea of being a web crawler. You send out, you search every web page, you scan them, you pull text, and then you rank them based on connections, and that gets you search engine results. And of course the problem is the web keeps getting bigger and bigger, the number of pages keeps changing, it keeps updating all the time, so it’s always doing this. It’s a massive business. Like Google, if you actually look at the number of engineers that work on search at Google, it’s stunning. You know, it’s a really specialized business and they’re building out AI, which I mentioned, how do things relate to each other? Speech technology, computer vision, machine translation, dialogue systems, natural language processing, this idea of going from information to knowledge. That, you know, a lot of search has been kind of stupid where they just sort of tell you, I want to learn about hotpot in guanjo and then they give you information on hotpot But it’s not real knowledge and expertise. They’re connecting you with or providing they’re just kind of doing the matching But you know this idea of search going from something that’s just a matching system like a phonebook To something that more has has knowledge and information and can answer your questions directly itself whether it’s done by typing, speaking, whatever. So there’s this kind of interesting idea of going from information to knowledge, a lot of data apps. I mean, it’s just massive. There are employees, about 3000, and this is kind of like Google. If you break down the employees and then you look at what are they really doing, 78% are in R&D. I mean, that’s really kind of interesting. That tells you what business they’re in. This is not 50% of people in sales and marketing or manufacturing. 70 to 80% of all their people are just doing research and development. And about 40% of their people have a PhD or a master’s. So there’s an enormous amount of brain power in this type of company. And there’s also some pretty interesting business model questions because Search is not like a standalone thing where you go to order dinner and it gets delivered. Search, it kind of extends itself outward into lots of other sites and programs. I mean, you go into any random site and there might be a little box for a search, and it’s probably going to be powered by a SoGo or a Baidu or something like that. So they kind of naturally build out these landing points throughout the web. Obviously the partner here that matters is Tencent, hence the deal we’re talking about. It’s been their largest shareholder for a while. They’re the default general search engine for a lot of Tencent products, QQ, mobile, qq.com. 30-40% of all their searches are coming directly from Tencent, and it’s not like you click over. It’s embedded in the page. Now they do have something which is what everybody wants is they’re kind of one of the search engines within WeChat, because everybody wants to be on WeChat. They can search the WeChat official accounts. You know, they’re kind of matched within the ecosystem. Now they did this by a deal, because Tencent is a minority owner up until recently, but there was an agreement that was going through 2023 that they were the default search engine. And there’s a lot of collaboration on data and all this stuff. had another couple years to go, but now they’ve bought them. Now I was at the WeChat Open Class, which was in January, right before China shut down. I was in Guangzhou at their big event. I got out literally days before China closed down. And one of the things we were talking about with them was search, where are they going with search? And what they kept bringing up over and over, this is public knowledge, it’s nothing private, was mini programs. Yes, you can search within WeChat and that’s nice. And you can search the official accounts. So whatever these various companies are putting up, Hewlett Packard, all their official pages. But the big initiative within WeChat is mini programs that we are gonna build all these companies within WeChat. This is gonna be their home, their mini program. It’s gonna be a commercial site, an e-commerce platform. In theory, SoGo can search all the information across all of the mini programs, which would in theory let them do what no one has been able to do yet. I mean, as I kind of started out by saying, the big problem with search on a smartphone is you can’t search everything. You have to go app by app by app. All the information is walled off and you can’t search within every app like you can on a PC. However, within many programs within WeChat, if SoGo is the default search engine and they get permission to search all the many programs within that, they will have really probably the most comprehensive view of what’s happening information and data-wise on smartphones. Now, in theory, Android has this and whatever, but that’s why kind of many programs plus search was a really interesting idea about six months ago. and now bam, they buy SoGo and they’re taking it over. Is it related? I think it probably is. And that’s really kind of what I wanted to say about SoGo today, but before I transition, I’ll kind of make one point, which is, what’s interesting in all of this digital stuff is how much work is being done and how much value is being created for the user, which in this case could be people doing searches, or it could