Cannibalization is hard

Cannibalization is hard. Really, really hard. But it’s often the only way to survive.

When a new technology comes along, the biggest problem for incumbents is being willing to cannibalize their existing businesses. We’ve known this for decades, and it was reinforced as a major theme of Clay Christensen’s 1997 bestseller. This unwillingness to cannibalize seems to account for the paralysis and the CFIT for a wide range of information goods.

In particular, I’ve been watching it happen in three industries within the US media sector. One that I recently blogged about is the newspaper industry, my former employer. The second I wrote a teaching case for my MBA tech strategy class back in 2001 — about how the record industry botched the MP3 challenge. The movie industry faces the exact same problems as records, but their files are bigger so pirating content has been less technically feasible (so far).

This dilemma was the topic of the first session today at a workshop I’m attending at USC’s Institute for Communication Technology Management. It was a killer media panel, of the sort you could only find in LA (or maybe NYC).

Leading off the panel was USC vice provost Adam Clayton Powell III (son of the famous Powell) who like me is interested in the newspaper industry. Also on the panel was Chris Gwiazda, CFO of Generate and Gerry Tellis, a USC marketing professor who’s studied disruptive innovation for more than a decade.

But the issue of why Hollywood (the movie industry) seems in denial about the digital world was the central focus of the final speaker of the panel: Steve Weinstein, founding CEO of Motion Picture Laboratories, Inc. (“MovieLabs”). MovieLabs is a 501(c)(6) cooperative R&D arm of the big six studios — Disney, Fox, Paramount, Sony, Universal, Warner Brothers — set up to come up with a quick tech fix to deal with piracy.

Weinstein made it clear: Hollywood has done such a good job of optimizing their revenue model that that it makes change nearly impossible. It uses a standard time schedule for release (versioning in the Hal Varian sense):

• In first 3 months, theatrical release earns 25% of total revenues but almost no contribution margin
• Hospitality (e.g. airlines), negligible revenues
• DVD, 6 months after initial release with 50% of the revenue and 60% of the contribution margin
• Pay TV such as HBO and Showtime a year after initial release, with 10% of revenue
• Commercial TV with 10% of the revenue, but two years after HBO.

(Don’t quote me on the numbers, I was typing very fast).

Weinstein identified three generic problems that the industry faces. To avoid putting words in his mouth, I’ll mark my own comments in italics.

First, although they have the highest growth potential, the new revenue sources are small — perhaps hundreds of millions of dollars a year. DVD sales, while declining, are $16 billion/year and provide the bulk of the profits and thus the bulk of the clout within a studio. With this relative share of short-term revenues and profits, “another year of selling 2 billion DVDs would not be so bad. Maybe it will be 1.9 billion,” as they watch this largest revenue source gradually decline.

Of course, this is straight out of Christensen’s Innovator’s Dilemma — sales execs and CEOs banking their commission checks up until the plane hits the side of the mountain.

The second issue is that all the contractual commitments restrict what movie moguls can do. If HBO has been promised no ad-supported distribution for two years, then you can’t give the movie to YouTube at any price during that period. Similarly, the union contracts — which include revenue sharing agreements — are extremely difficult to change (as the last few years of negotiations have demonstrated).

Finally, the uncertainty about the digital future — particularly with the unions and other conflicting stakeholders — has produced an institutional paralysis. To use Weinstein’s example: “How much are the rights to a theme song on YouTube going to worth? No one knows.” Without a precedent — or a fair way to price one — no one is going to be reasonable in trying to negotiate a deal or pricing.

As Prof. Tellis noted in the talk (for his earlier research), not only is cannibalization hard, but it’s necessary: cannibalization determines which firms will be able to survive a radical shift into the new era.

If any of the big six will survive, I’d have to put money on either Disney or Fox (NewsCorp.). Their respective CEOs — Bob Iger and Rupert Murdoch — were both mentioned today as understanding this brave new world better than the rest of the industry. I think Disney has more of a margin of error (i.e. time to fix things) than the other studios, given their unique positioning (particularly now with Pixar). Fox seems to be the most aggressive in moving into new media (NB: MySpace). So watch for one of these two to come up with a better revenue model for online media.

Nothing I heard today made me think that anything significant will change in the next two or three years. But if nothing changes in the next 10 years, they’ll all be sold off for a fraction of their current value to new owners who will find a better way to realize value from these assets.

I can’t tell you why

This morning’s Wall Street Journal says that Dell is readying a new MP3 player to compete with the iPod. Unlike its failed effort in 2003, this would also include a client application and download service for both music and video. As CNET notes, the Page B1 article makes a nice trial balloon.

It seems like Michael Dell dreams of surpassing Steve Ballmer’s success with the Zune. In the US, Apple has 70+% and Microsoft has 4% (Both Apple and Dell are much less influential overseas, so Dell has to hope that he can first gain US market share.)

To make this work, Dell would have to move from assembling products from standard parts to being able to do its own systems integration. Of course, that is why they bought Zing last year (presumably for something close to $50 million).

It’s not completely clear, but providing its own service would appear to shift to a differentiation strategy — away from its historic strength as a low-cost, commodity producer with low R&D. It certainly is part of an ongoing (and mostly unsuccessful) effort to achieve a consumer market share comparable to what it has with big business.

Why is Dell doing this? The story brings to mind a song by my favorite band: I Can’t Tell You Why.

MobileMe Mess Maybe Gone?

Last night, Apple claimed to have fixed the MobileMe problems that have plagued “1%” of its users. I am curious to see whether the ill-will it generated from that “1%” will dissipate or having lingering effects. (Note that’s 1% of Mac.com subscribers, not 1% of Mac, iPod or iPhone users).

