Wednesday, May 19, 2010

Future of book publishing?

Follow-up to an earlier post. The book publishing business is clearly an opportunity waiting to be exploited. The current economics of publishing business is clearly skewed against the content creators and towards the publishers. In its current balance of power, the publisher premium for risk aggregation and distribution costs has eaten into the content creator - i.e. the market seems to be rewarding the former over the latter, something that clearly does not make sense in case of an artistic endeavor.
As with a lot of markets, the internet has the potential of shaking this up - yet another demonstration of the long tail effect. One such start-up is

The publishing space is an interesting space to watch out for over the next few years.

Saturday, May 15, 2010

How many autos is too many autos?

Anyone who has had to negotiate an auto-rickshaw fare in places like Chennai or Delhi knows that it is an experience that is highly unsatisfying, to say the least. Since there is no metering system in place, it is purely left to your negotiation skills, where the odds are stacked against you. You only have a vague idea of the distance and even little idea of what a reasonable fare per kilometer ought to be. In a perfect market, you can have multiple auto drivers bidding to meet your demand in a reverse auction mechanism which would settle the fare at the marginal cost. However, anyone who has tried that strategy with a clique of auto-drivers on a street corner in Chennai will testify that nothing could be farther from the truth - there is a well established cartel which controls the price bands. The only possible upside of these transactions is that once you have a rate agreed upon, it is the auto driver has every incentive to put you to your destination in the shortest distance and time possible.

Cities like Bangalore and Bombay, on the other hand, have a metering system in place. While it is vastly superior as a pricing mechanism, it can lead to other distortionary actions as well. For instance, once an auto driver has a passenger, there is clearly an incentive to maximize the distance covered in travelling from point A to point B since the alternative for the driver would be waiting for a passenger without any marginal revenues. These is even more so when there is an excess supply of autos which would create an incentive for the driver to 'hold on' to a passenger as long as possible. There are two ways to counter this: the first one is to offer a minimum guaranteed fare for the auto driver. In Bangalore, this is fixed at 2 km i.e. you have to dish out 2km worth of fare even if you need to travel less than this distance. This could act as an incentive for the driver to keep 'rotating' passengers, under the assumption that there is a possibility of landing up with short-distance rides. In other words, one way to create a dis-incentive for the drivers to take their passengers for a ride (literally!) could be to increase the guaranteed base fare.

However, there is a trickier problem at hand - if there is a supply glut (i.e. too many autos chasing too few passengers), it is likely to encourage the drivers to hold on to a passenger as long as possible, since in the absence of a point-to-point fare negotiation option, the only alternative to maximize revenue is to milk distance from each captive passenger. The opposite situation of too few autos is clearly undesirable. And that begs the question - how do we know the optimal number of autos required to serve a city? The simplistic answer would be to let the market decide but that is clearly not so straightforward in a market where the entry and exit costs are non-zero. In fact, the entry costs are quite high - the cost of procuring an auto, a driving license and then a license to operate the auto. The exit costs, meanwhile, could end up being quite high when the auto is bought on a loan (which is usually the case) and any exit from the market could end up being an expensive proposition, which often ends up forcing them to continue in the market even though it may not be economically viable.

One potential way to get around this supply-demand imbalance could be to make the auto-licenses transferable in an open auction market (like a secondary market for equities). This would essentially give each auto-license owner the right to auction it in this market, subject to a floor price (which would be equal to the cost of a fresh license). The premium at which the licenses would trade could then be a good indicator of the supply-demand gap. Thus, when the premium starts increasing, the government could issue fresh licenses, bringing the premium down. This has the clear advantage of the market determining the supply-demand equilibrium for autos in any city and would be a clear leg up over the current system of a government issuing licenses without any particular method of arriving at the optimal number.

And so, the question is not to ask 'how many autos should Bangalore have' but to create a mechanism by which the market will determine the right number. Would that mean that this proposed system could create an economic haven where you can always get the auto who would take you to your destination in the shortest possible route? Now that is like expecting economic theory to predict human behavior!!

Wednesday, May 12, 2010

Wisdom of crowds on the roads?

My daily commute takes me on a route which has a very narrow bridge on a two-way road - just enough room for cars to squeeze through in one direction. This obviously creates a huge requirement for spontaneous co-operation among the drivers since there is usually traffic flowing in both directions. Not an easy thing to do in India where we are notoriously poor when it comes to sharing of scarce resources, esp road space. Obviously the best solution to this would be
an enforcement mechanism like a traffic signal that regulate the flow of traffic in both directions. For some unfathomable reason, the boffins at the traffic department have not yet thought it necessary to provide that. And so that leaves it to the 'Wisdom of Crowds'. If all the drivers were homo economicuses (economicii?) then they would have done the most optimal thing to do - that is to follow an alternating strategy - one car at a time in each direction. This would even out the flow in both directions and most importantly, make it a predictable process where the costs (of waiting) are evenly spread across all the parties. Obviously - this does not happen.

