Time Preferences and Technology Transitions

The conventional wisdom is that the Internet killed Borders books.  Even the rejoinders to this thesis emphasize that poor strategic choices were mostly made by failing to appreciate the changing technological landscape.  Either way, it’s a fact that the money that used to flow into Border’s cash registers now goes to Amazon and iTunes instead.

Collapse in response to technological transition is a recurring business theme.  Digital photography bankrupted Polaroid, then Eastman Kodak — both former high-tech “blue chip” stocks.  Even Apple rose from the ashes of a company on the brink of liquidation, and at the very bottom, turned to arch-rival Microsoft for an infusion of desperately needed capital.  (That was way back in 1997.  MSFT sold their AAPL holdings later, without fanfare.  Compare the tone of the quotes from the executives.  What a difference).

So, if corporate executives have trouble managing technological change, what about consumers?  Here, news stories give us the impression that anything new is all the rage.  In fact, they rarely tell us about the high-tech products that go straight from the laboratory to the dustbin.  For consumers, the choice is often between incurring one-time investment costs (in new equipment, and the time required to learn it), but recouping that investment in cost savings over time.  While people will certainly pay more for increased functionality, or increased convenience, ultimately technological innovation is expected to enable us to do more, cheaper.

To assess the financial viability of any technological comparison, we need to understand the time value of money.  That is, we need to understand if future savings will justify present-day expenses.

Typically, cash flows that accrue in the future are discounted, in comparison to present day balances.  There are several reasons for this, but the two most important are: risk (What if the expected future benefits don’t actually materialize?) and opportunity costs (What has to be sacrificed now to obtain something more in the future?).

This video depicts a study of time preferences in children.  The marshmallow experiment is a famous test of this concept conducted by Walter Mischel at Stanford University in the 1960s.  A group of four-year olds were given a marshmallow and promised another if they could wait 15 minutes before eating the first one. Some children could wait and others could not. The researchers then followed the progress of each child into adolescence and demonstrated that those who waited were better adjusted, more dependable (determined via surveys of their parents and teachers) and scored an average of 210 points higher on the Scholastic Aptitude Test.

Problems of technology transition typically involve questions of time preference, where the new technology is more expensive up front, but results in savings later on.  To illustrate the point, we can study the transition from printed books to e-readers – ostensibly one of the important factors that drove Borders out of business. E-readers cost more now, but they generally offer books at lower prices in the electronic version (in comparison to printed).  So, in the long run an e-reader could save money.

Lots of people might be interested in knowing which technology is cheaper for them, over the long run.  For example, parents of young children generally buy lots of books.  Should they invest in an e-reader that their children can learn to use at an early age?  Or wait, reasoning that as the technology gets better, prices might come down?  Similarly, college students purchase lots and lots of books.  As more popular books (and textbooks) become available on-line, perhaps an aspiring freshman could save money by purchasing an e-reader for school?  Similarly, K-12 schools purchase millions and millions of books.  Would it save the school district money if they issued an e-reader to every student instead?

The classic conundrum of a typical technological transition has always been about large upfront costs balanced by longer term savings.  However, sharing economy apps like Lyft, AirBnB, and Turo present an interesting new twist on the old puzzle: Should they be owners of property, or renters?  While this dilemma has always been present in our lives, new information-communications-technologies (ICT) have changed the cash flow equation.  Once we’ve decided to purchase a smartphone, renting becomes cheaper and more convenient.  But so does owning, provided you’re willing to work to rent your property out to others and willing to accept the risks.

The balance seems to be shifting to renting.  For example, most people would rather stream their favorite movies over NetFlix or Amazon Prime, rather than own the DVD.  Many younger people feel its more convenient to use Lyft combined with public transportation or bicycle sharing, than it is to own their own car.

The economic advantage may be a greater utilization rate of capital — i.e., fewer empty rooms, or idle cars, resulting in cost savings.  But is that the problem that these sharing economy apps were invented to solve?

One thought on “Time Preferences and Technology Transitions

  1. jonathanedgington

    To eat or not to eat, that is the question ?

    I would have thrown the Marshmellow in the garbage so I didn’t have to look at it.

    I think that would have been the worst part just staring at it while waiting what probably seemed like forever for the woman to return.

    Reply

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