be the apps, the mini programs, the web pages. how much value these companies are creating versus how much value they’re extracting. Cause look at all the stuff I just said SoGo was doing. It’s all amazing, machine translation, computer vision, you know, all of that. But their revenue is about a billion dollars per year. That is a tiny fraction of the value that they’re creating. And that’s gonna kind of transition us to this next topic, which is digital economics. and this idea of how you can create so much value for consumers, which we would put under the term willingness to pay, which is what someone would be willing to pay for something, versus the actual price and the difference we call the consumer surplus. And a company like Sogo and Baidu and Google, I mean, the consumer surplus they are giving to us for free, beyond what we pay, is so ridiculously large. I mean, it’s really kind of amazing. Whether it’s Baidu or Sogo or Google, if you’re a regular consumer, think of what they’re giving you for free. Think of how much you’d be willing to pay for everything Google gives you. I’d be willing to pay. I can get all the knowledge of the human race through all of human history on my phone, any time of day. I would be willing to pay a lot for that. Oh, and by the way, it’s free, so the price is zero. So the consumer surplus, I don’t even know what that is. I mean, it’s ridiculous. Digital lets you do that in a way that no physical good ever could. So let’s switch over to information, digital economics, and why they’re so interesting. Now when we look at information economics, digital economics, the standard short list, which you absolutely need to sort of know, there’s not 50 things you have to know, but there’s like 7 to 10 you really do have to understand. And I’ll keep repeating them over and over in these courses so you’ll get it eventually if you don’t. But here’s the list. Zero marginal production costs, non-rivalry, versioning and pricing, bundling and cross-selling, willingness to pay in consumer surplus, compliments. That’s a very standard list. There’s others people would put under here like network effects and switching costs, but I put those into something else. Not gonna talk about those today. I’m going to go through each of these and sort of focus on the ones I haven’t talked about before. All of this goes under Learning Goal 29, Digital Economics. So you can always go there if you ever want to repeat, review, or whatever. Now everything I’m going to talk about has been around in business for a long, long time. None of this is new. It’s just that as things move from physical products and services to digital, things made of information, things made of bits and bytes, ones and zeros, some of these things became very, very powerful. And they started to change the economics of various businesses. When newspapers were printed on paper and put in trucks and delivered, they had one type of economics. when you move them to bits and bytes on a phone or a computer screen, the economics totally changed. That was a complete transfer because the old way went away. In most cases, what happens, we see a mixing. We see a mix of things that used to be one way, like retail. We put stuff on shelves, physical products in the stores, and it started to become online e-commerce 2003-2005. Okay. Definitely we have the digital aspect, the e-commerce site, the ordering, but a lot of it stayed physical because it was still a physical product that had to be shipped in a FedEx package or whatever. So in most cases we’re seeing a mix of traditional economics and sort of digital economics in the industry. Now, one of the things people talk about a lot is you know, you go back to Schumpender and the phrase he would use is combinatorial innovation, which is this idea of why do things innovate, why do things disrupt, and innovation, first of all, it tends to be combinatorial. That’s his term, combinatorial innovation, or he used it, I don’t know who came up with it originally. That it’s not about some new thing, it’s about putting things together in new ways. So we take a mechanical part from a factory, like a and we put those two things together in a new way and we get a new type of thing. So it’s taking various standardized and established tools and putting them together in combinations. We get a lot of innovation. And the argument is this is why innovation tends to happen in waves. It tends to happen in clusters where you could point to the 1850s to 1900. We had a wave of combinatorial innovation based on mechanical parts that as people built big factories for the first time certain parts of those factories which were mechanical became standardized you know here’s a i don’t know what you’d call it a drive shaft here’s an engine here’s a press here’s a steam engine here’s a crowbar as those things became standardized people started to put them together in different ways and there was just a We saw the same thing again when we moved to electronic parts. Well, one we saw with engines. Once people figured out engines, suddenly it was cars to motorcycles to airplanes, bam, bam, bam, bam. Later on, we saw it with electronic parts, transistors, semiconductors. Once there were enough of the parts together, we saw this sort of Cambrian explosion of innovation, people putting together the parts. So that would be kind