What actually happens is rather intriguing. Let's say that the vehicles are flowing in one direction and there is no backup from the opposite direction. All is well - until the queue starts building up in the opposite direction. At this point, it is completely left to an individual driver's selfless act of
stopping and letting the opposite side start. From that point onwards, it is left to the random occurrences of altruism from drivers in both directions, until there is no backlog in any one direction. Not a very rational process - since there is clearly no incentive for any driver to stop voluntarily because by doing that, she would have selected a high cost option (of waiting) as against the zero cost option (in units of waiting time) of driving through. However, someone or the other ends up doing that each time and what's more, this seems to settle down to a fairly predictable pattern. I have noticed that after 4-5 cars, the opposite side takes over. Which is remarkable since this essentially means that an altruist emerges for every 4-5 drivers. Is it that the drivers, battered by the abysmal infrastructure that passes for our road network, spontaneously arrive at this solution, i.e. is there really a 'wisdom of crowds' phenomenon working here? And then you begin to wonder - why doesn't this happen at all other bottlenecks? For instance, when a traffic signal fails (a not-infrequent occurrence!) then there is almost always a logjam and there is no such self-regulating flow mechanism that emerges.

The only possible explanation is that in case of the bridge, given that it is a predictable situation (the flow problem repeats itself every day), it is in each commuter's 'enlightened' self-interest to contribute to solving the problem. If that be so - why have traffic rules at all? Would a completely self-regulating mechanism appealing to the collective self-interest of the commuters work?? Or is there a tipping point beyond which aggregated individual behavior descends into chaos?

The economics of art?

Recently, I read Vikram Chandra's Sacred Games - a 900 page effort which, as the book blurb claimed, took 7 years to write. Like all art forms that are centered around a single individual (i.e. writing, painting etc), this makes art a highly unpredictable and fickle business - at least from the point of view of the artist. As an artist, you invest a huge amount of time and the corresponding opportunity cost of not doing a regular 9-5 job of say, accountancy. And in return, the piece of work that you produce may sink without a trace since you never really know what the market wants. And this is probably the fate of an overwhelming percentage of such artistic endeavors. Without getting to why they do it then, I am more intrigued how the publishing and music industries have evolved to manage this risk.

At the very least, it does make the case for intermediaries like publishers, who are basically the risk aggregators spreading the risk across several such potential bets. The way I suppose the publishing industry works is to place their bets (in the form of advances) on several artists with the assumption that at least some in the portfolio will return a multiplier large enough to create a reasonable return on the overall portfolio. In addition to the aggregation of risk, these intermediaries played another important role - that of connecting the artists with the consumers. With their marketing budgets they would create the buzz and then back it up with the distribution might to push the wares to the retail channels.

That at least was the theory on which the entire music and book industry has evolved with a handful of very large intermediaries. All was well - until the internet came along. The truly disruptive power of the internet was to allow the music artist to reach out her audience directly (the long tail et al) which is fast making the push strategy of the record labels increasingly out of fashion - at least the artists now have a much less expensive option for marketing their wares. And what remains now is the upfront investments (risk aggregation) that the labels used to provide - and bands are again figuring out ways around that by again leveraging the internet. A typical strategy is to upload your music on youtube and then leverage social networking as a means to create the viral marketing effect to kick-in. Then ride on the buzz to organize band gigs and concerts to start the monetization process. One critical thing that enables this in the music space is that the digital music file lends itself perfectly to such transactions. Each song is a tangible unit of output that can be downloaded, monetized (think itunes). In all this it is merely a matter of time before the record labels and retail stores with CDs etc are priced out of the market.

Back to the Vikram Chandra book: turns out that he was given a hefty advance to write this book as he was already a pretty big author who must have merited a decent advance. Which then begs the question - would anybody pay a first-time author to churn out a 900 page tome that may turn into a masterpiece or more likely end up being a dud? Probably not, in the sense that it is a highly risky venture to invest in - it is not like any startup where you can fire the members of the founding team if they are not working out. To top that, artists can be a fickle lot and may not take too kindly to an interfering VC to set timelines on inspirational activities!

So the intriguing question here is - will the book industry go the way of the music industry? The e-book industry may help this along - remains to be seen.