Measuring the Value of Digital Goods

by on August 20, 2007 · 16 comments

[Disclaimer: When a lawyer writes about economics, things can go dreadfully wrong. My terminology may be way off the mark – and maybe my thinking too. I welcome constructive corrections in the comments.]

Harvard University’s Samuel W. Morris University Professor of Economics Dale Jorgensen kicked off this morning’s session of the PFF Aspen Summit with a talk entitled Whatever Happened to the New Economy? [ppt here – Shane Tews, reading over my shoulder, wants me to mention the pretty colors!] In it, he examined both growth in the IT sector and growth in other economic sectors thanks to their adoption of IT. One of the delights of IT is that innovation in this area propagates out across the economy, magnifying the benefits to society.

I was interested in a slide he put up showing the “Relative Prices of Computers, Communications, Semiconductors, and Software and Computer Services Industry Output, 1960-2005,” slide seven in the PowerPoint. Each area showed consistent decline in price over this period, except Software and Computer Services, which has remained essentially flat.

I was curious about whether and how open source software was measured in Professor Jorgensen’s data, so I asked him during the break whether it was.


Indeed it is, and he mentioned Red Hat as an example of an open source provider that is within the data.

Given that open source software isn’t sold, Professor Jorgensen treats it as “advertising” used to draw people into using service providers like Red Hat. I think that’s a sensible and orthodox approach. As Mike Masnick has documented, lots of digital goods are “advertising” of one sort of another for some complimentary good.

But I think price will tend to understate the economic value of things like open source software (a thing Professor Jorgensen didn’t purport to be capturing, so I’m not criticizing his chart or approach).

People often use price as a proxy for value. After all, the price people will pay reflects very well how much they value a thing. (Well, actually, they value it more than whatever price they pay – every transaction has at least a little consumer surplus.) The price decline in all these sectors, of course, reflects not that their abstract value – the improvement they bring over a baseline of zero – has dropped, but that their scarcity relative to other things has dropped. People need to pay less, and they get more and more surplus (again, over a baseline of zero). Life keeps getting better and better.

To use price as a proxy for abstract value, one would think that life hasn’t gotten better in the software area, but this is plainly untrue (and again, this is not a case Professor Jorgensen was making). Open source is a challenge to the measurement of economic value. Millions of software downloads have brought marginal improvements to billions of lives with no measured economic exchange taking place.

Take the example of two pieces of software that do exactly the same thing. A million copies of Program A are sold for a dollar a piece. A million copies of Program B are given away, drawing users to a Web site at a rate equivalent to what $10,000 in banner advertising would bring. Did Program A add $1,000,000+ in value to the economy, while Program B added only $10,000? It can’t possibly be.

Economics has a challenge before it that I don’t think it has addressed yet: measuring the value of digital goods that are not distributed and sold subject to traditional intellectual property protections.

Update: Added a link to Masnick’s Grand Unified Theory On The Economics Of Free

  • http://techdirt.com/ Mike Masnick

    Very interesting…

    Actually, the idea that price equals value is one that bugs me whenever anyone brings it up. It’s simply not true, and never has been (and, in fact, this is an area that Adam Smith runs into trouble in Wealth of Nations).

    There’s a really simple way to demonstrate this (which I’ve tried to do a few times on Techdirt). People value air a tremendous amount — but you don’t pay for it. People who believe that price is indicative of value are easily proven wrong with that simple point.

    Price is simply what the market will bear, based on the interaction of supply and demand. *Value* plays into the demand side of the equation, but is not indicated by price at all. Assuming price equals value is to not understand supply and demand.

    Separately, though, I’d disagree that economics hasn’t addressed measuring the value of digital goods that are not limited under traditional IP… I’d agree that they may not have done so explicitly, but there’s plenty of data out there in the research, much of it I’ve been gathering for a coming project you may hear about soon…

    And, oops, I’ve said too much. :)

  • http://techdirt.com/ Mike Masnick

    Very interesting…

    Actually, the idea that price equals value is one that bugs me whenever anyone brings it up. It’s simply not true, and never has been (and, in fact, this is an area that Adam Smith runs into trouble in Wealth of Nations).

    There’s a really simple way to demonstrate this (which I’ve tried to do a few times on Techdirt). People value air a tremendous amount — but you don’t pay for it. People who believe that price is indicative of value are easily proven wrong with that simple point.