In its (largely successful) efforts to attract switchers from Windows, I wonder if Apple realize that it’s changed the game on itself. For years, it had legions of highly loyal Mac fanatics who would use a Mac no matter how many frustrations, obstacles, or business model irritations were thrown in our way: the Mac was a better product and there was no way we would use Windoze.

However, the latest switchers have much less of a history and — if they face initial problems – are likely to switch back. And those who have two years of history with Apple are more likely to switch in the face of problems than those who have 20. If Apple really does have 20% of the US consumer market and 8.5% overall, then the majority of their Mac sales come from the recent converts rather than the 3% hard core that stuck with Apple through 1996-1999.

Apple has enjoyed a halo effect from their laptops, desktops, MP3 players and now their cellphone, one that has attracted casual users and allowed them to command premium prices. A slight amount on the tarnish could stop their revenue growth, even if 99% of their MobileMe customers (and 99.99% of all their customers) were unaffected by the recent fiasco.

BTW, my earlier MobileMe posting was the first one picked up by Seeking Alpha, the stock analyst blog federation. It appears an article on Seeking Alpha gets 100x or 1000x the viewers on this blog, but since they are only picking up a fraction of the postings (two in the past week) my focus will still be on this blog.

Unstoppable commodization of information goods

Information goods tend towards zero price for two reasons: one economic, one legal.

The economic argument is that the marginal cost of reproducing information is zero, and thus (as Yannis Bakos famously observed back in 1998) competition will eventually cause producers to sell their products at marginal cost, i.e. free. This is the ultimate outcome of commodization if there is nothing to prevent it — i.e. a cost structure that prevents self-defeating competition.

The same point is at the heart of the excellent treatment of information goods in the Shapiro and Varian book, Information Rules. It is also the nominal moral (and theoretical) justification for the argument “information wants to be free,” which is plaguing the newspaper industry.

However, the second reason for free is more practical: information is given away free because people can steal it. For more than a decade, we’ve called this the “Napsterization” of an information-based industry. New digital representations of technology make copying costless and error free. In this new digital regime, Napster (and Kazaa and BitTorrent) demonstrated that even if there are copyright laws on the books, enforcing them is another matter.

This was a topic of my first published academic paper (back in 1995), where I was thinking about the converse case — societies that didn’t believe in IP laws but might someday:

Societal attitudes toward intellectual property are less easily changed than a mere regulation, and enforcement of intellectual property rights depends as much on moral legitimacy as the enforceability of legal sanctions.

My coworker, Prof. Randy Stross of SJSU, wrote about a new area of copyright enforcement battles in his Sunday New York Times column: college textbooks.

The law is the same, but practical barriers had protected the textbook publishers thus far:

Compared with music publishers, textbook publishers have been relatively protected from piracy by the considerable trouble entailed in digitizing a printed textbook. Converting the roughly 1,300 pages of "Organic Chemistry" into a digital file requires much more time than ripping a CD.

There are even websites dedicated to stealing textbooks, like Textbook Torrents and Scribd.

As Randy points out, the textbook publishers have angered their customers through aggressive monopoly rent-seeking and extortionate practices such as planned obsolescence. While some of their responses (such as renting online textbooks) may reduce the incidence of piracy, others will just make things worse.

So the $100/copy prices are used to subsidize the manifest stupidity and inefficiency of their scattershot marketing process — i.e. the vast majority of losers in their catalogs. I have a dozen of sample copies of entrepreneurship and strategy textbooks on my shelves, sent to me unsolicited by publishers. I am no more likely to use them than I am to recommend the 4th best book on open source licenses.

With high up front costs and (relatively) low marginal costs, textbook publishing is like other media: the big winners are obscenely profitable and the losers have no hope of turning a profit. Thus, textbook publishers are exactly like record labels: they grew accustomed to high profit margins on winners both to cover their losers, but also to transfer wealth to shareholders and executives.

Without practical or legal protection, that business model will be as extinct as the dodo bird. It happened to CDs, it’s happening to textbooks, and movies are next. The publishers’ anti-piracy czar said “It is troubling that there is a culture of infringement out there.” No duh.

I’m really furious at both the publishers and these student self-appointed Robin Hoods, because together they are creating a generation of information pirates. To all these students studying organic chemistry: would you really prefer a world without IP — that instead of having a job producing information, you will instead have a job making things, delivering personal services or digging ditches? Is that really your nirvana?

A few of these pirates are socialists or crypto-anarchists deliberately attempting to destroy societal institutions. But most of these pirates are ahistoric teenagers without regard for economics or the law of unintended consequences.

At this rate, historians will someday look back at the 20th century as the high water mark for the value (and profitability) of information goods.

Cellphones no longer a luxury

The LA Times has a great story this morning about how the obsolete tax treatment of cellphones is causing hassles for employers and employees:

When the makers of the 1987 film "Wall Street" wanted to convey corporate raider Gordon Gekko's power and success, they gave him one of the era's most exotic executive perks: a cellphone.

The Motorola DynaTAC 8000X that actor Michael Douglas carried as he strolled along the beach was roughly the size of a brick and cost $3,995 when introduced three years earlier. A call during peak times cost upward of 50 cents a minute.

Times and technology have changed. Federal tax rules have not. The Internal Revenue Service still considers cellphones to be a pricey fringe benefit and has started enforcing regulations beginning in 1989. That's when Congress decided that mobile phones should be treated like company cars and other executive perks: Their personal use qualifies as extra compensation.

