By Sandesh Trivedi, [email protected]
For value investors blindly shunning tech stocks they might want to read the book, Information Rules: A Strategic Guide to the Network Economy by Carl Shapiro and Hal Varian. Though the book might not help you catch the next Microsoft or Cisco or Amazon at a very early stage, it puts forth a very compelling argument that traditional economics still applies to the new economy. The book serves as a handbook to analyze the basic economics of tech businesses, and also whether they have any competitive advantages which might enable them to generate above average returns. The book might not make you an expert in the tech industry, but at least help you navigate successfully analyzing tech stocks. As the author mentioned in the beginning of this book, this book is seeking models, concepts, and analysis, which will provide reader with a deeper understanding of the fundamental principles in today’s high-tech industries.
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According to the authors the traditional laws of economics are still very much applicable to the tech businesses. To drive home their point, they cite similarities between the evolution of railroads, telephone and tech industries. Essentially the authors try to convey that traditional concepts like economies of scale and network effects are hardly unique to information economy, and fundamental principles of economics are relevant in an information economy too. In fact many information goods businesses have huge fixed costs in such as high R&D, and infrastructure costs in the case of telecommunications systems. Information is costly to produce but inexpensive to reproduce because some tech businesses have high fixed cost and low marginal costs. If a company lays fiber optic cable, buys switches and puts on a telecommunications system which are all fixed costs, after that it costs next to nothing for signals to be sent. One of the properties peculiar to information technology businesses is that they are subject to large increasing returns to scale on both the supply and demand side. Market outcomes in these markets tend to be concentrated and require standardization.
Traditional manufacturing industries had supply side economies of scale but often it ran into natural limits on the supply side, whereas a business like Microsoft not only has supply side economies of scale but it maintains absolute dominance is because of the demand side economies of scale. Microsoft’s customers value its operating systems because they are widely used and are the de facto industry standard. Unlike the supply side economies of scale, demand side economies of scale don’t dissipate when the market gets large enough. In fact it becomes a winner-take-all market. For investors willing to evolve and learn more about the economics of tech business this is a must read book.
To purchase the book on Amazon.com click on the following link Information Rules: A Strategic Guide to the Network Economy