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The economics of network industries
ARTICLE IN PRESS
Telecommunications Policy 27 (2003) 741–743
Book review The economics of network industries Oz Shy, 2002, Cambridge University Press, Cambridge, p. 330. ISBN: 0-521-80095-1 (Hardback) ISBN:0-521-80500-7 (Paperback)
‘‘The Economics of Network Industries’’ is a text aimed at graduate students and researchers of economic theory of high technology network industries such as computer software, telecommunications and the internet with a sector-by-sector approach. To understand the book it is necessary to have a basic knowledge of microeconomics and knowledge of industrial organisation—it is ideally pitched at both undergraduates and post-grads with a good knowledge of intermediate microeconomics. The author is professor in the Department of Economics of the University of Haifa, and has written articles in academic journals and book chapters mainly in fields related to Industrial Organization and International Trade, as well as being the author of Industrial Organization: Theory and Applications (MIT Press, 1996).
1. Indication of book’s contents The author’s stated goal is to ‘‘bring the economics of networks to a wider audience, including those with limited technical ability.’’ He has made strenuous efforts to avoid widespread use of calculus and algebraic equations, relying on logic argued through plain English. Of interest to anyone in the realm of industrial organisation, the book treats as its subject very different industries, all with one key aspect in common: in each of them, networks play a decisive role in their operation. Unlike oranges or apples, for example, high technology ‘‘network markets’’ like e-mail or DVDs have key distinguishing features. These characteristics are complementarity, compatibility, standards, externalities, switching costs, lock-in and scale economies of production. How this constrains or affects the services consumers can buy, and the choices they are able to make, forms the subject of this book. The book is divided into three parts. In the first part, there is a brief presentation of the characteristics and specific problems of network industries, with key concepts such as product complementarity, technical standard adoption and consumer lock-in explained using familiar examples like CD players with music titles, QWERTY keyboards and DOS and UNIX operating systems. Having established that competitive equilibria are not a feature of network markets resulting in market imperfections and failure, the author emphasises that this does not automatically imply that ‘‘government intervention is needed’’ to ensure selection of a first-best doi:10.1016/j.telpol.2003.08.007
ARTICLE IN PRESS 742
Book review / Telecommunications Policy 27 (2003) 741–743
technology standard. He cites the examples of the FCCs attempt to impose CBS colour TV standards in the 1950s, MITIs bank-rolling for HDTV and analogue MUSE broadcasting standards in Japan and the dilution of natural monopoly assumptions in America that led to the break-up of AT&T, access pricing and introduction of competition in long-distance telecommunications from the likes of MCI and Sprint during the 1980s. In the second part that constitutes the main body of the text, industries are analysed individually with a special emphasis on those related to the communications, computer and audio–visual sectors, although others like airlines, bank services and even languages, human interaction and litigation are included, giving a uniquely ‘anthropological’ feel to an otherwise serious economic treatise. The final part takes the form of three appendices, in which basic mathematical concepts such as game theory, Pareto comparisons and ‘undercut proof equilibria,’ employed in the preceding chapters are deconstructed. Each chapter and the appendices have some self-help (but non-resolved) student exercises designed to reinforce the acquired knowledge. The solutions are freely available on the internet at the instructor’s own site at http://econ.haifa.ac.il/Bozshy/netman21.pdf. In terms of relevance, this book covers, at least partially, an area of industrial economics that up till now has not been appropriately treated in many text books. The work carried out by Shy is excellent, since it summarizes a wide array of literature from leading journals on network economics, but at the same time adapting and ‘homogenising’ it in a way that it can be easily understood by people without too much previous knowledge in these areas: it is written in a particularly accessible and ‘light’ style. From the point of view of its contents, as well as of its clear exposition, the book may be characterized as an academic formalisation of themes previously raised by Shapiro and Varian in their respected text ‘‘Information Rules—A Strategic Guide to the Networked Economy.’’ What sets this text apart however, is that the central body of theory allows clear analysis of the specific problems characteristic of the individual sectors from a common methodological perspective. In particular, Chapter 1 provides the theoretical groundwork sufficient to underpin a student’s knowledge, and should they need to supplement this information, references to other material to obtain a wider vision of the whole ‘network’ industry phenomenon. The subsequent ten topic-specific chapters each begin with an introduction to the sector concerned. Thus the principles of digital bits, bytes, downloading, piracy and their interaction with types of hardware, provides the necessary backdrop to the analysis of the software industry. Central issues such as network externalities and how this affects the demand for telecommunications services (telephony, facsimile, e-mail), essential facilities and the socially optimal provision of telecommunications services are all clearly defined before the author deals with their relevance to telecoms deregulation. Thereafter, Shy discusses the competitive implications that arise from interconnection, including market entry, price controls and their impact on consumers. International settlement rates are also considered. Models for calculating access pricing forms the background for three separate chapters dealing with telecommunications, broadcasting, the internet and the cable industries. Subjects covered in other chapters include the economics of libraries, information goods, the internet, banks, money, ATMs, airline code sharing, spectrum allocation, the economics of entertainment places, and more mischievously, topics such as human conformity, vanity, gifts, religious affiliations, international time co-ordination and the longstanding debate about ‘‘who’s driving on the wrong side of the road’’.