The law requires employees to keep detailed records of all calls made on their work-issue cellphones, indicating whether they were business or personal. If they don't, the phone and wireless service are deemed a perk that must be listed as taxable income to the employee.

Of course, what’s new is not the law but the IRS decision to start enforcing it by sending employers tax bills for this “fringe benefit.” Reporter Jim Puzzanghera reports the story in the context of the University of the California, where 8% of its employees have UC-provided cellphones.

This onerous record keeping is an example of the tax code at its most asine — a negative sum drag on the economy, in which the taxes collected will hardly pay for the cost of compliance by IRS auditors, UC pencil pushers and of course the individual employees.

HR. 5450 was introduced earlier this year by Rep. Sam Johnson to repeal this rule. Small business accountants applauded this temporary burst of Congressional sanity.

Alas, such sanity was only temporary. Not surprisingly for this Congress, the PayGo guidelines were used as an excuse to impose onerous record keeping somewhere else. With this addition, Johnson voted against his own bill when it passed the House in April.

Perhaps our “elected representatives” (i.e., self-perpetuating ruling class) will see fit to eliminate this obviously foolishness without substituting a less obvious one. Given the rise of Nanny State thinking in D.C., somehow I doubt it.

What really matters

Unless you’ve been living under a rock, you have heard the story about Carnegie Mellon Professor Randy Pausch and his famous ”last lecture.“

In the summer of 2006 the virtual reality expert was diagnosed pancreatic cancer, which is almost always fatal. (Steve Jobs being the notable exception). Last September, Prof. Pausch gave a 76-minute lecture to his students which got a standing ovation and has won millions of online views at places like YouTube and Google Video.

Ever since, he has been the subject of ongoing publicity and attention. He was the subject of an hour feature on ABC News Primetime (which is also available online). (A transcript is also available at the CMU website).

The lecture became a book, which became a #1 New York Times bestseller and has its own website. The book was co-authored by a Wall Street Journal reporter who heard the lecture and worked with Pausch to see it published before he died.

Dr. Pausch died Friday at the age of 47, leaving behind a wife and three kids. Befitting the logic of an engineer, he optimized the use of his final months. As the NYT summarized a few months ago:

The real wisdom of Dr. Pausch is that he tries to enjoy every day he has left with his family, while at the same time trying to prepare them for life without him. To that end, he is videotaping himself spending time with Dylan, Logan and Chloe so they can look back and see how he felt about them.

No one knows how long they have in this world, but Dr. Pausch seems to have made the best possible use of his advance notice — and changed a few lives in the process.

Bad week -- and decade -- for newspapers

It was a week of bad news for the U.S. newspaper industry, just the latest installment of a decade of such bad news.

• On Monday, a study by former LA Times reporter Tyler Marshall documented the downward spiral of the nation’s 1,217 daily newspapers. After interviewing executives from 15 papers and surveying 259 newspapers, the study from the Pew’s Project for Excellence in Journalism showed that executives are cutting staff, national and international news, but don’t have a real plan to turn things around.
• On Wednesday, the industry’s premier property (The New York Times Company) announced dismal earnings. In just a year, the company’s stock price has fallen to half its earlier value, to the point that the flagship paper is valued nearly the same as its suburban rival, the much smaller Long Island Newsday.
• Finally, on Thursday, the San Diego Union-Tribune, the oldest business in my hometown of San Diego (and the second oldest newspaper in Southern California) went up for sale. Apparently his financial advisors convinced owner David Copley that he could more easily support his lifestyle if his wealth was in T-bills rather than an illiquid, privately held newspaper descended from papers his grandfather bought 80 years ago.

The problem for Copley — like other sellers — is that there are few buyers. Once upon a time, Copley might have hoped for a merger with one of the two nearest newspapers: the Orange County Register or LA Times (which ran a SD editon from 1978-1992). However, both are in trouble: like most family-owned newspapers, the Register has unhappy heirs that care more about money than journalism; the LAT went through this already, resulting in the paper being bought in 2000 by the Tribune Company (and being badly run ever since). Among other likely buyers, national newspaper chains like the Times Company, Gannett, and Media General are reporting declining earnings while struggling with high debt from previous acquisitions.

Of course, stress and realignment for the industry come with every major dip in the economy, when fewer housing sales and reducing hiring squelch the two major sources of advertising revenues. In California, the 1992 recession killed the San Diego Tribune and the LAT’s SD edition. I bailed out of the newspaper business at the end of the 1982 recession, only six months before my coworkers traded up to the bigger paper (and a $100/week raise) when classified ads rebounded.

However, in 2008 the real pressure is coming from long-ignored structural problems. Newspapers are the ultimate information good — lots of up front costs and near-zero marginal costs (even less than for software, which tends to generate support costs proportionate to the quantity sold).

So, as with any other network effect, the virtuous cycle on the way up (success increase profits which allows a better product which fuels success) becomes a vicious cycle on the way down (declining sales means cuts reducing product quality which lowers sales further). Of course, I watched this vicious cycle nearly put Apple out of business, first as an Apple ISV and then in my dissertation.

Newspapers have a particularly hard problem — escaping the complacency of the past four decades. With few exceptions, all the major newspapers in the US were either a monopoly or cozy oligopoly (usually a duopoly). They didn’t have to compete to make money, they just told advertisers “if you want to reach local buyers, we’re the only game in town” and (at least before television) told readers “if you want local news, we’re the only game in town.” (In two-sided market terms, this is called charging both sides, although advertising provided 70-80% of the revenue.)

Now, of course, we have at least a decade worth of young people that no more expect to pay for news than they would pay for music; somehow they still pay for movies, but that probably won’t last either. The papers have reached out to new readers with their online websites, but as U-T investigative reporter David Hasemyer dryly put it,

While many newspapers' Web sites have recorded jumps in readership, media analysts have pointed out that advertisers generally don't consider an online reader to be as valuable as a print reader.

Even for those newspapers that enjoy broader reach than ever — notably the New York Times — a shift from print to online means that revenue (and profit) per reader has plummeted.

Newspapers face two structural problems and have been unable to fix either one. Due to new web-enabled competition, newspapers have lost their pricing power both sides of the two-sided market — and there seems no turning back.

First, is there are so many other ways to reach readers via the web — whether CraigsList, Monster.com or Google’s localized version of AdSense. The cost of one impression has plummeted from the days of dead trees when there was only one regular way to reach a given household.

More seriously, online information is now a commodity: people get news free now from so many online sources. (One major sources is from Google and Yahoo news sites, that use AP news compiled from local papers). OK, the NY Times or the big city daily has better news, but how much better? If it’s $20/month (or even $10 or merely requires a login) will readers bother? Most won’t. As with other commodities, better loses to “good enough.”

Some newspapers think it’s just a matter of getting a good revenue model, or fixing website design to be more compelling, or some other tweak. After all, they argue, people want local news and there’s no other source. This argument has been made by insiders for years.

To this, I’d say: “where’s the existence proof?” The newspaper industry is notorious for copying each others’ design, circulation and advertising tips, so with 100+ newspapers with more than 100,00 circulation, one of them should have figured it out by now. Instead, newspapers are using the same online revenue models they always have.

The only exceptions are financial newspapers like the WSJ and FT (where business owners and investors are willing to pay a premium for slightly better information) and the free suburban weeklies and subway dailies (which pay little or nothing for content, and it shows.)

Of course, most journalism students (like poli sci or history students) know nothing of economics and little of business. (BTW, back in 1981-1983, that included me too). So they keep hoping that — since all their friends know they have a better product than the bloggers and the wires and the other free sites — someday the tooth fairy will come waive her wand and everything will be right. But it ain’t gonna happen.

For nearly a year, rumors have been swirling that a big city newspaper (such as the SF Chronicle) will stop killing trees and go online-only. The first one will get hit with a double whammy: someone else will swoop in and get the dead tree advertisers (in this case, the SF Examiner or the Bay Guardian or the Oakland Tribune) while the collapse of revenues will mean a cutback in the news staff and thus the quality of the online product. Maybe the paper could stabilize with an editorial staff of 150 instead of 500, but (as with any newspaper today) the process of downsizing would be bloody, shaking the confidence of employees, and both types of customers.

Some rich guys buy money-losing sports teams for ego reasons; perhaps someone will do that with a newspaper. The problem with this sugar daddy fantasy is that the pro teams are an appreciating asset, while newspapers are clearly a declining one. Also, there are no luxury boxes in the newsroom that billionaires can use to impress their friends.

Good news for mobile phone industry

Two developments this week presage well for the mobile phone industry, despite declining consumer confidence in the US that seems to be spreading elsewhere.

Most concretely, Qualcomm and Nokia settled their patent dispute yesterday with a 15-year licensing agreement and termination of all existing disputes. Given the pivotal role the two play in the industry, I have to think that having the two companies working together will help the industry more quickly develop and deploy new wireless technologies.

More subtle is the broader implications Handango CEO Bill Stone sees in Apple’s July 12 rollout of its iPhone 3G, specifically the new App Store. In RCR News, Stone argues that the success of iPhone apps will help sell more applications for all smartphone platforms.

Normally, I’d be skeptical about his claims. After all, in August 1981 Apple took a full page ad in the WSJ welcoming IBM to the PC industry. Fifteen years later, facing the deluge of Windows 95 Apple was on life support en route to certain bankruptcy.

However, Stone makes three convincing points — so convincing that I wish I’d made them. (Actually, I did make one).

• Having more people install apps will raise the awareness of applications among owners of all mobile phones.
• As I’ve argued, competitors won’t sit still: Apple’s efforts will cause competing handset makers and carriers to redouble their efforts to create and distribute compelling applications.
• Apple’s success in bypassing the carriers will encourage more experimentation beyond just the carriers’ (largely failed) walled gardens.

Despite his blatant self-interest, I think Stone has it exactly right. There are only two ways to fight innovation: with price cuts or more innovation. In the developed world, the cellphone industry depends on replacement sales to maintain revenues: people don’t buy a replacement phone because it’s cheap, but because it offers something they don’t have in their current phone.

So both developments are good for innovation in the industry, particularly in pushing users away from cellphones as merely voice terminals and towards their ubiquitous adoption as converged computing and communications devices.

MobileMe Mess

As part of the iPhone 3G launch, Apple also switched its Mac.com to me.com, which it now calls “Mobile Me”. Now it’s clear that the switch has been a fiasco. Walt Mossberg trashed it today, as did David Pogue. Apparently Apple is stonewalling as to the extent of the problems.

In particular, losing (or making inaccessible) e-mail is a big deal: people don’t like to be without e-mail, even briefly. I remember one university CIO telling me that any time e-mail went down, he’d get a call to his desk in less than 5 minutes.

Pogue has it exactly right

O.K., look: Even big companies screw up. Intel's done it. Microsoft's done it. Google's done it.

Maybe it wasn't such a hot idea for Apple to launch four enormously complex initiatives -- the iPhone 3G, the App Store, the iPhone 2.0 software update and MobileMe -- all on the same day.

I understand why MobileMe is important: Mac.com had a very low penetration among Mac users and none among Windows users, and they hope to create something that every iPhone buyer will subscribe to.

Still, it seems like it would have made sense to launch the MobileMe later, after the other initiatives are out there; the others have a bigger impact on the bottom line, and MobileMe could have waited a few months until it was ready to go.

Steve Jobs has a reputation of suffering fools not at all. I wonder who will lose their job over this — and, more importantly, what lessons the company will learn about hubris.

Repealing the SOX tax

I’m now back in town after a combined business/personal trip late last week, one without much Internet access. So I’m catching up on some back reading.

One of the articles I missed was printed in Friday’s WSJ, where a commentator noted:

Last quarter marked the first time in 30 years that not a single company backed by venture capital went public in the U.S.

Yes, OK, the market was not very favorable for IPOs, but we’ve had other down markets in the past three decades; the absence seems extraordinary. One obvious implication is that if the traditional exit strategy has been foreclosed, it will be harder to get funding for new startups.

Commentator James Freeman lays the blame at Sarbanes-Oxley, and IMHO (next to the convicted felons from Milberg Weiss), nobody deserves it more:

"A lot of our CEOs are reticent to go through the public process. The [Sarbanes-Oxley] and governance issues are cumbersome, and it means they spend all of their time as administrators versus growing their companies," reports Kate Mitchell of Scale Venture Partners. She adds that chief executives don't want the liability risks of running a public firm and the same goes for candidates to serve as outside board members.

As for Sarbanes-Oxley, or SOX, the hope was that by now firms would have gotten over the hump of learning to comply, and auditors would have stopped obsessing over minute risks. Last year the Securities and Exchange Commission explicitly advised firms to focus only on material threats to the integrity of a firm's financials. "The SEC's heart was in the right place, but the accounting firms' hearts are not," says Mark Heesen of the National Venture Capital Association. He adds that the Big Four accounting firms "continue to feast on SOX audits."

Ms. Mitchell says the "SOX tax" runs up to $3 million per year per company, which can reduce a firm's market value by much more. Mr. Harrick says the costs of being a public company can approach $5 million.

Despite the visibility of this problem, neither presidential candidate plans on eliminating the infamous Section 404. Interestingly, if one kook libertarian (no not that one) somehow had made it to the White House, 404 would be history.

The SEC is trying to improve things but it’s not clear if they’ll be effective. If they don’t succeed before Christmas, it seems unlikely that their reform efforts will survive the next administration.

Freeman identifies another form of innovation drag with Elliot “tripped on my zipper” Spitzer, the former chief persecutor of NY State. Since Spitzer’s onerous policies were not voted for by any national politician, it seems hard to see how they’ll ever be repealed, although some provisions seem ready to expire in another 12 months.

Of course, the history of politicians is to neglect a problem until someone screws up badly, and then overreact. There are other ways that the problems of Enron and WorldCom could have been solved, but those would not have made Sen. Sarbanes and Rep. Oxley household names.

Without IPOs, there’s still the acquisition alternative. Freeman aptly summarizes why this alternative tends to produce less innovation than the other:

Does anyone think that we would be better off if Bill Gates and Michael Dell had sold out to corporate behemoths early in their careers, instead of leading their firms for years as public companies? Would consumers enjoy the same vibrant market in Web services if Yahoo had gobbled up a nascent Google? How powerful would our computers be if Intel had become an IBM subsidiary, instead of going public in 1971?
…
An IPO generally means that the founders can continue to run the companies they have painstakingly built, except with greater resources. An acquisition generally means that the founders move on, see projects they championed get axed, and watch old colleagues get fired.

Perhaps someday Android will be open

I really like Matt Asay — the founder of the OSBC is one of the most thoughtful people in the open source industry. (Brian Behlendorf, Chris DiBona and Cliff Schmidt are others who come to mind.)

But (and you knew there was a but) he’s really taking a lot on faith right now with Google, Android, the gPhone and the Open Vaporware Alliance.

The OVA is a Linux-based consortium copying the LiMo playbook, but about a 6-12 months behind. To use the term coined by researcher Sonali Shah, both LiMo and OVA are an example of a “gated source” community, not an open source one. Some people and companies are invited within the walls of the gated community and are allowed to participate, but others are not. That’s not open source.

The problem is that we don't know the real intentions of Google and Android: promises of openness are not openness. This also applies to LiMo and (given Nokia’s track record) to the proposed Symbian Foundation too.

In fact, that’s the whole point of open source — we don't have to rely on promises, because an approved open source license is a credible commitment that the code will be available in perpetuity.

However, even if Google releases the code someday under an open source license, that really doesn’t mean they’ve created a vibrant open source community. The IP license is only one of three dimensions of openness for sponsored open source communities, and there are plenty of examples of sponsored communities that do not provide openness on the other two dimensions, i.e. accessibility for outsiders to participate in development decisions and formal governance.

Thus far, Google’s open source projects seem to be limited to sharing code but not sharing power. I am not aware of an example (I could be wrong) of one with outside committers, although it appears that at least some less strategic projects allow outside patch suggestions (which the Google committers can accept or reject).

Even if Google’s consortium allows other firms to participate in formal governance, that doesn’t mean that it will be fully open or democratic. As with various totalitarian regimes, franchise or candidates may be limited to those who will vote the right way or those nominated for office may be vetted to vote the party line. Packing the board is quite common for consortia, trade associations, standards committees etc. — big boys like IBM, Intel, Microsoft and NTT do it, so there’s no reason to think Google and Nokia will resist the temptation.

So if Google’s promising to be open someday, maybe they will be. But Symbian Foundation or LiMo could get there first — or, for that matter, so could Microsoft, Apple or RIM if they wanted to. Lining up to endorse or promote Android because it’s “open” is like planning to take your vacation next summer at a hotel that has not yet been built.

Managing sponsored open source communities

Sponsoring open source projects is a tricky matter. On the one hand, if people don’t feel like their participation matters, they won’t get involved. On the other hand, the firm paying to do the sponsorship wants to make a buck from its investment.

Four years ago, Siobhán O’Mahony and I sat down to try to explain how sponsored open source projects are different from their independent (or community-managed) counterparts. The result was a conference paper we submitted in June 2004 (published in a conference proceedings January 2005) that was one of the first (if not the first) to draw attention to how sponsored projects were different from the independent variety.

That 2005 paper was the subject of a blog posting earlier this month by Roberto Galoppini. (I must admit, I can’t keep up with all the open source blogs, but for the economics of open source Roberto’s blog seems to be right up there with the one by Matt Asay).

Like anyone, I appreciate the mention and the kind words about our work. However, it’s a little embarrassing, because that 2005 paper is an early draft of thinking that progressed a lot over the next three and a half years. A newer (and much better) version of the paper was published in April 2008 in a special issue of Industry and Innovation on the topic of online communities and open innovation.

The final title makes concrete the idea articulated by Tim O’Reilly of the importance of “The Architecture of Participation”:

• Joel West and Siobhán O’Mahony, “The Role of Participation Architecture in Growing Sponsored Open Source Communities,” Industry & Innovation, 15, 2 (April 2008): 145-168. DOI: 10.1080/13662710801970142

I won’t pretend to summarize 11,000 words and four years of research in a one-screen blog posting. However, the meat of the paper can be found in two places.

First, we talk about two types of openness: transparency (letting others watch) and accessibility (letting others have a say). (In an earlier draft of the paper, we used “permeability” instead of “accessibility,” and the former term was also used by Dahlander et al in their introduction to the special issue).

Here is a quote from the introduction:

In designing a community, sponsors were more likely to offer transparency than they were to offer accessibility to external community members. We found that sponsors faced a control vs. growth tension. To leverage the ability of communities to contribute to their firm’s bottom line, sponsors sought to maintain control over the community’s strategic direction. However, sponsors soon discovered that by restricting access to community processes, they limited their community’s ability to attract new members and grow.

Secondly, we mapped these two types of openness onto three forms of control: control of production, governance of decision making, and ownership of the IP. These ideas are summarized in Table 2 below:

		Form of Openness		Proprietary Model
		Transparency	Accessibility
Dimension of Participation Architecture	Production – the way that the community conducts production processes	Ability to read code and observe or follow production processes	Ability to change code directly	Production remains within a single corporation
	Governance – the processes by which decisions are made within the community	Publicly visible governance, observers can understand how decisions are made	Ability to participate in governance	The corporation makes all decisions at its own discretion
	Intellectual Property – The allocation of rights to use the community’s output	Rights to use code and access source code	Ability to reuse and recombine code in the creation of derivative code	Limited use rights are granted by the corporation for a licensing fee

Personally, I think the meat of the paper is in Table 3, which talks about the specific trade-offs made across the various independent and sponsored projects. But I’m hoping that others will find value throughout the 38 pages.

People who find this paper interesting may also want to read two other papers:

• Siobhán O’Mahony, “What Does it Mean to be Community Managed?” Journal of Management and Governance, 11, 2 (May 2007): 139-150. DOI: 10.1007/s10997-007-9024-7.
• Joel West, “Value Capture and Value Networks in Open Source Vendor Strategies,” Proceedings of the 40th Annual Hawai‘i International Conference on System Sciences, Waikoloa, Hawai‘i (Jan. 2007): 176. DOI: 10.1109/HICSS.2007.600.

Update July 17: I thought I’d posted about this article earlier, but didn’t find the earlier mention until after I’d written this blog entry. Apologies for the duplication.

iPhone installed base up 17% in 72 hours

To the installed base of 6 million iPhone 2G phones, in the past three days Apple sold 1 million of its new iPhone 3G. An unknown number of 2G owners have also upgraded to the iPhone 2.0 software, including at least two of my loyal blog readers.

Of course, the big news is that AT&T and Apple created a new activation process that failed miserably under the flood of new users and brought a flurry of bad publicity. (Of course, this utterly predictable problem happened because they changed the activation process to make sure all the iPhones got activated). It’s TBD whether this bad experience will have any lasting impact, although those who waited in line over the weekend were clearly the hard-core true believers.

Between the new and existing iPhone owners, Apple this morning also claimed 10 million downloads of native iPhone applications from the App Store since it was launched Thursday. Since the SDK was released in March, Apple’s iPhone ISVs have created many compelling applications (although not much for business). They don’t specify, but most of the publicity is on the free applications which I suspect account for 90+% of the 10 million downloads.

What I’m finding interesting is what’s not there. Some 17 months ago, I proposed the iChat test. iChat is still not on the iPhone but a (text only) AIM is. (AOL also announced AOL Radio for the iPhone). I’m guessing AOL has noticed that AIM is no longer cool, and thus having the first native IM client on the iPhone might help it with the younger demographic.

But where is the VoIP service via iChat or Skype? Will these applications be funded (authorized) by Apple? It’s not as though there’s a lack of demand or interest. (Some would attribute it to Steve Jobs’ opposition).

No one knows if the gPhone will support VOIP, and it’s safe to assume that the carrier-led LiMo will not. So perhaps Apple has months to worry about this because competing platforms are in no hurry either.