of the same idea of a combinatorial innovation wave. happening in mechanical parts and then happening in electronic parts. So the argument is we’re seeing that now, but with digital parts, with standardized digital components, like packets of information, bits of open source software that I can start to put together. Oh, here’s a new AI tool that is now free or licensable by everybody. Here is a Word document, I can use that. Here is a search engine. You can start to put together these parts in the same way, but the difference is it’s just much faster and much more powerful because it’s so easy to put together digital components. I mean, I can literally do it on my laptop. I can write something with a text, I can use a tool, put in a JPEG, I can… record into a microphone, I can put in an audio file, I can turn it into a mini app, I can put it in, I can do all of that, just mixing and matching various sort of standardized digital components. So the argument is, that’s kind of the demand side argument for this current sort of wave of combinatorial innovation. Now, another argument you get, these are not my arguments, I’m paraphrasing other people’s thinking. The other one is sort of the supply side version of that, that when enough tools are in place, you start to see people create the same thing. So, you know, the telephone was not just created by Thomas Edison. I mean, he beat another guy by like two weeks. You know, it was, he filed the patent something like 12 days before someone else figured it out. And the airplane, the Wright brothers, people figured that one out. I mean, Once enough tools are in place, you tend to see the same inventions pop up from all over the place. So that’s the same idea, but it’s coming from the supply side rather than say the demand side. And here’s the point of this. Another explanation you often hear is, look, this is really about compliments, which is one of the six ideas for today. It’s really about once you get enough compliments in place, you can start to put them together on a smartphone, or… games on a streaming platform or you know any of these enterprise SaaS software things, those are all complements to a larger ERP system. You can start to put all these things together. So they would argue like the language shouldn’t be this component language. What we’re really talking about is once you get enough complements in place you can start to put all this stuff together. And compliments can be everything from, hey, look at all these apps in the app store. They’re all compliments to my purchase of a smartphone. They can also be physical. Before you can do electric cars, you have to have electric charging stations all over the place. So Elon Musk is trying to build those. Those would be a compliment. You have to have roads. Well, we already have roads. But the car doesn’t do you any good unless you have the compliments in place. One of the reasons cars took off originally, gasoline cars, was because the roads were already there for horses and bicycles, and your average grocery store already sold gasoline because people would use that for generators. So cars were a natural thing. Railroads, complements would be things like little towns that sprung up on the railroad. Compliments to things like the electrical grid would be appliances in your house So you can you can look at any of this by the complement framework Which is what I’m going to talk about or you can look at it by my parts and combinatorial innovation But it’s the same phenomenon We’ve seen at least three times now the digital one the electronic one and the mechanical one We’ve seen several of these in the last couple hundred years that are really kind of amazing and we’re in the midst of one Right now so that’s my tea up to this And you can also sort of think about complements as an indirect network effect, depending how you want to define all this stuff. OK. So a couple of the ideas. First idea is, well, let me just mention one, but I’m not going to go into it. In the last digital economics lecture, which was under, I can give you the name, it was under podcast 15. which was learning goal number one review, which is why are things free on the internet? That was podcast 15. I talked about some of the basic stuff and also podcast seven. That was it. I talked about then zero marginal costs that when you make the first ebook, it costs you a lot of money, but when you make the second ebook, it doesn’t cost you anything. Doesn’t matter if it’s an Avengers movie for 200 million or some little article or podcast. where the first one costs you time or effort or difficulty, but the second version is just copy paste zero. That’s a unique thing about digital. And one of the common situations you see is zero marginal production cost plus a fixed cost often to maintain the platform. Very common for a digital technology company like a Sogo. to have a very fixed cost to maintain the service, the platform, but every additional user doesn’t cost you anything. And then oftentimes you will also see an upfront cost as well. So it’s usually like big or small upfront cost, baseline fixed cost, zero marginal production cost. That’s a very common picture for a tech company. Sometimes you don’t have the upfront cost, sometimes you do. Now, I’m not going to go through that stuff again. I’m going to skip right to the next