What Is A Commodity, Exactly?

Lynne Kiesling

This item has been sitting open on my desktop for a few days … I enjoy reading Jonathan Schwartz’s blog, and he recently had a post in which he discussed what it means to be a commodity. See also his post from July 2004 on commodification that he links therein.

Andrew Morton (of Linux kernel fame) gave a low energy speech in which he said “Operating systems are commodities, now we’re moving to commoditize the rest of the stack.” He made those statements as if to suggest “commodity” meant “no longer of value.” I don’t think Andrew understands commodity markets. Here are a few: oil, gas, financial services, telecommunications and electricity. Commodity markets are the biggest and highest value markets in the world – because they represent products and services for which there’s global, perpetual demand. They tend to be markets won or lost based on research and development (check out the largest R&D spenders in the world, they’re almost all serving commodity markets). Computing may be a commodity – computers, and their operating systems, are most certainly not.

What interests me about the way he discusses commodification in these two posts is how relevant they are to my conception of the electricity industry. It’s sadly common for people to characterize electricity as a commodity, because “it’s just electrons, and people don’t care about it as long as the lights come on when they flip the switch”. However, just like bandwidth, the homogeneous nature of electrons does not make electric power service a commodity. As Jonathan said in his July 2004 post:

Can you discriminate one company’s bandwidth from another? Pricing, yes. Bandwidth, no. Can you discriminate one company’s browser from another? Yup, especially recently. How about one company’s mobile handset? Linux distro? 4-way x86 server? Absolutely. They all make that bandwidth useful and interesting, but they’re highly differentiated technology products.

[warning: vast overgeneralization ahead] Engineers and so-called consumer advocates like to call electricity a commodity, because thinking of it as such serves their interests. Thinking of electricity as a commodity maintains the focus on the physical assets of a closed system that requires real-time balancing. It also provides the impetus for an argument that prices should stay low and stable, preferably through some top-down regulatory mechanism.

That’s what is potentially threatening about the more modern, more empowering view of electricity as highly differentiated technology products bundled with a commodity. Such a concept of electricity opens up the system to be the union of the physical assets, and the physical reality of their operation, with the human preferences and human cognition that creates value through the consumption of highly differentiated technology products. It also means that the value proposition to customers becomes much, much richer than price level and stability. It becomes “we want to sell you things you can do with this commodity”, not “we have a monopoly to sell you a commodity at a regulated price”.

So here’s my question to you: is electricity a commodity? I say no. Electrons are a commodity. Electricity is a highly differentiated technology service, if we would only let it happen.


7 thoughts on “What Is A Commodity, Exactly?

  1. I prefer to avoid positive characterization of “electricity” because it is not a sufficiently specific term. Electricity is certainly not a commodity. Electrons are not literally a commodity because delivery of electric energy is not delivery of electrons, not in the way that delivery of natural gas is literally delivery of molecules. Besides, electrons are everywhere. The power system delivers electrical energy. The question is whether electric energy is a commodity in the same way that its energy sources may be.

    Can electric *energy* be equated with a “service”? Literally I don’t think it can. The work that electric energy can do can be services, but at the outlet it doesn’t seem that the energy itself is a service. Nevertheless, it is possible to consider the function of the electric system to be a service of delivering energy from remote sources. Electric energy is the delivered form of energy derived from a variety of sources, none of which is electric in nature. Commodity trading of electric energy is a proxy platform for forward trading of real energy sources (gas, coal, uranium) converted to a single form. The conversion and delivery system that makes this all possible performs a real-time service well after the fact of commodity trading, and this service is specific down to the delivery point.

    All that said, I’m not sure I understand your concept of a highly differentiated technology service as you intend it, but I suspect that it is separable from the energy commodity.

  2. Something I used to tell my consulting clients: “The existence of a commodity product means that a marketing manager is not doing his/her job.”

    Even commodities are not commodities: To a Japanese steel mill, coal purchased from Australia has different attributes to coal purchased from Brazil, both in terms of physical attributes (the precise chemical composition will impact the burn rate in the furnace, for example) and in terms of pre- and post-sale attributes (such as the different likelihood of strikes by seamen disrupting delivery times from the two countries).

  3. It’s not clear to me where you’re suggesting that the differentiation occurs, which would seem to be important to the definition of electricity as a commodity or a differentiated set of services. If the differentiation occurs at the generation end, that results in a highly differentiated service, whereas if the differentiation occurs after the electricity reaches the consumer, I’d argue that it is most certainly a commodity.

    The reason I see differentiation in generation is that electricity providers are providing (from what I can see) essentially three different services. The first is a base load service, which relatively low-cost, but inelastic; a nuclear power plant is the perhaps the perfect example of this. The second is a peak load service, which is highly elastic, but comes at a relatively high marginal cost; a diesel generator would be a good example of this. The third is a broad umbrella of niche services, like wind power generation, many of which can only supply a small percentage of grid demand due to their constant output fluctuations. In this sense, electricity is a differentiated service—and through the purchase of green certificates, for example, even individual consumers can select which service they wish to purchase. Further, under even fairly crude variable-rate pricing schemes, consumers can select between purchasing peak and base load services.