    Price is simply what the market will bear, based on the interaction of supply and demand. *Value* plays into the demand side of the equation, but is not indicated by price at all. Assuming price equals value is to not understand supply and demand.

    Separately, though, I’d disagree that economics hasn’t addressed measuring the value of digital goods that are not limited under traditional IP… I’d agree that they may not have done so explicitly, but there’s plenty of data out there in the research, much of it I’ve been gathering for a coming project you may hear about soon…

    And, oops, I’ve said too much. :)

  • http://www.cato.org/people/harper.html Jim Harper

    Luckily, I said “people often use price as a proxy for value” without endorsing the idea. Can’t wait for the release of this exciting project, Mike. I expect to value it as much as the life-giving air I breathe! – and I’ll hope to pay a similar price. ;-P

  • http://www.cato.org/people/harper.html Jim Harper

    Luckily, I said “people often use price as a proxy for value” without endorsing the idea. Can’t wait for the release of this exciting project, Mike. I expect to value it as much as the life-giving air I breathe! – and I’ll hope to pay a similar price. ;-P

  • http://www2.blogger.com/profile/14380731108416527657 Steve R.

    I don’t think your question has been correctly structured. Furthermore, the question presented is not “neutral” but is biased in favor of the traditional sales model.

    1. To follow-up a bit on Mike’s comments, the sale of Program A for $1,000,0000 does NOT add any value to the economy versus the $10,000 that program B brought in. There are several components to this.
    First, the value added to the economy is derived by the productivity the customer derives from using the software. In theory giving the product away free to millions of people will create more wealth for the economy then selling the product to only a few people. (I acknowledge that this not plausible, since we all need to earn money.)
    Second, when software is sold the buyer must first earn the money to pay for the product, so selling the product is simply a transfer in wealth from the customer (who created the wealth through work) to the seller. Now, if the product is distributed free of charge, the customer is free to spend his/her money on other other products. In terms of the overall economy it is irrelevant if the customer buys a beer or buys Program A. Again, wealth creation (to the overall economy) comes from the productivity enhancements the product creates for the consumer – not the actual sale of the product.
    Third, If Program B is given away for free, but only brings in $10,000 in revenue through advertising – you would also need to ask the question as to whether or not the advertising generated additional sales of other products. While the owner of Program B may only see $10,000 a bunch of his/her friends may also be profiting. Finally, you need to ask the question as to whether Program A could even be sold.

    2. You bring up the phrase “traditional intellectual property protections”. I would advocate that there is no such thing. Based on what I have been reading the content producers are creating rights by taking away the rights of consumers. For example, I can take a book that I am reading here. If I go to England, I can still read it, but I can’t do that with my DVD because of region encoding. Also Google just left many of its customers high and dry when it abandoned Google Video (TLF August 13, 2007 post).

  • http://www2.blogger.com/profile/14380731108416527657 Steve R.

    I don’t think your question has been correctly structured. Furthermore, the question presented is not “neutral” but is biased in favor of the traditional sales model.

    1. To follow-up a bit on Mike’s comments, the sale of Program A for $1,000,0000 does NOT add any value to the economy versus the $10,000 that program B brought in. There are several components to this.
    First, the value added to the economy is derived by the productivity the customer derives from using the software. In theory giving the product away free to millions of people will create more wealth for the economy then selling the product to only a few people. (I acknowledge that this not plausible, since we all need to earn money.)
    Second, when software is sold the buyer must first earn the money to pay for the product, so selling the product is simply a transfer in wealth from the customer (who created the wealth through work) to the seller. Now, if the product is distributed free of charge, the customer is free to spend his/her money on other other products. In terms of the overall economy it is irrelevant if the customer buys a beer or buys Program A. Again, wealth creation (to the overall economy) comes from the productivity enhancements the product creates for the consumer – not the actual sale of the product.
    Third, If Program B is given away for free, but only brings in $10,000 in revenue through advertising – you would also need to ask the question as to whether or not the advertising generated additional sales of other products. While the owner of Program B may only see $10,000 a bunch of his/her friends may also be profiting. Finally, you need to ask the question as to whether Program A could even be sold.

    2. You bring up the phrase “traditional intellectual property protections”. I would advocate that there is no such thing. Based on what I have been reading the content producers are creating rights by taking away the rights of consumers. For example, I can take a book that I am reading here. If I go to England, I can still read it, but I can’t do that with my DVD because of region encoding. Also Google just left many of its customers high and dry when it abandoned Google Video (TLF August 13, 2007 post).