one, which is versioning and pricing. Now, the previous podcast on this, the question I raised was, why are things free on the internet? Because, you know, all this economic stuff is great. Look at all we can make all this money. That’s true. But if that’s true, why is everything free? And the vast majority of software companies go bust or make no money. All those apps on your phone? calculator app, the phone, you know, the alarm clock app, none of them are making any money. Well, the economics that can make you into Bill Gates, he’s a digital economics billionaire, also create a big problem with pricing. Because if the standard way of thinking about pricing is you should price based on the marginal cost. If it takes me one, let’s say 50 cents to make the next bottle of Coca-Cola, I should sell that for 75. You base your pricing on the marginal cost. But I just said the marginal cost was zero. So how do you do it? I mean, you can’t base it on marginal cost. That simply won’t work. So cost-based pricing, forget it. You can almost never do that. The other way people tend to price things is they price based on competition. Okay, the other companies charging 70 cents will charge 65. But again, if this doesn’t cost anything, everyone’s just gonna compete themselves down to zero on the marginal cost. Now you could argue, well, there’s an upfront cost. We had to spend a lot of money to build this, you know, first version of Avengers or this first ebook, but those are sunk costs. Once you’ve already spent it, people just, they tend to price on the marginal cost anyways. So the standard answer is how do you price digital goods? Well, you price on the quote, perceived value to the customer. Forget the cost. Price on what you think people will value this as, i.e. the willingness to pay, right? The willingness to buy. This is the value to the consumer, and then we price below that to some degree, and that gives us the consumer surplus. The difference between the willingness to pay, willingness to pay, and the actual price is the consumer surplus. So it’s somewhere under there. But okay How do we price because You know this podcast might be worth nothing to some people But it might be worth a heck of a lot to someone if you have to write a paper for your boss in Three days about information economics. I could probably charge you for this The problem is what something is valuable in the perception of the customer changes all over the place. So how do you price? well Hence, versioning. Hence, we try and charge people different prices based on what we think they’re willing to pay, and we try and take that pretty far. So the most extreme version of that, we would call the market of one pricing. The quote unquote market of one, where we literally price a product, whether it’s a digital good or a physical good with a digital component, we price it specifically for each individual user. People call that mass customization, they call it market of one pricing. That’s a very extreme version. We don’t see a lot of that today, but people are kind of doing that more and more. It tends to make people kind of angry when you learned out that your friend got charged different for the hotel reservation you just booked. Or you go to a concert and the person next to you paid half the price you’re paying for the concert ticket. That kind of makes people mad, but this move toward mass customization, market of one pricing is definitely happening. What is more common is versioning, which is second degree price discrimination, where we create multiple versions of the same product and then each one is priced differently and then the customer sort of self-select against those various types of prices or features. So, hardcover versus paperback books. Same exact thing. The only thing we’re changing is really when it is released. Well, one has a hardcover, one has a paperback cover. But really the difference is when it’s released. Hardcovers get released first. People who really want the new Harry Potter book will buy it immediately because they want it today. And they call it a hardcover, but it’s really about timing of release. And then other people wait six months and they buy it, and you price those differently and the customers self-segment themselves. Fine. And you can vary lots and lots of features to create different versions of digital goods. It turns out this is quite easy. Pretty much everybody does it. Delay, people pay more for new releases. Current information, here’s the latest stock trades. You have to pay for this. Everyone else has to wait six hours. Traders tend to pay more. Convenience, you can restrict the time or location or the amount of information a customer can access. how long you’re on the internet, where you can do it. You can watch Netflix on one device versus five devices. Comprehensiveness, you go on the New York Times. You pay one price, you can access all of their back catalog. You pay for the free version or the low-priced version, you only get to see today’s version. I’m kind of basically doing the same thing. I’ve built about forty-two hours worth of lectures and about four hundred The vast majority of those are only gonna be available to members and then I’ll offer some stuff for free or less price but generally most of my content is gonna go under that and the learning and the progress is gonna