I recently received an email from our hosting provider Amazon Web Services relating to a new data warehousing product they are offering.
However it wasn’t the petabytes or terabytes that I noticed, it was the last line, which read:
“and costs less than $1,000 per terabyte per year, a tenth the cost of most traditional data warehousing solutions.”
What struck me about this email was the scale of the price deflation involved (90% in one product cycle).
If this was just a one-off instance it would not warrant a blog post, however I am now seeing these sort of deflationary outcomes across multiple product and service industries.
In fact at Mclowd we recently moved our internal accounting to a free service called Wave. This is price deflation of 100% against the fees we were previously paying to MYOB.
(As the Founder of Mclowd I am obviously not unfamiliar with these trends, having launched a free SMSF accounting software platform).
For much of our modern economic history we have leveraged our collective ingenuity to make progressively better ‘mousetraps’, and this process has been the foundation of our current standards of living.
As an IP lawyer in the early days of the Internet I saw a lot of the value that was unlocked by the web-based technologies and business models that have become a key part of our day-to-day lives.
But having been involved with Mclowd since its inception what is becoming clear is that the confluence of cloud computing and crowdsourcing has the potential to destroy much more value than it creates.
The micro-economic implications of this process is reasonably easy to define – 90% price deflation will eliminate any incumbent vendor who cannot adjust to this change in temperature in a relatively short space of time.
(There is no question of predatory pricing or other anti-competitive behaviour here – this is just the economics of cloud computing at work, where the marginal cost of delivering another peta or tera has fallen so far and so fast that prices have simply followed suit).
But the macro-economic implications are less clear.
If one assumes that the cost savings are simply transferred to clients, then at a macro level there would be no change to income or employment (the ‘value’ on the table would simply have been transferred from one party to another).
However my experience at both eHound and Mclowd does not provide any evidence to support this hypothesis.
In competitive markets price deflation in one (input) market just lowers marginal cost in another, and hence drives down prices (and hence ‘nominal’ value) in related markets.
There is an alternative view that per unit price deflation actually creates value (eg users consume more data warehousing which creates value).
While this was certainly the case in the early days of the Internet, there are a couple of reasons why the macro story is unlikely to pan out the same way this time:
• Internet and mobile penetration rates mean that the speed and scale of the changes taking place may not be outweighed by this incremental value creation (the disintermediation triggered by 3D printing and bitcoin alone could wipe out whole industries within a few years)
• The geographic impact is skewed – the value destruction is centred on developed economies, while a lot of the creation is being shifted to more capitally-efficient locations thanks to crowdsourcing
Debt and Deflation
Deflation in and of itself is not problematic (wages and prices both have the ability to deflate to a new equilibrium). However where debt is involved deflation becomes an existential threat.
This is where things get interesting.
The world is sitting on $70 trillion of debt – accumulated over an extended period of time based on assumptions about the amount of ‘value’ that is on the table (now and for many decades into the future).
The challenges that arise when you mix a cocktail and debt and deflation are being seen on a daily basis in the US, UK and Europe, where monetary authorities are having to go to great lengths to avoid deflation in order to maintain stability in the banking system.
I am skeptical that these efforts will ultimately be successful because the whole process by which value is being created and captured is changing quicker then the monetary authorities can respond.
Value Creation – Perception vs Reality
To understand how the concept of value is changing one must distinguish between ‘perceived’ and ‘actual’ value.
Perceived value is what most developed economies are built on, as it permits pricing above marginal cost.
Perceived value is in turn built on a number of foundations:
• Lack of transparency
Over the last 200 years developed economies have become progressively more intermediated, reflecting the evolution from agricultural to more complex service-based industries. (Nearly 25% of the Australian economy is service-based).
This process of intermediation is both a cause and an affect of improvements in living standards (which have supported greater and greater levels of labour specialisation).
This is reflected in the rates that an accountant or lawyer in Sydney or Melbourne might charge their client for specialist advice, as they represent ‘peak intermediation’.
But there is evidence that we may have in fact passed ‘peak intermediation’.
Consumers now have access to numerous tools which allow them to eliminate the costs associated with intermediation.
Wikipedia is a good example. By creating a superior (and free) tool the crowd has eliminated the cost of maintaining the organisational structure that was previously required to support Encyclopedia Britannica.
Similarly Mclowd has leveraged the cloud and the crowd to eliminate the costs associated with maintaining incumbent SMSF accounting platforms such as BGL, Class and their peers.
However 3D printing is probably the most powerful example of disintermediation, allowing many consumers to disintermediate the entire supply chain (manufacturer / wholesaler / retailer) in one fell swoop.
The marketing function as a whole is designed to create the perception of value in order to support pricing above marginal cost.
But there is increasing evidence that the role of marketing is being compromised.
The best example would be the proliferation of private label brands in supermarkets. Private label brands still have personality and values (just like Mclowd), but pricing is much closer to marginal cost than traditional marketers would like to see.
Similar trends are apparent in financial services. While it is as much about disintermediation, the growth of ETFs reflects the decline in perceived value of active asset allocation brands. (I would argue that ETFs are just a step on the way to direct ownership of assets at scale, which is one of the goals of Mclowd).
Lack of Transparency
The other plank is transparency (or lack thereof).
Much of the value-add which vendors are able to create and capture arises from a lack of transparency – or more accurately the cost of acquiring transparency.
But here the landscape is also shifting rapidly.
Physical retailers in Australia are a classic example of this. In recent years their ability to create and capture value above a globally-defined marginal cost is evaporating.
This is because the cost of acquiring transparency is now $0 in many cases.
The Three-Legged Chair
As these forces converge they create enormous challenges for incumbent vendors – the MYOB example above being illustrative.
12 months ago my ‘perceived’ value of cloud-based, SME accounting software was $350 per year: the cost of an account with MYOB Live Accounts. This price was built on:
1. Intermediation – the economics of building a single-use SME accounting platform did not stack up
2. Branding – the MYOB brand had considerably perceived value
3. Transparency – I wasn’t aware of lower cost alternatives, and opportunity cost made it difficult to invest the time required to acquire this knowledge
But just like a three-legged chair it only takes one of these legs to fall over for the chair to collapse. In the case of MYOB it was transparency.
Six months ago I came to realise that the ‘actual’ value of cloud-based SME accounting software is in fact $0. At that point perceived value evaporated.
Over the last 18 months I have taken my mother on a similar journey. Until she began that journey her perceived value of SMSF administration services was $200 – $300 per hour. Today she has access to a free SMSF accounting platform and has discovered that the actual value of professional services is 90% below that figure.
With each Blog and each Newsletter Mclowd is slowly removing the legs on which pricing within the funds management industry has been built. Over the next ten years we have targetted savings in the vicinity of $15 billion per annum on Australia’s $1.5 trillion in superannuation assets.