  • http://linuxworld.com/community/ Don Marti

    See Robert Lefkowitz on
    Calculating the True Price of Software” — much of software’s price, even proprietary software’s, can be considered an option on future support.

  • http://linuxworld.com/community/ Don Marti

    See Robert Lefkowitz on
    Calculating the True Price of Software” — much of software’s price, even proprietary software’s, can be considered an option on future support.

  • http://www.techliberation.com/contributors/braden_cox.php Braden

    Markets demand that we equate price and value as much as possible. When we can’t, we have a market failure that invites government regulation. But price is just one component of value. One of the arguments cable companies make about why cable TV prices haven’t fallen is to show how consumers have more channels and better quality digital (or even HD) reception. The same is true with software. Features have been increasingly bundled together while prices have been flat.

    Steve, you say: Now, if the product is distributed free of charge, the customer is free to spend his/her money on other other products..

    You lambaste Jim for bias in favor of a “traditional sales model” by which I assume you mean licensing. But you fail to recognize (as Don mentioned) the services model, a proven model that has existed for years now. A company like Red Hat (or any other company that has a business model based on services) gives its software “for free” and then the customer is more likely to spend his/her money on support services from the company that provided the software “for free”!

    And maybe this is too much of a quibble (for I like beer as much as the next guy) but it does matter to the overall economy how people spend their money. Think of it this way – consumer spending rewards the investment in the current generation of products and helps fund the next generation. This has up/downstream effects on the kinds of jobs, research, etc. that exist in your community/state/nation.

  • http://www.techliberation.com/contributors/braden_cox.php Braden

    Markets demand that we equate price and value as much as possible. When we can’t, we have a market failure that invites government regulation. But price is just one component of value. One of the arguments cable companies make about why cable TV prices haven’t fallen is to show how consumers have more channels and better quality digital (or even HD) reception. The same is true with software. Features have been increasingly bundled together while prices have been flat.

    Steve, you say: Now, if the product is distributed free of charge, the customer is free to spend his/her money on other other products..

    You lambaste Jim for bias in favor of a “traditional sales model” by which I assume you mean licensing. But you fail to recognize (as Don mentioned) the services model, a proven model that has existed for years now. A company like Red Hat (or any other company that has a business model based on services) gives its software “for free” and then the customer is more likely to spend his/her money on support services from the company that provided the software “for free”!

    And maybe this is too much of a quibble (for I like beer as much as the next guy) but it does matter to the overall economy how people spend their money. Think of it this way – consumer spending rewards the investment in the current generation of products and helps fund the next generation. This has up/downstream effects on the kinds of jobs, research, etc. that exist in your community/state/nation.

  • http://www.xanga.com/zaleplon zaleplon

    Zaleplon can not Sonata

  • http://www.xanga.com/zaleplon zaleplon

    Zaleplon can not Sonata

  • http://www.xanga.com/zaleplon zaleplon

    Zaleplon can not Sonata

  • http://www.xanga.com/zaleplon zaleplon

    Zaleplon can not Sonata

  • http://favvia.iespana.es/class-a-diesel-motor-home-for-sale.html Tifany

    Avro Arrow Specs [url=http://favvia.iespana.es/avro-arrow-specs.html]Avro Arrow Specs[/url] Digital Certificate Definition [url=http://favvia.iespana.es/digital-certificate-definition.html]Digital Certificate Definition[/url] Key Chain Gifts [url=http://favvia.iespana.es/key-chain-gifts.html]Key Chain Gifts[/url] Solar Calculators [url=http://favvia.iespana.es/solar-calculators.html]Solar Calculators[/url] Tibet China Conflict [url=http://favvia.iespana.es/tibet-china-conflict.html]Tibet China Conflict[/url]

  • http://favvia.iespana.es/class-a-diesel-motor-home-for-sale.html Tifany

    Avro Arrow Specs [url=http://favvia.iespana.es/avro-arrow-specs.html]Avro Arrow Specs[/url] Digital Certificate Definition [url=http://favvia.iespana.es/digital-certificate-definition.html]Digital Certificate Definition[/url] Key Chain Gifts [url=http://favvia.iespana.es/key-chain-gifts.html]Key Chain Gifts[/url] Solar Calculators [url=http://favvia.iespana.es/solar-calculators.html]Solar Calculators[/url] Tibet China Conflict [url=http://favvia.iespana.es/tibet-china-conflict.html]Tibet China Conflict[/url]

Previous post:

Next post: