How Big Tech Firms have redefined the paradigms of economics!

Not a day passes by without using at least one product or application of the Big Tech companies.  These companies have redefined the long established principles of economics.

1. Networking Effects:

Networking effects is the phenomenon where the value of a product increases due to the addition of every new customer/user.

The effect of networking in tech industry implies that the company/product which is the 'early mover' has an advantage and the value of the network grows with every additional user. In 'network industries' the equilibrium tends towards a few products and their companies. Consider Microsoft, the predominant operating system of the world. Consumers want to stick to (Microsoft) technologies that are dominant and compatible with all the other users, software and hardware products. Once consumers get used to these applications or products they do not wish to change easily.  Similarly, with Facebook, any new user benefits due to the gigantic network of users already present on the social media platform. For a new user it is worthless to choose any new social media platform with limited users and therefore limited networking benefits.

From the product perspective, as new users join the network, the company can offer better user value based on the data collected from them.

(I have chosen Google Chrome as my default browser not Microsoft Edge while blogging this article as I am so used to it!)

In 'network industries' the rule of the game is that 'the winner takes it all' which results in establishment of huge monopolies with market capitalizations that are bigger than national incomes of most countries. Once these technologies/companies gain user acceptance it is next to impossible to dislodge them. The entry barriers are so high that there is virtually no competition in these 'networking industries'.

2. Economies of Scale/Negligible Marginal Costs :

The marginal cost of adding one user for a big tech company like Facebook(Meta),Microsoft, Google(Alphabet) is zero unlike the traditional physical product based business models. While the cost of making a first version of a software product may run into billions, the cost of producing the additional copies and distribution is virtually zero.

So if the technology or company is lucky enough and people get hooked, it enjoys huge economies of scale which in turn lead to monopoly profits. 

3. The Outsourcing Model:

Big tech firms like Apple, Nvidia are based on Ronald Coase's outsourcing model. These companies add bulk of their value through software, research and design rather than in-house manufacturing. They outsource most of the components of their products to companies based out of Taiwan, China, Vietnam, Japan, South Korea, India etc. The cost of outsourcing is much cheaper than producing their electronic components inhouse.

The profit markups that these companies command are mind boggling and this highlights the importance of value addition through research and design. The market cap of Nvidia is around $3 trillions where as that of its component suppliers TSMC is at $800 billions and SK Hynix is at $80 billions.

4. Subscription-based Models:

Big Tech companies like Amazon, Microsoft, Netflix are subscription based models. Once these services or products become part of the user's routine, the revenues keep flowing month after month, year after year. 

For Microsoft its revenues shoot up each time a new version of Windows operating system or MS Office application is released into the market. For companies like Apple with a huge fan base, each new version of its i-phone rakes in huge revenues.

5. Cross selling products:

 Due to the network effects, users stick to the same platforms and as a result they become potential new customers for cross selling other products of the same company. This gives the existing companies with large user-bases an unfair advantage over potential new entrants.

6. Innovation, R&D:

These companies spend billions of dollars in innovation, research and development which puts productivity at logger heads with job creation. While humanity as a whole reaches new pinnacles of glory, through these research and development expenditures, the immediate damage caused in the job market can lead to unrest in many economies.

Nvidia can generate a market cap of $3 trillion dollars with less than 30,000 employees! 

7. Unit Economics: Unit Economics are strongly loaded in favor of the big tech firms. Customer acquisition costs are negligible, revenues are sticky, user base is enormous and the switching costs are steep.

8. Monopolistic practices and Regulatory Oversight:

From a regulatory perspective, the companies operating in these industries need to be reigned in during the early stage, before they turn into behemoths. This is probably the reason why Nvidia has attracted the attention of regulators. Google is undergoing a hearing for monopoly practices. Microsoft during the 90's used so many monopolistic practices to capture market share and the regulation was behind the curve most of the time.

Most of these Big Tech firms regularly pay penalties to regulators in Europe, US and elsewhere.

9. Energy Consumption:

The computing of the future relies on data centers which consume huge quantities of energy. This leads to immense pressure on energy sector and alters the energy dynamics of the world. 

For example, the number of data centers in the US alone is more than 2500 and if new energy sources are not created in the near to medium term, both the climate change situation and civilian energy usage may get negatively effected.

10. Electronics supply chains:

As stated earlier, many of the Big Tech firms outsource their production to Asian countries. The number of industry jobs created in a country is dependent on its alignment to these supply chains. On top of it, these supply chains have led to geo political tensions between the US and China which may very well lead the world to a third world war! To reduce the dependence on these supply chains and create more jobs, countries like US are replacing outsourcing by 're-shoring' and ' friend shoring'.

References: Economics by Samuelson, Mint news daily, Microsoft Co-Pilot

Inspiration and Acknowledgements to Prof. Damodaran.