    But I don’t really see differentiation at the consumer end—what the consumer chooses to do with the electricity—as sufficient justification to view electricity as a differentiated service, rather than as a commodity. If we consider two possible analogies, I think this point becomes clear. If we consider Jonathan’s point that different companies’ mobile handsets are differentiated, despite the fact that they are bundled with a homogenous commodity (bandwidth), this provides one analogy—the whole package is a differentiated technology service, with a commodity as a part of the bundle. Another analogy can be found in any generic commodity—let’s choose wheat. I’d argue that electricity is more like wheat. It’s not actually bundled with anything that differentiates it like the mobile handset/service is. Since all electricity has to meet basic standards (waveform, voltage, amperage), much like wheat does, there’s not much to differentiate what the consumer receives from what the consumer would receive from another producer. And, perhaps most importantly, we can look at wheat from the perspective of selling “things you can do with this commodity” as well, but it’s still a commodity. With wheat, it might become a loaf of bread or a hefeweizen (highly differentiated!), but the end product’s differentiation doesn’t affect the commodity-nature of the intermediate product. In the same vein, electricity be used might run my computer or my Big Mouth Billy Bass, but the power company is selling me the electricity, not these highly differentiated services.

    I should probably note, though, that even if electricity is a commodity, I don’t think that makes the top-down approach any more justifiable.

  4. It’s not clear to me where you’re suggesting that the differentiation occurs, which would seem to be important to the definition of electricity as a commodity or a differentiated set of services. If the differentiation occurs at the generation end, that results in a highly differentiated service, whereas if the differentiation occurs after the electricity reaches the consumer, I’d argue that it is most certainly a commodity.

    The reason I see differentiation in generation is that electricity providers are providing (from what I can see) essentially three different services. The first is a base load service, which relatively low-cost, but inelastic; a nuclear power plant is the perhaps the perfect example of this. The second is a peak load service, which is highly elastic, but comes at a relatively high marginal cost; a diesel generator would be a good example of this. The third is a broad umbrella of niche services, like wind power generation, many of which can only supply a small percentage of grid demand due to their constant output fluctuations. In this sense, electricity is a differentiated service—and through the purchase of green certificates, for example, even individual consumers can select which service they wish to purchase. Further, under even fairly crude variable-rate pricing schemes, consumers can select between purchasing peak and base load services.

    But I don’t really see differentiation at the consumer end—what the consumer chooses to do with the electricity—as sufficient justification to view electricity as a differentiated service, rather than as a commodity. If we consider two possible analogies, I think this point becomes clear. If we consider Jonathan’s point that different companies’ mobile handsets are differentiated, despite the fact that they are bundled with a homogenous commodity (bandwidth), this provides one analogy—the whole package is a differentiated technology service, with a commodity as a part of the bundle. Another analogy can be found in any generic commodity—let’s choose wheat. I’d argue that electricity is more like wheat. It’s not actually bundled with anything that differentiates it like the mobile handset/service is. Since all electricity has to meet basic standards (waveform, voltage, amperage), much like wheat does, there’s not much to differentiate what the consumer receives from what the consumer would receive from another producer. And, perhaps most importantly, we can look at wheat from the perspective of selling “things you can do with this commodity” as well, but it’s still a commodity. With wheat, it might become a loaf of bread or a hefeweizen (highly differentiated!), but the end product’s differentiation doesn’t affect the commodity-nature of the intermediate product. In the same vein, electricity be used might run my computer or my Big Mouth Billy Bass, but the power company is selling me the electricity, not these highly differentiated services.

    I should probably note, though, that even if electricity is a commodity, I don’t think that makes the top-down approach any more justifiable.

  5. Everything that Procter and Gamble makes is a commodity, and they brand it and sell it for more than others can.

  6. I didn’t see where you defined what a commodity _is_, maybe I missed it. If oil is a commodity why isn’t electricity?

    Oil is a differentiated product: various types of crude, refined products and byproducts. Time and location tend to be less important, as one can store it and shipping costs are low.

    Electricity is quite homogeneous (all electrons are effectively identical) but importantly differentiated by time and location.

    In each case, the differentiating factors are traded actively in big liquid markets. For example, spreads between different types of crude oil and refined products are traded. Electricity location spreads are also traded.

    There’s no dearth or richness and complexity. What’s valuable is not rich variety but its opposite, standardization.

  7. When a software engineer says operating systems are a “commodity”, he doesn’t mean “no longer of value”. He means they no longer are subject to proprietary lock-in, and the services (i.e. interfaces) you get from them are now available from other vendors’ products. He’s right. The OS differentiation that Microsoft earned in the 90’s (with Win95 and then NT) has largely evaporated, due not to the magic bullet of a more abstract platform (like Java or the browser), but rather due to a lot of hard work by the open source community.

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