be based on that. I’m kinda doing that. Manipulation, some people you can store the data, you can copy it, you can print it, other information you’re not allowed to do that. Community, some members get access to a forum. You can chat about this stuff. I will probably do that at some point the members will have our own community where we talk about this stuff Not available to everybody else Annoyance you can turn off Advertisements or turn them on YouTube is pushing this sign up for YouTube red. I think they still put ads in there. I Don’t know free YouTube has got ads the other version doesn’t Speed some software runs quicker Data processing functions if you do your taxes on Intuit or whatever. A lot of the functions are paywall, a lot of the functions are free. Image resolution. Have you ever noticed if you buy a photo? Flickr, Stockphoto, iPhoto, Getty Images. The higher quality versions which you would use for a print version cost more than the free versions you might or the low cost versions you might put in a blog or online. support desk. Some people get to call the support desk, some don’t. So you can vary the features all over the place. You create three, four, five versions of a product. If you create 20, it gets annoying. Three, four, five, you price them differently and then your customers self-segment themselves. That’s a pretty common situation. But we would put all of that under second degree price discrimination. The world is really moving towards mass customization market of one pricing. But that’s, you know, that’s kind of a big idea. You got to understand versioning and pricing of digital goods. Because even if we’re talking about traditional goods, services, physical products, more and more of those goods are being paired with a digital offering like Nike, which I’ve talked about a couple of times now. is you know you buy your shoes on Nike but you can also go on the Nike Running Club which is an app you can download which is fantastic by the way and you can exercise together as part of a community and a lot of it’s free and some of its payroll then it ties to the physical product so all of this is kind of coming together under versioning and this sort of digital pricing so you kind of got to understand this stuff it’s all over the place. So next topic is bundling this would be Now it’s on the list of six to know about. I’ve talked about this a little bit before. Bundling, I mean it’s been around forever. You go into the drug store and there’s the shampoo bottle and then there’s the conditioner bottle and then there’s one package which is shampoo plus conditioner for one price. So basically any time you take two goods, which could be products or services, or more than two, and you sell them for one price. Simple, been around forever. And… The economics of this are surprisingly powerful. You would think this would not be a big deal, but it actually makes a big difference. Basically because it kind of benefits the buyer and the seller. It’s really about willingness to pay. I am willing to pay a certain amount for shampoo. Let’s say $4. I’m not really as willing to pay for conditioner. My hair stinks anyways. $1, $2. Let’s say most people it’s closer to $3. So my willingness to pay for shampoo is $3, my willingness to pay for conditioner is $4. So if you price both of these things at $4, I buy the shampoo but not the conditioner, no sale, or $3.50, no sale. If you put it together and you bundle the whole thing for $5, and therefore my willingness to pay is $4 plus $3, which is $7. Well, suddenly it’s underneath, you know, the price is underneath my willingness to pay for both together, and I end up buying. So what happens is the people who sell shampoo into conditioner actually make more money than they would otherwise, and the consumer actually does really well because it basically expands my consumer surplus. If the shampoo is $3.50, and my willingness to pay is four, my consumer surplus is 50 cents. I don’t buy the conditioner because it’s overpriced in my view, but once we put it together and suddenly it’s $5 versus seven, my consumer surplus is actually expanded to two. So the buyers and the consumers, I’m sorry, the sellers and the buyers both win when you bundle effectively. We’ve seen this forever. The cable people have been doing this for decades, where they bundle 200 TV shows together. The vast majority of it, it’s not that we don’t want to watch them, it’s just that our willingness to pay for them is quite low. But when you bundle it all together, it works out fine. So the cable package is actually a tremendous deal for both sides. And, you know, when we take this into the digital world, what happens is we realize, oh, it’s really easy to bundle stuff. We can bundle pretty much anything when it’s digital. I can put this movie with that movie. I can take a thousand movies, put them together, and sell the whole thing to you for $4.32 a month, which is Netflix. If you order it in Bogota like I did, if you get it other places, it’s like $9 to $10. It’s a massive bundle. It’s really easy to bundle digital goods. And even if you don’t want to do digital goods, let’s say you’re Alibaba, what they have been doing is, let’s say Amazon. You go on Amazon, you’re going to buy a book, a physical book, you’re going to buy shampoo, something physical. It will immediately show you