David Warsh (1998): Whose `Rules?’: “For the last year, hardly a week has passed without…

…some bright new book fetching up on my desk promising to explain some aspect of the business dynamics of the new age of information…. In all this stack of books on managing knowledge, intellectual capital, the ecology of information and the like, the single volume most worth reading — and, for many persons having, for it bears consulting again and again — is ‘Information Rules.’…

Shapiro and Varian are professors at the University of California at Berkeley. Shapiro served for a time in Washington, D.C., as deputy assistant attorney general for economics. Varian is dean of Berkeley’s School of Information Management and Systems, an expert on Internet economics and the author of a leading microeconomics text as well.

As they increasingly were drawn into the policy battles of the information age, Shapiro and Varian heard the constant refrain from entrepreneurs, consultants, and journalists: the old rules had been broken; a new set of principles was required to guide business strategy and public policy.

They write in their introduction:

But wait, we said. Have you read the literature on differential pricing, bundling, signalling, licensing, lock-in, or network economics? Have you studied the history of the telephone system or the battles between IBM and the Justice Department?

Our claim: You don’t need a brand-new economics. You just need to see the really cool stuff, the material they didn’t get to when you studied economics.’

And so they wrote their book.

The battle over incompatible standards, for example, is as old as North vs. South in railroad track gauges; between Edison and Westinghouse in electricity. True, the old story had been given some new twists, by Sony vs. Matsushita in videotape players, or 3Com vs. Rockwell and Lucent in modems. The jury is still out on DVD and Divx (both of which play CDs). But same as it ever was, standards wars may end in truce, as with modems; in duopoly, as with video games; or in annihilation of one of the parties, as with videotape players.

The keys to the analysis of networks are the twin concepts of positive feedback and network externalities, the authors say. Neither one is a recent arrival. Network externalities — when the value of a product to one user depends on how many other users there are — have long been recognized as keys to transportation and communications industries.

For example, a handful of telephones will have only limited value. Then positive feedback sets in: as the installed base of telephones grows, more and more users find it worthwhile to tap into the network. Eventually growth levels off, but only after a successful technology has taken over the market. Railroads, highways, electricity grids, television, e-mail: all obey the same basic principles.

‘Information Rules’ has something to say about nearly every aspect of today’s business terrain; it is hard to exaggerate how pervasive is the logic of positive feedback. Among the most interesting chapters are those on recognizing and managing ‘lock-in,’ the widespread situation in which choices today are hemmed in by selections made in the past. The cost of abandoning your Toyota for a Ford may not be great, but just try switching from a Macintosh to a Windows PC.

Savvy marketers, moreover, are trying to raise the switching costs to their customer base, and not just through tricks of engineering, training, and design. Frequent-flier miles are an especially successful device for increasing lock-in, a subtle form of volume discount. Consumer loyalty programs are proliferating everyday as computation power creates ‘synthetic frictions,’ little barriers designed to influence your choice. Those supermarket cards, for example, that gain you sale prices, in return for the windfall of information about your tastes that store owners receive, are a prime example.

The overriding virtue of ‘Information Rules’ is that it is clearly written but deeply grounded in a sense-making discipline that has evolved over a couple hundred years. If you want to know more about the whys and wherefores of ‘Goldilocks’ pricing — if your market doesn’t segment naturally, choose three versions, just like Goldilocks — you are referred to a paper by Itamar Simonson and Amos Tversy (and to the three sizes of peanut butter in your supermarket!). Got a question about the virtues of standardization through committees vs. the market? See the recent work by Joe Farrell and Garth Saloner.

Economics isn’t perfect — far from it. But it has raced ahead in the last 25 years in topics of the greatest concern in industrial organization. This book is the best available introduction to the nuts and bolts of new learning.