ARTICLE IN PRESS Book review / Telecommunications Policy 27 (2003) 741–743
743
The book is especially recommended to two types of readers: on the one hand, professionals and investigators interested in enlarging their knowledge of the economics of certain network industries, and on the other, students who want to complement their knowledge of traditional network sectors with other new ones of growing importance in the economy, such as the internet. In particular, the author is to be commended for his excellent contribution to an understanding of the implications of the internet and its inter-relationship to other forms of communications media, giving this work considerable added value. Although the approach used by the author is the appropriate one from an academic point of view, simplifying the topics in order to show only the truly relevant aspects for the analysis can confuse certain readers, particularly engineers who require more technical but less conceptual terminologies. This way, for example, the chapter dedicated to the software industry includes an analysis of the interaction between the production economics of software programs as well as their audio-visual contents, since they both share the same economic characteristics, but from a technical point of view, only the programs are considered to be software. 2. Methodology, technical soundness, originality Most of the calculus topics can be skipped without affecting the understanding of the text. Only a very basic knowledge of probability and game theories is necessary. In terms of presentation, the graphics and charts are used widely and appropriately throughout the book. The mathematical aspects are shown in a simple and systematic way. 3. Audience The audience for this book is mainly upper-level undergraduates and graduate students in economics or industrial organization who want to carry out a specialized course in network industries and it would prove an ideal text for either one or two-semester courses. But equally, Oz Shy has succeeded in simplifying the arguments that economists have been feverishly debating in academic journals in the fields of network industries from telephony to the internet. It will thus be of considerable interest to researchers, industry professionals and regulators seeking a clear and concise explanation of the economics of high technology network industries as well as anyone interested in the activities of companies such as Microsoft, Verizon or Vodafone.
Federico Pablo Mart!ı Department of Estad!ıstica, ! Estructura Economica y O.E.I, Plaza de la Victoria, 2, ! 28802 Alcala! de Henares, Spain Universidad de Alcala, E-mail address: [email protected]
Telecommunications Policy 27 (2003) 741–743
Book review The economics of network industries Oz Shy, 2002, Cambridge University Press, Cambridge, p. 330. ISBN: 0-521-80095-1 (Hardback) ISBN:0-521-80500-7 (Paperback)
‘‘The Economics of Network Industries’’ is a text aimed at graduate students and researchers of economic theory of high technology network industries such as computer software, telecommunications and the internet with a sector-by-sector approach. To understand the book it is necessary to have a basic knowledge of microeconomics and knowledge of industrial organisation—it is ideally pitched at both undergraduates and post-grads with a good knowledge of intermediate microeconomics. The author is professor in the Department of Economics of the University of Haifa, and has written articles in academic journals and book chapters mainly in fields related to Industrial Organization and International Trade, as well as being the author of Industrial Organization: Theory and Applications (MIT Press, 1996).
1. Indication of book’s contents The author’s stated goal is to ‘‘bring the economics of networks to a wider audience, including those with limited technical ability.’’ He has made strenuous efforts to avoid widespread use of calculus and algebraic equations, relying on logic argued through plain English. Of interest to anyone in the realm of industrial organisation, the book treats as its subject very different industries, all with one key aspect in common: in each of them, networks play a decisive role in their operation. Unlike oranges or apples, for example, high technology ‘‘network markets’’ like e-mail or DVDs have key distinguishing features. These characteristics are complementarity, compatibility, standards, externalities, switching costs, lock-in and scale economies of production. How this constrains or affects the services consumers can buy, and the choices they are able to make, forms the subject of this book. The book is divided into three parts. In the first part, there is a brief presentation of the characteristics and specific problems of network industries, with key concepts such as product complementarity, technical standard adoption and consumer lock-in explained using familiar examples like CD players with music titles, QWERTY keyboards and DOS and UNIX operating systems. Having established that competitive equilibria are not a feature of network markets resulting in market imperfections and failure, the author emphasises that this does not automatically imply that ‘‘government intervention is needed’’ to ensure selection of a first-best doi:10.1016/j.telpol.2003.08.007
ARTICLE IN PRESS 742
Book review / Telecommunications Policy 27 (2003) 741–743
