I.
As every good explorer knows, the first step towards understanding the terrain is to draw a map. This newsletter seeks to explore the economy of bits, the value stored and transacted between computers over the internet. It is terra icoginita: a sprawling land, where many laws of conventional economics break down, that grows larger — and weirder — every second. So far we have been flying blind in our exploration, but as we delve deeper into the inner workings of the digital economy this will increasingly become a hindrance.
Conceptual maps serve much the same purpose as their geographic analogs. Maps seek to carve reality at its joints: to separate objects from each other to bring order to large systems. By giving this high-level, organized view of a topic, they help you both understand that topic at a holistic level and navigate within the fine-grained details.
In this essay, I want to emphasize two important dichotomies that separate the different products and companies that comprise the economy of bits. First, whether a given company sells a product or a service. The distinction between the two is primarily a question of the tangibility of a good: products are tangible (e.g. a book), while services are intangible (e.g. a ride in a car). Second, whether that product/service is purely digital — composed solely of bits that exist on the internet — or whether it “Offline-to-Online” — a digital representation of something in the physical world. These are the the axes we will use to map the E-conomy:
II.
All Dollar figures are projected 2019 revenue for given market in the US economy, in billions
Pure Digital Services
Featured Markets: Music Streaming, Video Streaming, Software as a Service
Notable Companies: Spotify, Netflix, Salesforce, Disney
Businesses built on digital services enjoy two large advantages. For one, by offering goods purely over the internet, they have negligible marginal costs to serving their customers. In addition, because they generally offer services that solve ongoing problems, these businesses attract recurring customers, cutting down the work they have to do to acquire new customers. These favorable characteristics mean that the limit on digital services is largely on the demand side: as long as some people want a digital service, it is generally viable to offer it.
So far the largest markets for digital services fall into two categories: B2C companies offering subscriptions to media, and B2B companies offering enterprise software as a service (SaaS). In both cases, companies invest heavily in creating something, which can then be sold to customers over the internet, often at a high margin. For media companies, such as Netflix, that something is original content, while SaaS businesses invest in building software that solves problems for businesses. Expect to see sustained growth in digital services as the fantastic unit economics continue to attract entrepreneurs and investors.
Pure Digital Products
Featured Markets: Online Advertising, Video Games
Notable Companies: Google, Facebook, Buzzfeed, Epic Games
Purely digital products is an almost contradictory concept: products are by definition tangible, but the digital world is by definition intangible. Given this, how do you define what constitutes a digital product? I define it as some piece of information, whether it be a news article, google search, or video game, that you purchase, either directly with dollars, or indirectly with your attention partly devoted to advertising. Under this conceptualization, the online ad market can be mostly grouped in to the category of digital products, as well as the video game market, which has largely moved to the internet.
Perhaps the most interesting story in this quadrant is how many companies are trying to get out of it. Take for instance Adobe’s move in 2012 to transition from selling their software as products for a flat price to selling Creative Cloud, a bundled subscription service. In terms of our map, Adobe moved “north-ward”: converting from a company that sold individual digital products to a company that sold a general service that provides a suite of creativity software. Doing so allowed Adobe to tap into the favorable economics of digital services, which has catalyzed a period of serious growth for Adobe’s business:
Meanwhile, the most popular video game of this year, Fortnite, flouts the traditional product model in video games. The game itself is free, but it monetizes by selling digital add-ons, such as character skins or dances. In addition, Epic Games, the company behind Fortnite, sells a “Battle Pass” a subscription that bundles together all of these products into a singular service.
I don’t think digital products are going away: people can only subscribe to so many services. Nonetheless, the trend from products to services is one of the most powerful forces currently underway in the digital economy.
Online-to-Offline Services
Featured Markets: Ride Hailing, Food Delivery
Notable Companies: Uber, Lyft, Doordash, TaskRabbit
Offline-to-online services are the most controversial — and arguable most interesting — corner of the digital economy. By combining the scale and frictionless nature of the internet with the physical world, companies in this quadrant have introduced truly new and interesting services to their customers. And consumers, for their part, have flocked to these new experiences in droves. Uber, for example was founded just over 10 years ago, and yet has processed over 5 billion rides over its brief existence.
The key unlock for these companies as to tie real-world objects to digital representations within the logic of an app. This allowed them to apply software to problems that were traditionally handled by inefficient human-run systems, such as taxi dispatches, or tackle problems that just weren’t solved at all, such as doing odd jobs. Couple that with the ubiquity provided by the rise of smartphones, and you have the recipe for an explosion in products in this space, rapidly scaling to billions in revenue.
However, that explosive growth and disruptive force has not come without drawbacks. Because these services are radically new, they don’t fit neatly into existing regulatory frameworks, leading to intense blowback from governments across the world. Meanwhile, the markets for these companies are not yet proven: basically no company offering O2O services has ever turned a profit, and gig workers on these platforms often struggle to earn a living wage.
Dealing with the real world is far messier (and far less profitable) than working solely with bits. However, I expect that as companies mature and become better situated within society, there will continue to be a lot of opportunity in building Online-to-Offline services.
Online-to-Offline Products
Featured Markets: eCommerce, Online Travel
Notable Companies: Amazon, Wish, Booking.com
The sheer size of this quadrant belies a simple truth: most things people care about are not on the internet. Online-to-offline products connect physical stuff people want — books, clothes, hotel reservations, toothpaste — with buyers over the internet. The first ever transaction over the internet occurred when a pair of Stanford students sold an undetermined amount of marijuana to an MIT student across the country. Since then, eCommerce has seen explosive growth: it is only 10% of total US retail spending and yet its market size is larger than all of the other markets featured on this map combined:
Expect this sector to continue to grow, as internet-native generations grow older and gain more purchasing power, pushing more commerce to the internet.
III.
Putting together all of these quadrants gives you the E-conomy map:
Now this map is a starting point, not an ending point. I expect over the coming months and years, as this newsletter develops and I gain a more nuanced understandings of the workings of the internet economy, for the map to change along with that understanding. For now, I hope that this article has developed your understanding of the different companies, products, and business models that exist in the digital economy. I’m looking forward to exploring more.
Thanks for reading! If you have any comments, feedback, or thoughts feel free to reply to this email. I always am down to discuss what you thought of my arguments — especially if you disagree with me 😉. Finally, if you enjoyed this post consider sharing it with a friend who you think might be interested.
See you next Sunday,
Noah