Stuffing the pipeline

Our SJSU summer break began May 25 and ends Aug 22. Given our heavy teaching load, every year most of our research needs to get done during the summer if we hope to accomplish anything at all.

I've now finished 7 weeks of the 13 week summer break. I had a lot on my plate, but I think (unlike during 2007-2008 and 2006-2007) my research pipeline is coming along about where I'd like to be:

Stage	Goal	Completed	Remaining
Conference Talk†	2	2	0
Initial Journal Paper§	5	2	3
Revised Journal Paper	2	1	1
Final Journal Paper	2	2	0
Total	11	7	4

† which may eventually become a journal paper
§ one is a book chapter.

This includes presenting at a couple of conferences, doing one (1) field interview, a family vacation, and some stuff as the father of a tween who’s under foot.

Blogging is getting less time than during the school year. This may suggest why it was I got little research done during the school year, and thus what I need to do going forward.

Yet another stupid acquisition

One of the things that I teach my strategy undergraduates is that most acquisitions destroy value. Related diversifications realize less synergy than claimed, vertical integration locks a firm into a substandard supplier (or customer), any merger has culture, integration, and strategic defocusing problems.

Acquisitions make sense as an exit strategy for little companies: sometimes they even work, but either way they get to cash out. But, as I tell students, most big acquisitions are about the CEO moving up the rankings in the Fortune 500 (or increasing the base for a bonus based on revenues or net income).

There are always nominal reasons for the acquisition, but they are filtered and twisted to support what executives want to do. In the principal-agent problem, the principal (shareholders) gives the agent too much discretion and then shouldn’t be surprised when that delegation is abused.

This morning’s Exhibit 2,423 in the Stupid Acquisitions Hall of Fame comes from AMD. AMD admits that the $5.6 billion it paid 21 months ago for videochip maker ATI is now worth only $3.1 billion. Friday’s write-down of $880 million comes on top of a $1.6 billion write down in January. Despite punditry endorsing the deal two years ago, the company is struggling to service its $5 billion in debt and shares fell to a 16 year low. Value destruction doesn’t get any more clear or convincing than that.

The fundamental problem of acquiring public companies is that you have to pay more than the market price — so the claim is either you know better than the market (never true) or that you will realize synergies that increase the value of the acquired company (almost never true). So the choice is between buying overpriced good companies, or troubled companies not worth buying at any price. Acquiring a troubled company means you acquire their troubles — whether it’s exposure to an industry past its peak (AOL Time Warner, Viacom-Blockbuster) or a company with a justifiably lousy market position (Daimler Chrysler).

There's one other problem with megamergers — small numbers. Cisco makes more acquisition mistakes than any tech company in the world, but since they have more at-bats, they have more successes too. (Evidence suggests their batting average is much better than most). Big mergers are almost no upside and huge downside: think Sprint Nextel, or any of the recent Oracle acquisitions.

The poster child for diversification was once General Electric. Its extreme diversification has always meant a lack of financial transparency, which meant that investors were putting blind faith in management. That faith no longer appears justified: GE has missed projections two quarters in a row, and the stock is back where it was in May 2003 (and October 1998). Normally I don't like to inflict new (expensive) editions of the textbook on students, but I think we need one that drops the praise of GE’s diversification skills — which apparently only worked when management skills were scarce among its competitors.

Steve Jobs is not a crook

The WSJ and the Merc this week have reported that the SEC is not going to file criminal charges in the stock option backdating “scandal”† at Apple. Apple doesn’t seem to have acknowledged in either its PR or investor relations website pages. Obviously they don’t want anything to take away from the favorable publicity for the Jesus Phone II, which I hear is due any day now.

I guess I should not have expected a press release that said “I am not a crook.” Shareholders must be relieved that they weren’t going to see Jobs banned from being a public director, or even get the typical slap on the wrist (of a $10+ million fine) that such charges tend to bring. A civil action and a shareholder lawsuit are still pending, but somehow (unlike OJ) I imagine the result will be the same.

This happy outcome does not nullify the one particularly sordid aspect of the backdating kerfuffle†: how Jobs threw two of his most valued executives under the bus to save his own skin (and, some would argue, the company): CFO Fred Anderson and General Counsel Nancy Heinen, who also will not be charged. The strong suspicion is that even if they were personally involved, any such policy would have been approved by higher authorities.

After serving as CFO of ADP, Anderson joined Apple in 1996 as the only bright light of competence during the brief, dark Amelio era (which is why he was the only board member who got to keep his job when the iCEO came aboard). The company couldn’t buy a clue on its finances and inventory until Anderson imposed the necessary discipline.

Anderson was a holdover not a NeXTie, so it’s not surprising that there’s no love lost between the two nowadays. Last year, after he settled charges, he fired back at Jobs saying that the CEO knew more than he claimed.

Meanwhile, Heinen has been very silent despite being told to take the fall. She has a long history with Jobs after becoming NeXT general counsel back in 1994, continuing at Apple until May 2006: perhaps that’s why she hasn’t said anything. But those who knew her said that she was very very competent, even more so than her high profile husband Roger who was the Apple software SVP in the 1980s before jumping ship to Microsoft. Roger was (at least until recently) a partner at Flagship Ventures in the East Bay, but I can’t find any trace of Nancy on the web.

Nancy Heinen is certainly smart enough to know the answer to the question: “Which office do I go to to get my reputation back?” She is unlikely to be hired in a senior position by a public company, and at 51 it’s too soon to retire. I don’t know if she’s going to do nonprofit work, work for a VC or other private held firm — or (as acquitted Tyco counsel Mark Belnick did) go into private practice. But I hope that she can attain personal redemption with her considerable remaining (and underutilized) talents.

