When you act on what you hope your market will do, instead of what you predict your market will do – you’re in trouble.
This is a story about understanding your market, and an example of using game theory – specifically, the Nash Equilibrium in “non-cooperative game theory” to predict market responses to your products.
To sum up the particular idea I’m talking about – Mr. Murdoch has put the Times of London behind a pay-wall (you have to subscribe to access the content online), and removed the articles from Google’s search index. He did this because he believes that people accessing the content for free are “stealing it” and that the only way to make money in the news business online is by forcing people to pay for content. For more nuanced and deeper discussions of what Mr. Murdoch is doing, check out these articles from The Atlantic explaining what he’s attempting, the Editor & Times report of a 66% drop in traffic, Newser‘s investigative journalism of what’s happening inside the company, or Business Insider’s take on the matter.
My opinion is that Mr. Murdoch expects his market will respond the way he wants them to – by subscribing to the online version of the Times of London – in stark contrast both to pundit predictions and what professor Nash’s Nash Equilibrium model of non-cooperative gaming predicts will happen.
As results have finally started surfacing, they appear to completely support what game-theory would predict and utterly refute what Mr. Murdoch would have hoped for.
Game Theory for Predicting Market Behavior
I was enthralled by Scott Steven’s lecture series, Games People Play: Game Theory in Life, Business, and Beyond – a DVD set of a series of lectures from The Teaching Company [link goes to Amazon].
Understanding your market involves not only knowing what problems your customers face, but also predicting how your competitors will behave. Competitive analysis is not just capturing a snap-shot of their products and positioning today, but also forming predictions of how they will respond to the disruptions you will create in your market by innovating. Markets are not static – you have to understand both how your customers’ needs will evolve and how your competitor’s offerings will change, in order to understand how your product will perform.
One of the “games” in game theory is called The Coordination Game, and it is the one that captures Mr. Murdoch’s conundrum. The coordination piece of this game is in acknowledging that what you do (to pay-wall or not to pay-wall), and what your competitors do (pay-wall or not) are interdependent decisions, of which you only control your own decision.
You can’t (successfully) unilaterally decide what you are going to do, without taking into account what your competition is going to do. And vice-versa. That’s the part that makes it hard – there is a circular reference that has to be resolved. I suspect that’s the source of elegance in the Nash Equilibrium – he realized that there are “stable” and instable combinations of the decisions – yours, and your competitors.
The Pay-wall Coordination Game
Mr. Murdoch and “everyone else” (his competition for consumers of news) are both faced with a choice – should they allow free access to the articles, or not. Free access to articles can generate revenue by two mechanisms.
The first is one of the freemium business models – billing Peter to pay for Paul – charging money to advertisers for access to viewer’s attention.
The second mechanic is by leveraging word of mouth – people reading your free article, then encouraging others to read your other articles. This approach can either be used to get a percentage of people as paying customers (with a “leaky pay-wall” model that allows some free views, but encourages paid-subscriptions), or to get additional traffic that increases revenue from advertising. One way to maximize this approach is by making your product implicitly viral so that it promotes itself.
Alternately, Mr. Murdoch, or any of his competitors can create a pay-wall, where only paying subscribers will have access to the content. Presumably, certainly historically, a subscription model with the same level of readership – if that could be achieved – would generate more revenue for the publisher than either freemium model.
The crux is that we have tons of market data to show that “the same level of readership” simply will not happen.
There are four possible scenarios that can happen in this market –
- Both Mr. Murdoch and “everyone else” institute pay-walls, making all online content available only to paying subscribers.
- Mr. Murdoch erects a pay-wall, but everyone else continues to allow free access to content.
- Mr. Murdoch allows free access to content while everyone else erects pay-walls to prohibit access to content.
- No one erects a pay-wall, and free access is allowed to all content.
[Update 2010.07.21: Why "everyone?" See comment #2 below]
In scenario 1, assuming people don’t just stop reading online, everyone wins – everyone charges subscription prices, achieving the maximum amount of revenue. So why didn’t this happen? Because the decisions are interdependent, and because the market is starting out in scenario 4.
Mr. Murdoch has moved the market (from his perspective) into scenario 2, which is clearly bad for him, in hopes that everyone else will move as well, to reach scenario 1. Once Mr. Murdoch put the Times of London into scenario 2, then everyone else’s best move is to stay there. No one else will join him, because everyone else never will. The market, once stabilized in scenario 4 (the starting point) can never move to scenario 1 – without collusion, which is conveniently illegal.
Someone will always be there to refuse to move to scenario 1. “Everyone else” is destined to allow free access, or exit the market.
Understanding Your Customers
It is possible that Mr. Murdoch looked at the Wall Street Journal, which has a pay-wall, and said “I want to do that too.” And perhaps he discounted all of this game-theory “nonsense” because if it worked for them, it can work for him – the model is BS.
However, I believe the Journal’s market is different, and it works for them for different reasons. The market for business news pays a premium for immediacy and quality of information – because getting the best information first is worth a lot of money to them. There are “free” immediate sources of business news information, but the market indicates that it perceives that information to be of lower quality. And there are free high-quality information sources, without the immediacy.
The reality, which you can only get from understanding your customer’s goals – is that the business-news market is stable in scenario 1. It could be destabilized, by someone offering free, timely, high quality information. If that happened, as professor Nash showed, the market would either re-stabilize in scenario 1 (the company that changes says “oops” and reverts their policy), or the market would transition to a stable state in scenario 4 (everyone offers free content).
The more concentrated the market [see: measuring market concentration], the more likely a reversion to scenario 1. The more competitive the market, the more likely that it will stabilize in scenario 3.
Non-business news on the internet? Very competitive. And stable in scenario 4, no matter what Mr. Murdoch might hope. Sadly, there are profits to be made in scenario 4, but they aren’t as appealing as the double-rainbow of scenario 1 – however impossible it is to achieve.
The two photos at the start of this article of Mr.s Murdoch and Nash are licensed through the Creative Commons Attribution Share-Alike 2.0 Generic and the Attribution Share-Alike 3.0 Unported licenses, respectively.
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