By Simon Bond

In a world of negative interest rates and falling prices and demand what does the future hold? The decision by the RBA to reduce the official interest rate was a direct result of the recent "deflationary" economic release. And they really had no choice if they were true to their charter.

Yet again we find that due to the Internet we are in unchartered territory, the traditional economists have missed this because when they were at school and university the online world didn’t exist. And this is a big reason why they have been so continually wrong footed about deflation, it’s not their fault, that’s just the way it is.

Bill Gates once said; “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten”.

Software is a completely new type of good in that it is copyable which means that any piece of software can have unlimited supply, leading to a theoretical price of $0, and then Internet was the big enabler as a means of distribution.

The Internet is the most deflationary force the world has ever seen, it creates global pricing transparency and it is going to be increasingly difficult to analyse the future based on the past. The two companies that dominated earnings in a largely gloomy quarter — Facebook and Amazon — are both uniquely enabled by the Internet; Amazon lets you rent computer power without buying a server, and Facebook serves 1.6 billion people customized content from an effectively infinite number of sources. 

The dominant business model since the industrial revolution has been that of manufacturing goods and selling them at (hopefully) a profit. This had a huge number of knock-on effects, including the shift in population from rural areas to urban ones, in cities created around transportation hubs and markets. Manufactured goods (or food produced on increasingly mechanized farms) were then transported to a central location, made available for purchase, and carried home by individual buyers, themselves primarily occupied in the creation of said goods. 

Over time, as economies matured, new types of businesses sprang up like professional services (lawyers, doctors, etc.), transportation, or luxuries like grooming or dining, but it was manufacturing that led to the creation of the critical mass of people necessary to make these sorts of businesses viable.

Over the past thirty years, this way of organising people (in developed countries) has been increasingly hollowed out as improved communication and transportation has linked a wave of globalisation and shifted manufacturing to the developing world and made services an increasingly central part of the economy (78% of U.S. GDP in 2015). 

The fundamental difference between manufacturing and services is that one entails the creation and transfer of ownership of a product, while the other is much more intangible: you visit a doctor or hire a lawyer, and you don’t get a widget to take home. 

In essence, services and software are both intangible, both scale infinitely, and both are infinitely customisable. It follows that a services business model, IE payment in exchange for service rendered, without the transfer of ownership is a much more natural fit for software than the transaction model characteristic of manufacturing. 

The enabling factor for both Uber and Airbnb applying a services business model to physical goods is your smartphone and the Internet: it enables distribution and transactions costs to be zero, making it infinitely more convenient to simply rent the physical goods you need, instead of acquiring them outright.

In the new economy, companies are enabling new business models in their own right. Amazon Web Services has dramatically lowered the barrier to entry for startups, and Facebook may very well do the same when it comes to advertising: it is easier, cheaper, yet far more measurable (and thus justifiable) for a small business to advertise on Facebook than any other medium ever.