an alternative option that’s a bundle. So you can bundle physical products in endless combinations online because the purchasing aspect is done online digitally. You can’t do that within a store. You can’t offer 10,000 different bundles to people in a drug store. You can do that on Amazon. It’ll just start bundling them with the algorithm and offer you combinations, and you might buy one. You can bundle services. That’s why you go on C-Trippy, you go on Expedia, the first, and you book for a flight. The first thing they’ll try and do is bundle it with a hotel. So you can do that bundling aspect online. And now what? Alibaba is doing, which Amazon I don’t think they’re doing, is they’re starting to bundle products plus services. So when you buy makeup at your local in-time department store, which is an Alibaba department store, they’ll say, we will ship this to you down the street in an hour, two hours, would you like someone to come and apply your makeup or cut your hair with you? And they’ll bundle local services plus products. So it’s getting really interesting. this bundling aspect, not just the digital goods, but the physical products as well as services and suddenly you can maybe bundle them all together. Here’s a membership for an Alibaba VIP membership. You can get a discount on renting bicycles because they have Hello Bike plus movie tickets plus online streaming plus things you order the delivery fee. They can start bundling this stuff all the way around the place. And we can start doing what we just talked about, which is versioning and pricing, where in theory we could do mass customizations, where you could get a series of bundles that are totally specific to you that no one else gets. The same way what you see online on Amazon or Alibaba is specific to you. The bundles you see could be specific to you. So pricing of one, market of one. So bundling’s a big, big deal. And people talk about that all the time. The part they don’t talk about as much is the competitive aspects of bundling. If you are just a shampoo maker, or you are just a physical sale of product website, like we sell lots of shampoos on site, or an e-commerce company, and Alibaba starts bundling products and services, you have to match what they’re doing. You know, if one company offers you the hotel and the flight, and you can only offer the hotel, you are at a competitive disadvantage. So when your competitor starts offering multiple product lines that you don’t offer and starts to bundle them, that puts you in a bad position. So a lot of digital online content people, they’re starting to bundle together various types of products and services. Okay, the last idea for today. We’re in the homestretch, so if you’re getting tired, wake up, this is the last bit. The last idea, last concept is compliments, which is super important. I mentioned it briefly before that, you know, compliments have always been around, ain’t nothing new, physical compliments are, this is a terrible example, but you know. hot dogs and hot dog buns or hamburgers and hamburger buns. It’s two products that tend to go together that sort of increase the value of the other product. Or you could say it’s part of one solution. Having, buying a bunch of hot dogs isn’t terribly good unless you have the buns and maybe the mustard. Those things are all compliments. And they tend to go up and down in sales together. And depending how you want to define it, you could say, well, the roads are compliments to, you know, cars because the cars aren’t as good without the roads and the appliances in your house are compliments to the electrical bill you pay. You’re, you know, the value to you, not what you pay, but the value to you tends to go up when there’s more things you connect to it. So kind of depends how far you want to take that line of thinking, because it can get kind of ridiculous after a while. But generally things tend to increase the value of each other. The product sales tend to go up and down together. If you drop the price of one, often you’ll get an increase in sales of both. If you’re selling something like hamburgers, which is a little more expensive hamburger meat, and you drop the price of the meat, you’re going to sell more meat, but you’re also going to sell more hamburger buns. Things like that. Now, how does this work? If you draw the supply and demand curves, this is terrible to explain on a podcast, the demand curve goes from the upper left to the lower right, the y-axis is price, the x-axis is quantity sold, which basically means as you drop the price you sell more. As you raise the price, as you move left on the curve you sell less as the price goes up. So it’s a downward sloping curve from the left to the right. Basically, and underneath that, whatever you sell is sort of the volume, the area underneath that, and then there’s a consumer surplus. When you add a complement to a product, what it does is it shifts the demand curve to the right. Or basically, even if you keep the same price, you’re going to sell more. Because it’s just more valuable to people. Doesn’t mean you’re charging them more. but the value to them goes up. So the more appliances you can buy at the Suning store, the more valuable your electricity becomes. Things like that. And there’s lots of examples, fertilizer and seeds. The fertilizer makes the seeds more