David Stutz and Software "Commodification"

 

In my first post, I said that I probably wouldn’t be posting any treatises on Economics. Well, I’m sorry to say, I’m posting one now. Why? Because yesterday the O'Reilly Network Developer News, pointed to an article written by David Stutz. For those who don’t recall, David Stutz headed up the Rotor project before leaving Microsoft, and was a vocal advocate of open source both before joining Microsoft and when he was employed at Microsoft. His parting open letter to Microsoft, written a little more than a year ago, found some cachet within open source circles.

 

My only personal contact with David occurred just before he left Microsoft. The lead program manager for Mac Word, Jason Webber, was leaving Mac BU to join the Visual Studio.NET team. One of us had the brilliant idea of sending Jason off with the, then yet to be released, version of Rotor that ran under Mac OS X, so I fired off a piece of e-mail to David asking where we might find the bits. David was more than accommodating, and very easygoing.

 

I’m inclined to think that David’s really a very nice guy, which is why I’m so very disappointed with his whole concept of software “commodification”. Besides the fact that “commodification” is the wrong word (the correct word is “commoditization”), he really fails to grasp the essential details of the concept. As a result, his conclusions are misguided at best and procrustean at worst. Hence, this post.

 

If you’ve slogged your way through David’s essay and found yourself saying, “Huh?” don’t feel bad. He’s talking about the process by which certain goods and/or services become “commodities”. As David correctly points out, commodities are fungible regardless of the producer. You can substitute one producer’s output for another producer’s output without noticing the difference. As such, commodity producers tend to compete solely on the basis of price, and relative profit margins are determined by each individual producer’s costs of production (what accountants call “cost of goods sold” or COGS). Commodity markets tend to most closely resemble what Economists call “perfect competition”.

 

For example, milk is a commodity. Given a taste test between Lucerne 2% milk and Wilcox 2% milk, only a very small percentage of the population would be able to tell the difference. Between various stores, you might find as much as a 50% difference in prices for a gallon of 2% milk, but that’s mostly because some retail sellers use milk as a loss-leader to bring people into their stores.

 

Contrast this with, say, DVD players. If you go to PC World’s price grabber, you’ll find the most expensive player priced at just under $4100.00. The least expensive DVD player is $49.00. With a price differential of nearly two orders of magnitude, clearly the market for DVD players is not a commodity market. If we’re going to understand the process of commoditization, then our understanding had better account for the difference between the market for milk and the market for DVD players.

 

One way to understand that difference is to claim that all goods and services either are commodities already or will eventually become commodities, and that goods and services in markets with huge price differentials simply haven’t become commoditized yet. This seems to be David’s stance, though he doesn’t explicitly say so. The problem with this stance is that some markets appear to never become commoditized, and there is no real way to see how they can become so. Consumer electronics has resisted commoditization since the invention of the radio, and there’s no sign that commoditization is near. While overall prices in the market for consumer electronics have dropped steadily over the years, a wide variety of prices continues to be a feature of that market. Indeed, if anything, the price differentials have increased, not decreased.

 

Another way to understand the difference is to note that some goods or services lend themselves to something called “product differentiation.” This concept is predicated on the idea that consumers have a wide variety of tastes, and that some are willing to spend more than others to satisfy those tastes. Goods and services marked by product differentiation tend to compete on the basis of “features” rather than price. Economists tend to not like this idea, because it makes for very messy mathematical models.

 

That David’s argument fails to grasp this distinction is bolstered by the fact that David quotes Karl Marx. Marx, along with most of his 19th century contemporaries, was mired in an effort to arrive at some objective notion of “value,” and all of Das Kapital is predicated on the idea that this objective definition exists. Without it, the whole idea that the proletariat even has something that can be called an “excess value” that can be appropriated by capitalists fails to make any sense (which is probably why so many people fail to get past Economics 101).

 

But I digress. Our question is whether the market for computer software (which is a stratified market) more closely resembles the market for milk or the market for DVD players. We might note the lack of variety in, say, desktop software, and conclude that software more closely resembles the market for milk, but I think that would be a mistake. The difference between a commoditized market and a non-commoditized market does not lie in the variety of products in the market at any given time. Rather, the difference is whether or not products within that market lend themselves to competition on the basis of features.

 

I don’t know that there’s any more conclusive evidence on this issue than the fact that everything we talk about in the software industry has to do with features. Every religious debate from vi vs. emacs to Macs vs. PCs is really a debate between differing individual preferences. Even the discussion involving “total cost of ownership” is really a discussion about features, or, more precisely, it’s a discussion about the way in which certain features justify a differential in price. We can “taste” the difference, which means the market for software is not like the market for 2% milk.

 

 

Rick