4: FOLLOW THE FREE

Why the Net Rewards Generosity

The very best gets cheaper each year. This principle is so ingrained in our lifestyle that we bank on it without marveling at it. But marvel we should, because this paradox is a major engine of the new economy.

Before the industrial age, consumers could expect only slight improvements in quality for slight increases in price. Over the years the improved cost more. But with the arrival of automation and cheap energy in the industrial age, manufacturers could invert the equation: They offered lower costs and increased quality. Between 1906, when autos were first being made, and 1910, only four years later, the cost of the average car had dropped 24%, while its quality rose by 31%. By 1918, the average car was 53% cheaper than its 1906 counterpart, and 100% better in performance quality. The better-gets-cheaper magic had begun.

The arrival of the microprocessor accelerated this wizardry. In the information age, consumers quickly have come to count on drastically superior quality for drastically reduced price over time. A sensible recommendation to anyone asking for shopping advice today is that they should delay buying a consumer good until about 60 seconds before they actually need it. Indeed, a transportation specialist told me that almost nothing in the information industry is shipped by sea anymore; it all goes by air, so the price won't have a chance to drop while the product is in transit.

So certain is the plummet of prices that economists have mapped the curve of their fall. The cost of making something--whether it is steel, light bulbs, airplanes, flower pots, insurance policies, or bread--will drop over time as a function of the cumulative number of units produced. The more an industry makes, the better it learns how to make them, the more the cost drops. The downward price curve, propelled by organizational learning, is sometimes called the learning curve. Although it varies slightly in each industry, generally doubling the total output of something will reduce the unit cost on average by 20%.

Smart companies will anticipate this learning curve. Very smart companies will accelerate it by increasing volumes, one way or another. Since increasing returns can exponentially expand the demand of items--doubling their totals in months--network effects speed the steep fall of prices.

Computer chips further compound the learning curve. Better chips lower the cost of all manufactured goods, including new chips. Engineers use the virtues of computers to directly and indirectly create the next improved version of computers, quickening the rate at which chips are made, and their prices drop, which speeds the rate at which all goods become cheaper. Around a circle the virtues go.