Supply and Demand in Economics 101. The textbooks explain that shifts in demand cause corresponding changes in supply. No matter what the changes are, the point where the curves intersect sets the price of the good or a service. This law provides a powerful explanation for how markets come to equilibrium.We learned the fundamental law of
But this law makes important assumptions which are often overlooked - that supply and demand are treated as flexible and having unlimited quantities. In the real world this is simply not the case, because of the laws of physics. However the Internet, because it does not have geographical restrictions, changes the rules once again. So in this post, we look at some different types of supply / demand scenarios. Our conclusion (sorry to ruin the ending) is that Google is the ultimate money making machine on the Internet. Now let's find out why...
How Things Work in the Physical World
A classic example in the physical world, and perhaps the earliest example of urban business, is the mom and pop grocery store. Since Mom and Pop are mere mortals, their daily output is fixed. This simply means there is a physical limitation on how many customers they can serve. Hence, the supply is limited. Also, because it is a physical store, there are only so many people who can come to it - regardless of how good their stock is. Geographical locality implies limited demand. All of these physical limitations are bad news for mom and pop. No matter how hard they work, their revenues will peak and max out after they get to maximum efficiency at what they do.
Large corporations like Starbucks solve this problem by breaking away from one store and expanding into various geographies. This allows them to tap into economies of scale, where they are able to produce additional units of output at a lower cost - typically because of technology and know-how. Historically, geographical expansions are done by Franchising - the creation of independently operated units that obtain supply from the parent company, as well as maintain brand and comply with regulations. Curiously Starbucks is not technically a franchise, so it is perhaps the exception that proves the rule. In any case, a smartly operated franchise has the chance to leverage geographical expansion to generate exponential growth in revenue.
How Things Work in the Online World
Surely the laws of physics apply to the online world? After all we use electricity to channel bits around and to power our computers. For example Amazon servers take up physical space. And finally, our brains consume real calories to generate all of the source code and HTML on this planet. Yet, the Internet is far from being bound by the laws of physics in the same way that the real world is. This is because there is almost no friction. At least, we do not perceive any friction when we drag and drop widgets or type our blog entries. Two facts: software is 'soft' and the Internet has no geographical boundaries. So this results in a completely different business scale and dynamics.
To understand this, let's start again with an example of a bounded online business. Case in point - a niche blog such as Read/WriteWeb. Again, as in the real world, the supply is limited. Our writers work around the clock to bring you fresh analysis posts about web technology, but the number of posts per day is limited - to say no more than ten. There is also a 'limited' amount of people that come to Read/WriteWeb. Now we are very successful blog and have a daily audience of over 80,000 readers, which is a large number, but still it is limited.
Finally, any blog has a maximum revenue that it can generate - dictated by the traffic and amount of advertising that it can present. So in terms of limitations on supply and demand, blogs are similar to mom and pop shops. But there is a key difference: scale. What local store would be able to serve 80,000 customers daily?
The difference in scale becomes more obvious when we compare Amazon to Barnes and Noble. Amazon started with just books, but after building the brand it expanded into many other categories - eventually surpassing Barnes and Noble. Amazon's revenue curve has a slope that is far greater than the slope of Barnes and Noble. The key difference: no geographical constraints in the physical sense.
Amazon (red) vs B&N (blue)
Why Google is the Ultimate Money Making Machine
Despite Amazon's success, the very nature of its business model limits its potential revenue - because it is a web site. A web site is an online geography. Granted, it is not hard to find Amazon, but that is different from saying Amazon follows you everywhere when you are online. Amazon does not, but Google does!
In addition to being one of the top three online destinations, Google - through its text ads strategy - has managed to weave itself into the very fabric of the Web. In doing this, the company freed itself from even Internet geography and became ubiquitous. By empowering companies and individuals to publish Google ads on their sites, Google solved the unlimited supply and demand problem in one fell swoop.
So how does Google compare to Starbucks, which is a very good money making machine in the real world? The key differences between Google and Starbucks are:
- Starbucks spends money on expansion, but Google ads spread themselves;
- Starbucks spends a lot of money on maintenance, Google spends little;
- Starbucks spends money on marketing, but businesses flock to Google because it just works;
- Starbucks relies on people, Google relies on software.
These differences make Google by far the more attractive business, compared to Starbucks. To put it simply, Google has almost no friction.
Google (red) vs Starbucks (blue)
So one can't help but wonder: what model could possibly beat Google?
We are not talking about a better search engine; we are looking instead for a better, less costly and more efficient business model. At the moment, it is difficult to imagine what could possibly beat billions of links meeting millions of eyeballs daily.
However, human history is the history of progress and innovation. In the seventies it was difficult to imagine what comes after IBM and in the nineties it seemed that Microsoft was unshakable. So there has to be the next leap after Google. At the very least, making Google's model work in the mobile world would increase revenue, by hitting more eyeballs with ads more often. Google is, of course, already working on just that.
But beyond wireless, and in the decade to come, will there be a better business model than Google's current Internet model? Let us know in the comments what you think is going to be the next big business break through.