valuable, blades and razors, train stops on the railroad, the more places you can stop. Again, you can take this sort of. as far as you want, and at a certain point, you can start describing this as an indirect network effect and maybe a platform. And hence, what I started with today, which is this idea of combinatorial innovation. When you start to get a lot of compliments and people start putting things all together in lots of combinations, the value goes up, there’s an explosion, blah, blah, blah. Okay. Without getting too much into that. When you start to talk digital compliments, all of this becomes 10 times more powerful because digital goods and services often, usually, have a zero marginal production cost. So it doesn’t cost you anything to give those away for free. So you can start to say, hey look, buy this smartphone. It’s a nice handset. This is the core product. It’s a smartphone. Oh, by the way, it comes with 200,000 free compliments, which is everything in the app store of free content you can get on Facebook once you sign up. Digital content. Dropbox. Box.com. Tons of free services. You can basically give away free compliments till the end of time if you’re making them yourselves is one thing, but if you’re doing it as a platform business model then other people are making compliments to your core product which is the platform. So it all gets ridiculous. your standard examples. The examples we’re seeing in China, Asia, which are cool, is because most things in the world are manufactured in China, Asia. Your refrigerator, your TV, your speakers, everything in your apartment that plugs into a wall probably came from Asia, probably China or Japan or Korea. As those dumb objects are becoming more digital and infused with software, you can start to add digital compliments to things like your refrigerator, your scooter, your moped. your car, your appliance, your, I don’t know, your air conditioner, your smart TV, everything, your shoes, your luggage can start to become smart. So we’re starting to make those things smart, i.e. smart and connected, which means software, and you can start loading them up with compliments, which is what’s kind of what’s happening right now. And then you add onto that a digital platform as a business model. That’s when not only are you adding compliments, other people make them for you. So this is sort of stepping up in power. Digital goods were powerful as compliments to begin with. Smart products that are adding digital compliments, that’s the next level. And then digital platforms, that’s even the next level. And it’s getting kind of crazy. And that’s where we are. So that’s kind of the last idea for today. I’m gonna let you go, cause this has been a lot of theory today. This all goes under learning goal 29, which is digital economics two. The main ideas I want you to take away, the main concepts, zero marginal, all under the banner of digital and information economics, zero marginal production costs, versioning and pricing, bundling, willingness to pay and consumer surplus and compliments. Those are kind of the ideas for today. Don’t worry about remembering it. It’s all in the show notes. For those of you who are members, it’s all online. It’s all laid out within your various levels of what you’re supposed to be learning week by week by week. And that’s where we are. Okay, I think I’ll let you go. It’s been a lot. But anyways, hopefully that’s helpful. It’s pretty fascinating stuff, I think, but I think all of this is fascinating. And yeah, I’m having a good time. I’m up in Chiang Mai and I’ve been reading a ton. I sort of stack up podcasts and books. Literally stack them up, either on my iPad or a stack in my room. every now and then I sort of go off to hide and read. So I have gone through like four books, three and a half books. And I don’t know how many podcasts in the last four days. It’s crazy. I’ve just been basically walking around, taking a scooter around, listening. And the problem is I always take notes. So I have to keep pulling over to tap notes into the phone and then get back on. So yeah, it’s been kind of a fun thing, but yeah, it’s great here. And I’m gonna go see some animals. That’s kind of my… I really do this a lot. I go to safaris in Africa and I hunt around Thailand and I just seem to be, I don’t know, I don’t want to say obsessed, that’s too strong of a word, but sort of, you know, elephants and tigers and I watch all these documentaries now. I never used to do this. It’s really been the last couple of years and I keep drawing analogies to business competition, which are marginally helpful. I do think it’s useful to think about nature as an ecosystem. like business as an ever-changing ecosystem. I think that is actually very very helpful. When you start trying to say, well this company’s a cheetah and this company’s a, you know, a hawk, well okay it’s probably getting a little silly. So that’s what I’m doing up here. I’m gonna traipse around the jungle for a couple days more, go see some elephants, go see some tigers, stuff like that, and then I’ll be back. And I promise the audio quality will be better next week. I know this microphone is not awesome. Sorry about that, but… That’s it from me, and anyways, hope this is helpful, and I will talk to everybody next week. Take care.

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