The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Thursday, July 06, 2006

Netflix and the Sandpile, Part 1 of 2: The Power of Inertia

Recently, I had the (belated) chance to read a fascinating article in the New York Times -- What Netflix Could Teach Hollywood -- by David Leonhardt, who writes on quantitative and economics related issues for the Times. While I was reading the article, there were two sets of profound insights (although I don't know whether Mr. Leonhardt intended to inspire these particular insights) that I felt drawn to write about. I will write about the second epiphany I had -- the power law versus 'normal' / bell curve distribution -- as part 2 of this series in the near future.

Today, however, I will tackle the first epiphany I had after reading David Leonhardt's column: the power of inertia.

Inertia is a relatively simple concept from physics. Inertia can be best described as the embodiment of Sir Isaac Newton's First Law of Motion: A body tends to persist in its state of rest or uniform linear motion unless it is compelled to change by forces acting on it. In other words, things tend to stay as they are -- either standing still or moving in a straight line -- unless something strong enough moves it off its state of rest or moves it off course.

Mr. Leonhardt invokes the concept of inertia to defend Netflix's business model -- renting DVDs via a physical delivery system (i.e., the postal service) -- against naysayers who quite reasonably claim that movies sent over broadband internet connections will make Netflix's current approach as obsolete as the horse and buggy:

But it could be years - 5? 20? - before downloading approaches the size of the DVD business. Sometimes, inertia can outlast technology long enough for somebody to build a very big business. And once a business gets big, it doesn't easily go away.

In other words -- drawing an analogy to Newtonian physics -- sometimes a business with a good, but not great, business model can survive and evesucceeded because it is simply easier to maintain the status quo -- ordering movies on the web but waiting a couple of days for it to arrive by mail -- until some 'force' is strong enough to knock it off its position. In the meantime, as the article points out, Netflix may have enough time and capital to develop a downloadable delivery system for films. Thus, in the business world, inertia can become a powerful 'force' (I realize I'm taking poetic license here with the scientific concept of force) that sustains business models that seem vulnerable to technological improvements.

The power of inertia, as applied to Netflix and the possibility of downloading films off the internet, is reinforced by Hollywood's attempts to use intellectual property law and licensing in order to hinder progress in the distribution of films over the internet. As Mr. Leonhardt points out, it is Hollywood's "fading business model" that seems more vulnerable than Netflix.

What can tip the balance in favor of technology over inertia so that downloading full length films over broadband connections is as appealing as renting DVDs from Netflix? This brings us to the 'sandpile.'

According to the of , as developed by a trio of physicists (Per Bak, Chao Tang, and Kurt Wisenfeld) at Brookhaven National Laboratory, carefully dropping grains of sand onto a specific area will create and build up a sandpile. Most of the time, each grain of sand will tend to 'stick' to other grains of sand due to friction, thus building up the sandpile. However, at various points throughout the evolution of the growing sandpile, a grain of sand will trigger a catastrophic avalanche that will topple large portions of the sandpile, thus displacing and re-shaping the pile.

(Bak, et al.'s, original model was a computer based simulation based on idealized mathematical algorithms. In real life, rice grains and rice-piles tend to behave more like the 'sandpile model' than real life sand grains do.)

The sandpile model of SOC has also been found to apply to earthquakes, forest fires, ecological population models, and financial markets. All of these examples of self-organized criticality exhibit the empirical signature of the power law (more on this in part 2 of this series of blog posts).

Returning to the question posed earlier, what can tip the scales in favor of new technology versus existing business models like Netflix or Hollywood studios? This is analogous to asking what are the conditions in which a particular grain of sand will cause a catastrophic change in the sandpile.

My interpretation of the sandpile model of self-organized criticality is that a grain of sand has to hit a point along a sufficiently pervasive network of criticality -- what science journalist Mark Buchanan refers to as "fingers of instability" -- to trigger catastrophic avalanches. Similarly, I believe based on my understanding of SOC, that the technology to make movies more readily downloadable will have to hit a collective social 'nerve' in order to bring about the kind of revolutionary change that can displace the business models that are currently protected by what David Leonhardt calls "inertia."

Perhaps something like the video iPod or YouTube will get people used to the idea of downloading video content off the web and, thus, be the kind of triggering event or technology that takes advantage of network effects -- i.e., hits a collective social nerve. I tend to think that the inertia-displacing technology will be something else that may only be a glimmer in the eye of some entrepreneur somewhere. I'm willing to bet that we will here about it sooner rather than later. In the meantime, Netflix is probably safe (although I wouldn't say that for Hollywood movie studios). Who knows ... perhaps the inertia that protects Netflix will give it enough time to develop or adopt the 'avalanche' trigger that will make downloading movies as ubiquitous as downloading music.

Stay tuned for part 2 of this series -- power law versus the bell curve -- sometime in the near future.

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