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Information Rules: A Strategic Guide to the Networked Economy

Author: Carl Shapiro, Hal R. Varian
Publisher: Boston, MA: Harvard Business School Press, 1999
Review Published: July 2002

 REVIEW 1: Edward Castronova

Carl Shapiro and Hal R. Varian's Information Rules: A Strategic Guide to the Networked Economy says something rather shocking about the Internet, namely, that it is not a particularly new or unique phenomenon. True, the Internet is an unprecedented form of human interaction. In terms of prices, incomes, and profits, however, the Internet adds nothing special. It is like a railroad or phone system, just faster, more extensive, and easier to use. As a result, old theories from the economics of information and networks can be applied to the Internet with minor modifications. The book does this with gusto, thinking of itself as a war manual for the cybercorp CEO: What Bell did with phones, you can do with Widgets Online. Be first to market, let customers switch to your product with ease, then lock them in and hold on. In its economic aspects, online society does not appear to be any different from Earth society, at least for the foreseeable future -- a point that is very useful to keep in mind for those interested in cyberculture in general.

To judge the book, I asked whether its lessons apply in my own area of Internet interest, massively-multiplayer online role-playing games (MMORPGs or just "Virtual Worlds") [1].

Here, game developers create an alternative world for people to navigate with their avatars. Unlike conventional avatar spaces and chat rooms, however, virtual worlds are incredibly unfriendly. Jungles by design, they are filled with biots (biological robots) who gobble up new avatars until they learn how to fight or flee. Virtual worlds are popular, with hundreds of thousands of avatars active online at any one time. They are also profitable, with several worlds now in heavy competition and many more ready to launch in the next few years.

What advice do Shapiro and Varian have for the producers of a new virtual world? First, they point out that the software that runs the world is an information good, costly to produce, but costless to reproduce. Such goods should be priced according to the value customers place on them, not the cost to produce a given unit. Think of CDs. Once Belle and Sebastian have made the music, the cost of making each CD copy of it is about one US dollar. You do not charge USD1.00, however. You charge USD15.00 because that's what people are willing to pay. Ideally, you would try to charge every person a different amount, since all people value things differently. Virtual worlds, it turns out, charge about USD10.00 on a monthly basis, meaning that those who like the game and play for a year pay USD120.00. Those who don't like it pay USD10.00 and quit.

Shapiro and Varian point out that the ease of copying information makes information owners nervous about the product slipping out of their hands, hence the interest in copyright protections. They argue that companies should focus less on copyright per se, and more on the bottom line. Sometimes, illegal copying helps profits. In virtual worlds, most companies have taken the position that the goods in these worlds (i.e. the "Sword of Retribution") cannot be sold from player to player for USD. Nonetheless, such selling is extremely active on Internet auction sites, and it clearly makes the games more popular with a large chunk of the player base. It also publicizes the game. The companies don't seem to be doing anything to stop it. Shapiro and Varian would probably judge the companies' inactivity as reasonable, from a profit perspective.

These are just two of the many lessons from the book that apply directly to the economics of virtual worlds. Among the others:

    Information is an experience good: you know its value only once you use it. Brand names and reputation matter. Correspondingly, game companies often offer the first month for free, and they are obsessive about their customer service operations.

    Communication media are network goods: you can build a social world with them, but only if everyone has the same software. The value of the software rises as more people use it, a thing called positive feedback. Correspondingly, game sellers pay close attention to the social aspect of the game, encouraging people to make friends in their world and keep them there.

    Information goods are often subject to high switching costs, and that creates lock-in. It would take me a long time to figure out the Mac world, so I stick with PCs, greatly to the benefit of Bill Gates. Correspondingly, game developers allow avatars to rise in power as they spend more time in the world. Want to switch to another world? Go ahead, but you will start out at Level 1 again, naked, in mortal fear of little rats and insects.

    Policy issues involving networks are the same as those that motivated the Sherman Act of 1890. Society should regulate monopoly if and only if it threatens the general well-being. It is not clear that the world is worse off from having MS Windows on 90 percent of the computers. Correspondingly, in the game arena, it is not clear that the buying and selling of game items hurts the game-playing community at large. Making good policy in these areas will be as difficult in the future as it has been in the past, requiring sophisticated assessments of the impacts of various choices on human well-being.

While the lessons that Shapiro and Varian discuss do apply quite handily to virtual worlds, there are important aspects of the phenomenon that their book and its analysis cannot engage or unpack in any useful way. They don't make much of the fact that identity is a slippery concept when taken online, nor ask what the implications may be for the economy. In virtual worlds, you can play avatars of any sex, race, or physical ability, and it is apparent that people switch all the time. I cannot predict what impact this anonymity (and possibly the erosion of gender, racial, and physical ability stereotypes) will have on the sales of various goods, but it will surely not be trivial. On a more fundamental level, economists view each consumer as a logical actor, with a rational and unchanging set of preferences. It will be interesting to see how useful this essentially positivist model can continue to be in an environment where every Self is fractured.

They also do not discuss the possibility that the Internet may radically change the nature of human society. In my own work, I noticed that many people spend more hours per week in virtual worlds than they do working for pay. They can make money in the virtual world too, and at a pretty decent pace too if they apply themselves. The Internet is becoming another place for people to live. What if large segments of the population start living in virtual worlds, making objects there, selling them for cash on Ebay to pay the rent and buy rahmen noodles? The measured GNP of earth nations will fall. We will call it a 'depression' and there will be political and social change. The consequences may be extraordinary.

Shapiro and Varian's Information Rules does not map out that economic future, but it does provide an accurate, useful, and accessible opening to thinking about it. It is a must-read for anyone doing analytical work on the evolution of society in the Internet age.

1. See Edward Castronova, "Virtual Worlds: A First-Hand Account of Market and Society on the Cyberian Frontier."

Edward Castronova:
Edward Castronova is an Associate Professor of Economics at Cal State Fullerton.  <ecastronova@Exchange.FULLERTON.EDU>

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