The Superstar Economy: Why It’s Better To Be The Best In Today’s Winner-Takes-All Economy

This Oct. 16, 2012 photo shows author J.K. Rowling at an appearance to promote her latest book "The Casual Vacancy," at The David H. Koch Theater in New York. Rowling, the popular author of the "Harry Potter" series,... This Oct. 16, 2012 photo shows author J.K. Rowling at an appearance to promote her latest book "The Casual Vacancy," at The David H. Koch Theater in New York. Rowling, the popular author of the "Harry Potter" series, spoke for just over an hour before a capacity crowd in her sole U.S. public appearance to promote her first novel for grownups. (Photo by Dan Hallman/Invision/AP) MORE LESS
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J. K. Rowling, author of the Harry Potter series, is the world’s first billionaire author in an industry not known for minting the super wealthy. As George Mason University’s Alex Tabarrok notes of Rowling’s success:

Homer, Shakespeare and Tolkien all earned much less. Why? consider homer, he told great stories but he could earn no more in a night than say 50 people might pay for an evening’s entertainment. Shakespeare did a little better. The Globe theater could hold 3000 and unlike homer, Shakespeare didn’t have to be at the theater to earn. Shakespeare’s words were leveraged.

J. R. R. Tolkien’s words were leveraged further. By selling books, Tolkien could sell to hundreds of thousands, even millions of buyers in a year—more than have ever seen a Shakespeare play in four hundred years. And books were cheaper to produce than actors, which meant that Tolkien could earn a greater share of the revenues than did Shakespeare.

Rowling’s stories can be captured in movies and video games as well as text, but each of those formats, including the original books, can be transmitted globally at trivial cost. She and other superstar storytellers now reach billions of customers through a variety of channels and formats.

At the same time, others working in the content and entertainment industries have not seen a big increase. Only 4 percent of software developers in the burgeoning app economy have made over a million dollars. Three-quarters of them made less than $30,000. While a handful of writers, actors, or baseball players can become millionaires, many others struggle to make ends meet.

The economics of superstars was first formally analyzed in 1981 by economist Sherwin Rosen. In many markets, buyers with a choice among products or services will prefer the one with the best quality. When there are capacity constraints or significant transportation costs, then the best seller will only be able to satisfy a small fraction of the global market (for instance, in the 1800s, even the best singers and actors might perform for at most a few thousand people each year). Other inferior sellers will also have a market for their products. But what if a technology arises that lets each seller cheaply replicate his or her services and deliver them globally at little or no cost? Suddenly the top-quality provider can capture the whole market. The next-best provider might be almost as good, but it will not matter. Each time a market becomes more digital, these winner-take-all economics become a little more compelling.

Winner-take-all markets were just coming to the fore in the 1990s; the compensation was mainly determined by relative performance, to traditional markets, where revenues more closely tracked absolute performance. To understand the distinction, suppose the best, hardest-working construction worker could lay one thousand bricks in a day while the tenth-best laid nine hundred bricks per day. In a well-functioning market, pay would reflect this difference proportionately, whether it could be attributed to more efficiency and skill, or simply to more hours of work. In a traditional market, someone who is 90 percent as skilled or works 90 percent as hard creates 90 percent as much value and thus can earn 90 percent as much money. That’s absolute performance.

By contrast, a software programmer who writes a slightly better mapping application—one that loads a little faster, has slightly more complete data, or prettier icons—might completely dominate a market. There would likely be little, if any, demand for the tenth-best mapping application, even it got the job done almost as well. This is relative performance. People will not spend time or effort on the tenth-best product when they have access to the best. And this is not a case where quantity can make up for quality: ten mediocre mapping tools are no substitute for one good one. When consumers care mostly about relative performance, even a small difference in skill or effort or luck can lead to a thousand-fold or million-fold difference in earnings. There were a lot of traffic apps in the marketplace in 2013, but Google only judged one, Waze, worth buying for over one billion dollars.

In addition to the technical changes that have increased digitization, telecommunication, networks, and other factors that create superstar products and companies, there are more aspects at work in boosting superstar compensation for individuals. In some cases, cultural barriers to very large pay packages have fallen. CEOs, financial executives, actors, and professional athletes may be more willing to demand seven- or even eight-figure compensation deals. As more people get those deals, a positive feedback loop emerges: it becomes easier for others to make similar requests.

Laws and institutions have also changed in ways that often boost the incomes of superstars. The top marginal tax rate was as high as 90 percent during the Eisenhower years and over 50 percent early in Ronald Reagan’s administration, but fell to 35 percent in 2002, where it remained through 2012. While this shift obviously boosted the after-tax income of top earners, research suggests it can also affect reported pre-tax income by motivating people to work harder (because they keep more of each dollar they earn) and report more of their actual income, rather than seek ways to hide or shelter it (because the costs of reporting to tax authorities aren’t as high as before).

Although the top 1 percent and 0.01 percent have seen record increases in their earnings, the superstar economy has faced a few headwinds. Perhaps the most important among these is the growth of the long tail—the increased availability of niche products and services. Technology has not just lowered marginal costs; in many cases it has also lowered fixed costs, inventory costs, and the costs of searching. Each of these changes makes it more attractive to offer a greater variety of products and services, filling small niches that previously went unfilled.

Instead of going head-to-head with a superstar, some individuals and businesses are instead finding ways to differentiate their products, to find or create an alternative niche where they can be the world’s best. J. K. Rowling is a billion-dollar author, but there are also millions of other authors who now have a chance to publish for more specialized audiences of a few thousand or even a few hundred readers. Amazon will stock their books and make them accessible to people across the planet. That will be profitable for Amazon even if it would have been unprofitable for any physical bookstore, with a much smaller set of customers, to stock the book. Even as the technology destroys geography—a barrier that used to protect authors from worldwide competition—it opens up specialization as a source of differentiation.

Instead of being the thousandth-best children’s book author in the world, it may be more profitable to be the number-one author in Science-Based Advice for Ecological Entrepreneurs, or Football Clock Management. Following this principle, developers have created over seven hundred thousand apps for the iPhone and Android, while Amazon offers over twenty-five million songs. An even larger number of blog posts, Facebook stories, and YouTube videos have been created in the sharing economy, creating economic value if not necessarily direct income for their creators. As we’ve seen, however, opportunities to create new products don’t necessarily come with big paychecks. A superstar or long-tail economy with low barriers to entry is still one with far more inequality.

Adapted from the book The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies by Erik Brynjolfsson and Andrew McAfee. Excerpted by arrangement from W. W. Norton & Company. Copyright 2014.

Erik Brynjolfsson is the director of the MIT Center for Digital Business and one of the most cited scholars in information systems and economics. Andrew McAfee is a principal research scientist at the MIT Center for Digital Business and the author of Enterprise 2.0.

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