Social Arbitrage: The New New Path to Abnormal Returns

Jeff Bezos was not a dissatisfied customer.

He didn't start Amazon because he could never find what he was looking for. It wasn't because of poor staff recommendations. Nor did he just plain hate leaving the house.

Bezos wanted to take over online retailing, and he used the skills he gained as a quant trader to do it. He looked at the top twenty retail products sold via catalogue, and figured out why each product worked or didn't work. He looked at storage space, shipping costs, turnaround time, market demand, etc.

Amazon sold books not because Bezos was dissatisfied with the qualitative experience of bookstores, but because his analysis identified books as an arbitrage opportunity.

And it worked. And others noticed, and the programmer/quant combination became the backbone of the dotcom revolution.

But that opportunity is gone. It's been arbitraged out. Whereas ten years ago there was widespread temporary economic disequilibrium ready to be exploited, we've now reached a state of balance. It's not that rigorous quant analysis isn't important anymore; it's just as important now as ever. It's just that supply has caught up with demand, and so being a brilliant programmer and mathematical thinker is no longer enough to guarantee retirement by age 25.

So what's next? Social arbitrage.

Back in 1995 the biggest websites were all tools: Amazon, eBay, Yahoo!, Hotmail, etc. As tools, these websites did something for the user or enabled them to do something. The way to get rich was to build the tool that did the most stuff for the most people.

Today, all the good tools already been taken. That's why the hottest web startups today are not tools, but spaces: MySpace, Facebook, YouTube, Digg, Reddit, Squidoo, etc. If eBay is a single paintbrush, then MySpace is more like an art studio: a nice place to hang out with friends while working on similar projects and sharing a common toolset.

And in order of importance, what each tool does is less important than the social interaction that goes on around them.

Don't believe me? Remember oFoto and Shutterfly and Webshots? Remember what happened to all these sites? Flickr.

As tools, all of these predecessors worked as well or better than Flickr. (Remember Flickr's early flash uploader?). Flickr's innovation was to transform photos from an object of art into an object of sociability, and to transform photosharing from a set of tools into a community.

So, what does it all mean? To quote Howard Rheingold, "The 'killer app' of tomorrow won't be software or hardware devices, but the social practices they make possible." In the past, the key to creating the next blockbuster was having the best understanding of how people used technology. Today's big hits are coming not from those who have the best understanding of how people actively use technology, but rather from those who have the best understanding of how design decisions tacitly shape  social interactions between users.

For example, understanding the effect that Reddit's karma system has on the quality of discussion.  Using social psychology to motivate user contribution to online communities.Grokking the difference between the bond between a user and the group and the bond between multiple users, and being able to make intelligent design decisions accordingly.

We've reached the point where there is a growing body of academic research into online communities, but very little of it is making its way back into practice. That's partially understandable, since much of it is tentative or inconclusive. But what this early research is telling us is that, by and large, human behavior is human behavior. That is, the Internet is at best only a mediating variable, and a fairly predictable one at that. What this means is that we can apply to the ideas of traditional sociology, organization behavior, psychology, educational theory, etc. to online community design.

That's right, I said it: design.

By understanding the Internet's role as a mediating variable in social interaction, we can apply the knowledge of traditional social science to actively designing online communities. They don't teach courses on this in college. You can't buy a book on it on Amazon. But by combining the research with a little intuition and some good old fashioned mucking around, we can go a long way.

Look around and you'll see a lot of mistakes being made. And mostly it's the same mistakes being made over and over again. It's as if we're in another bubble.

During the first dotcom bubble, we had lots of startups run by MBAs that were getting trounced by the competition run by hackers. Today, the dotcoms run by guys who only hack are going to be trounced by the startups that also understand social systems.

Call it a temporary economic disequilibrium. Or, if you will, an arbitrage opportunity.

***

Consider this my "Hello, world!" post. Expect to see more on this topic in the future. And if you can't figure out what sensemaking means then don't bother subscribing to the RSS feed; you probably won't get it anyway.

Comments

[Frank Ruscica]

Agreed. Hence, a new key to sustainable competitive advantage is creating media that:

* increases awareness of the community
* showcases participants in the community
* generates profits

[Joseph Wecker]

Perfect. Great hello world post. Thanks Alex.

[pageman]

Another killer app would be the constructs that would allow cultures/communities to bridge each other. I'm thinking of contextualization/localization/internationalization.

[Ethan]

"Today, all the good tools already been taken."

Bonehead.

[Edward Vielmetti]

1. community. 2 ??? 3. PROFIT !1!1!

The arbitrage opportunity I see is a structural holes one - find parts of the net that aren't interconnected yet and bridge the gaps. This has been the classic way to build internetworks for the longest time, no change there.

[Cleo]

Very good article - many thanks for sharing
Have made a translation into French
on my blog with the link to your
site and original English text
If you want to check
http://cultureinternet.com/alex-krupp-arbitrage-social-traduction.

[Alex Krupp]

Thanks Cleo, I appreciate it. Feel free to translate anything you want from this blog. :-)

[איפור מקצועי]

Great and nice blog on The arbitrage opportunity there must be a structural holes one - find parts of the net that aren't interconnected yet and bridge the gaps.