Jan. 1, 2012 at 1:43pm with 12 notes
It’s a numbers game

There’s a lot of talk online about how to make business on the web work. Can one sell work (by “work” I here mean anything ranging from songs to articles to books) online without using the middle men? The usual answer is “yes,” and people like Radiohead or Louis CK or Neil Gaiman are given as examples. Inevitably, the argument is then extended so show that “sharing” of work really is no problem (the counter-argument is that “piracy” destroys business). 

I want to believe in the internet being able to work that way, but I yet have to be convinced. First of all, here’s the problem with almost all of the successful cases: They are all very well-known people (think of them as “brands” if you will). The first problem is that there is a selection bias at work here: Since these people are famous they will inevitably get a lot of press. In contrast, folk singer Nancy Smith who tried to sell her album online and sold ten copies is hardly going to make it into the news (this is a hypothetical example, I don’t know whether there is such a folk singer, but you get the idea). 

The second problem with these examples is the following. Imagine one million people know you and like what you do. Now imagine you’re trying to sell something for, let’s say, $10. We all know that not all of the one million people will pay $10. Instead, a fraction of people will do it. I have no idea what the fraction is, but even if we take 1% that’s still 10,000 people - and you end up with $100,000.

But now let’s assume 10,000 people know you and like what you do. Play the same game. Let’s try to sell something for $10. If we take the same fraction, 1%, that’s 100 people, giving you a total of $1,000. 

Let’s not focus on whether 1% of your fans will give you money or 10%. Let’s instead focus on scale: It’s much easier to make considerable money online if you have a well-known brand. None of the debates about selling something online to make money has taken this very important point into consideration. It’s almost as if people believe that the same rules apply to Radiohead and to Nancy Smith. And in a sense, they do. But there’s a huge difference between $100,000 and $1,000 - you can’t run a business with $1,000. And if you can’t run a business with $1,000 that means you’ll have to do other stuff on the side, which, of course, is detrimental to the real business you want to be in (quality is likely to suffer).

Which leads to the next, somewhat related problem: Not all markets are the same. Let’s focus on just one aspect here, namely audience size (the above example assumes that Radiohead and Nancy Smith have the same target audience - if you disagree simply replace Nancy Smith with whatever unknown band is trying to compete with Radiohead). If you’re interested in politics, celebrities, or cute animals, say, you don’t have to worry about audience size. There are millions of people online who look for that stuff.

If you are interested in, let’s say, Arthur Honegger or conceptual fine-art photography, it’s a very different game. It’s probably very fair to say that way less people are interested in Arthur Honegger than in cute animals. So when you’re trying to sell something you’ve written about Arthur Honegger, you’re already starting out with a vastly smaller number of possible customers. Add to that the fact that only a fraction of those people will give you money, and you’re basically in trouble.

I don’t have the answers for how all of this can or might work. But one thing is very obvious and really needs to be addressed when talking about business online: Scale. The vastly smaller size of people interested in anything that’s not consumed by millions of people produces a huge problem for those people who might want to try to have a business online. 

A good way to look at this is to do a little math (the following is inspired by the Drake Equation). What you need to find out is the base number of people, B, who will give you money. B is the product of three other quantities:

B = M*fA*fp

Here, M is the market size (let’s say the number of people who are interested in Arthur Honegger or the number of people who listen to pop music or are interested in watching videos of cute animals or whatever else).

fA is the fraction of people you actually reach (think of them as your fans or your subscribers or whatever else). Of course, you always want to maximize fA - you want to reach as large a fraction of the market as possible.

fp is the fraction of the people you reach who will be happy to buy something from you. fp is the great unknown, with guesses and examples all over the place. 

Let’s do an example. Let’s say your market size is 1,000,000 people. Let’s say 10% of them are fans of you. And let’s say 10% will buy something from you. That yields:

B = 1,000,000 * 0.1 * 0.1 = 10,000

So you have 10,000 people who will buy something from you.

In all likelihood, most people would love to run the game in a different way. Let’s play the 1,000 true fans game. So you’d have B = 1,000. If your market size M again is 1,000,000 people it’s easy to see how you can make the equation work easily:

1,000 = 1,000,000 * fA * fp

What you get is fA * fp = 0.001. So if you want to assume, for example, that 10% of the people you reach will buy something from you, you only need to reach 1% of the total market. If you reach 10% of the total market, you need to convince only 1% of those people to buy something from you. Etc.

Now let’s assume the market size M = 50,000:

1,000 = 50,000 * fA * fp

That gives you fA * fp = 0.02. If you reach 10% of the total market, you now need to convince 20% of those people to buy something from you. That’s a different game.

This is also why debates about online piracy (file sharing, call it whatever you want to call it) often miss the point: If your B is very large, piracy is not going to harm your business since you’re making very good money - and you can then tell everybody how you’re not worried about it. What’s happening is that essentially, you might make a little less money than you would if there was no piracy, but you can convince yourself that piracy makes more people buy your stuff (you can always find a study to back this up).

However, if your B is very small, piracy can pose a tremendous problem: Look at the last example: If you need to convince 20% of the people to buy something from you, piracy could easily pose a huge problem for you (you can always find a study to back this up).

The above also show easily why many simple ad models for websites are flawed: If you have 1,000,000 visitors to your website you can make thousands of dollars with ads where you get a few bucks per 1,000 views. But if you have only 10,000 visitors, the same ad model will give you tens of dollars. (Someone told me people are now moving away from such simple models precisely for this reason)

My current feeling is that small businesses in niche markets might not be sustainable online: The size of the target audience is so small that even if you are able to get a large fraction of them to give you money, you’re not making enough money to sustain your business.

A side effect of this problem is that the smaller your target audience, the more time you have to spend on doing PR to reach as many people as possible. Which means that niche markets with small target audiences suffer from PR overload way more than large markets (something we can clearly see in fine-art photography already!).

The main result of this is likely to be the following: For large target audiences, there will be a real, viable economy online. The sizes of people involved alone mean that a business can be built easily, because even reaching small fractions of people already results in considerable income.

For small target audiences, a real, viable economy online does not exist. People will either have to make most of their income in other ways (essentially, their online presence will be a loss for their business), or they’ll simply give up, leaving the field to organizations/corporations large and rich enough to be able to cover that niche, too. 

Which means that in terms of diversity, large markets will strive, whereas small markets will suffer: There will be a small number of offerings, most of them from major corporations, and the few independent contributors will be overworked, flooding the market with PR to get heard, while working at least one other job elsewhere to be able to get by.

  1. africanlens reblogged this from conscientious
  2. vastmachinery reblogged this from conscientious and added:
    Conscientious Redux: It’s...numbers game, by Jörg M. Colberg. Usually,
  3. conscientious posted this