technology standard. He cites the examples of the FCCs attempt to impose CBS colour TV standards in the 1950s, MITIs bank-rolling for HDTV and analogue MUSE broadcasting standards in Japan and the dilution of natural monopoly assumptions in America that led to the break-up of AT&T, access pricing and introduction of competition in long-distance telecommunications from the likes of MCI and Sprint during the 1980s. In the second part that constitutes the main body of the text, industries are analysed individually with a special emphasis on those related to the communications, computer and audio–visual sectors, although others like airlines, bank services and even languages, human interaction and litigation are included, giving a uniquely ‘anthropological’ feel to an otherwise serious economic treatise. The final part takes the form of three appendices, in which basic mathematical concepts such as game theory, Pareto comparisons and ‘undercut proof equilibria,’ employed in the preceding chapters are deconstructed. Each chapter and the appendices have some self-help (but non-resolved) student exercises designed to reinforce the acquired knowledge. The solutions are freely available on the internet at the instructor’s own site at http://econ.haifa.ac.il/Bozshy/netman21.pdf. In terms of relevance, this book covers, at least partially, an area of industrial economics that up till now has not been appropriately treated in many text books. The work carried out by Shy is excellent, since it summarizes a wide array of literature from leading journals on network economics, but at the same time adapting and ‘homogenising’ it in a way that it can be easily understood by people without too much previous knowledge in these areas: it is written in a particularly accessible and ‘light’ style. From the point of view of its contents, as well as of its clear exposition, the book may be characterized as an academic formalisation of themes previously raised by Shapiro and Varian in their respected text ‘‘Information Rules—A Strategic Guide to the Networked Economy.’’ What sets this text apart however, is that the central body of theory allows clear analysis of the specific problems characteristic of the individual sectors from a common methodological perspective. In particular, Chapter 1 provides the theoretical groundwork sufficient to underpin a student’s knowledge, and should they need to supplement this information, references to other material to obtain a wider vision of the whole ‘network’ industry phenomenon. The subsequent ten topic-specific chapters each begin with an introduction to the sector concerned. Thus the principles of digital bits, bytes, downloading, piracy and their interaction with types of hardware, provides the necessary backdrop to the analysis of the software industry. Central issues such as network externalities and how this affects the demand for telecommunications services (telephony, facsimile, e-mail), essential facilities and the socially optimal provision of telecommunications services are all clearly defined before the author deals with their relevance to telecoms deregulation. Thereafter, Shy discusses the competitive implications that arise from interconnection, including market entry, price controls and their impact on consumers. International settlement rates are also considered. Models for calculating access pricing forms the background for three separate chapters dealing with telecommunications, broadcasting, the internet and the cable industries. Subjects covered in other chapters include the economics of libraries, information goods, the internet, banks, money, ATMs, airline code sharing, spectrum allocation, the economics of entertainment places, and more mischievously, topics such as human conformity, vanity, gifts, religious affiliations, international time co-ordination and the longstanding debate about ‘‘who’s driving on the wrong side of the road’’.
ARTICLE IN PRESS Book review / Telecommunications Policy 27 (2003) 741–743
743
The book is especially recommended to two types of readers: on the one hand, professionals and investigators interested in enlarging their knowledge of the economics of certain network industries, and on the other, students who want to complement their knowledge of traditional network sectors with other new ones of growing importance in the economy, such as the internet. In particular, the author is to be commended for his excellent contribution to an understanding of the implications of the internet and its inter-relationship to other forms of communications media, giving this work considerable added value. Although the approach used by the author is the appropriate one from an academic point of view, simplifying the topics in order to show only the truly relevant aspects for the analysis can confuse certain readers, particularly engineers who require more technical but less conceptual terminologies. This way, for example, the chapter dedicated to the software industry includes an analysis of the interaction between the production economics of software programs as well as their audio-visual contents, since they both share the same economic characteristics, but from a technical point of view, only the programs are considered to be software. 2. Methodology, technical soundness, originality Most of the calculus topics can be skipped without affecting the understanding of the text. Only a very basic knowledge of probability and game theories is necessary. In terms of presentation, the graphics and charts are used widely and appropriately throughout the book. The mathematical aspects are shown in a simple and systematic way. 3. Audience The audience for this book is mainly upper-level undergraduates and graduate students in economics or industrial organization who want to carry out a specialized course in network industries and it would prove an ideal text for either one or two-semester courses. But equally, Oz Shy has succeeded in simplifying the arguments that economists have been feverishly debating in academic journals in the fields of network industries from telephony to the internet. It will thus be of considerable interest to researchers, industry professionals and regulators seeking a clear and concise explanation of the economics of high technology network industries as well as anyone interested in the activities of companies such as Microsoft, Verizon or Vodafone.
Federico Pablo Mart!ı Department of Estad!ıstica, ! Estructura Economica y O.E.I, Plaza de la Victoria, 2, ! 28802 Alcala! de Henares, Spain Universidad de Alcala, E-mail address: [email protected]