Photo of Nancy Heinen from Apple Insider.

---

† Merriam-Webster dictionary:

• scandal: 2: loss of or damage to reputation caused by actual or apparent violation of morality or propriety : disgrace
• kerfuffle: see fuss. fuss: 2a) a state of agitation especially over a trivial matter

Built to Last

I was sorting through old newspapers in the pile to read and found a column from the Merc that struck a nerve. Normally, business columnists are either shallow and superficial, or opinionated with conclusions not supported by the evidence presented (let alone reality). This was definitely neither of those cases.

The May column by Chris O'Brien refers to a speech by utility executive Jim Rogers:

Rogers described how he has embraced something called “cathedral thinking” and he was calling on the Valley to join him. I cringed at first mention of the term, worried that he was going to digress into some awkward religious metaphor.

(I’m not sure why O’Brien automatically assumed a religious metaphor would be awkward. Has he not heard of The Cathedral and the Bazaar, a metaphor embraced by as irreligious a bunch of geeks as you’ll ever find?)

Fortunately, O’Brien listened long enough to get the full story.

Rogers talked about a recent visit he’d made to Europe where he visited a number of the great cathedrals. It struck him that the person who often envisioned these great buildings didn’t live to see them built. Instead, they articulated a powerful vision that galvanized people to work on something that took generations to realize.

Rogers is proving the timelessness of two well-understood principles of effective business (or military) strategy. One is a long-term vision of what needs to be done; the second is creating a strategy (or perhaps just a culture or a set of enabling competencies) that will bring that vision to fruition, even if it’s long after the strategist is gone. This latter point is the theme of the Jim Collins bestseller. Bill and Dave certainly had it, Tom Watson Jr. had it, and I suspect (in their own narrow self-interested way) Gene Kleiner and Tom Perkins had it too.

The American political system is seriously broken by the exact opposite thinking Solving a real problem (like homeless people, failed public housing, structural budget deficits, social security) is important for society but too hard for politicians – so they don’t try. Instead, they “kick the can down the road” on these problems and find some symbolic quick victory (like televised hearings) to get re-elected one more time. Duane Delacourt, Doonesbury’s fictional “secretary of symbolism” for President Carter and then Governor Moonbeam, is now no longer exceptional enough to be worth mentioning.

Similarly, today’s CEOs want to string together 10 or 15 quarters of increasing earnings by a penny each time, so they can be handsomely rewarded for sandbagging their objectives before they are sacked. And VCs want to flip a company onto some greater fool before anyone is the wiser.

The occasion of the column and Rogers’ visit was a party commemorating the birthday of a 20-year-old startup, Echelon Corporation. Echelon had an unusually patient management team and board of directors; today its Pyxos embedded control platform appears to be both technologically ripe, and to have found a timely business need —managing industrial, commercial and residential energy usage. The IRR is probably not impressive for the venture investors, but the vision of the CEO and late COO have been validated — and the world is a better place for it.

iPhone day 2 minus two

A little more than a year since the first iPhone day, people around here are getting excited about rollout plans for the iPhone 3G on Friday.

I found a few interesting articles: a CNET Q&A on the US rollout, and a Seeking Alpha post summarizes the rollout in nine countries. Of course, the old business model with AT&T is out the window, but Tom Yager of InfoWorld thinks the new business model is at least as lucrative for Apple.

Of course, my interest in the iPhone is unchanged: I hate candy bar phones, and it comes with my least favorite phone service. I was toying with buying a used (unactivated) iPhone to use an iPod Touch with a camera, but apparently the old 2G models are becoming prized on the assumption that the new ones will be harder to unlock.

At this point, I’ll limit myself to watching others play with their new toys.

Incongruous segues

I sat down this morning for breakfast with a bowl of fresh picked strawberries from our yard on top of “Crunchy Nuggets” (the generic answer to Grape-Nuts®). Because I only had a few minutes, I decided to read the Merc (which usually takes 10 minutes) instead of the Wall Street Journal (which could take an hour).

The front page talked about Microsoft-Yahoo, and the business section led with Hasbro‘s latest response to Scrabulous, the unlicensed (and possibly infringing) ad-supported Scrabble knock-off up on Facebook. (Note this comment on how Mattel and Hasbro split worldwide Scrabble rights which has fragmented their response to this challenge).

But it was the 2nd business page (2C) that alerted me to at least one (probably more) incongruous segue in the tech world.

• Doug Field, the former CTO of Segway (the electric vehicle company) has become VP of product design for Apple, working for SVP Jonathan Ive. I wonder what the reuse of skills or expertise is here?
• The LA Times reminds us (via the Merc) that battery-powered portable TVs become useless with next February’s digital TV handover. The recommended alternatives: $200 battery powered TV, use your laptop, run the DTV-to-NTSC box using an inverter, or get TV service on your phone.
• The newspaper ran a 1/9 page ad entitled “Ads by Google”, with plugs for B&H Photo and four other vendors. Apparently this is an old program, but I hadn’t seen it before.

Is it possible to have more than one segue, i.e. is the plural of segue "segues"? Most people don’t know how to spell segue (although I imagine more can spell the scooter).

Symbian's new ecosystem

Today Symbian officially announced its new ecosystem program, the Symbian Partner Network. The new program is available now and the old one goes away next month. Existing partners were briefed under NDA last April but the announcement was delayed until June (and then July) to allow time for the transition.

David Wood (author of DW2-0) was quoted this morning as explaining the new program to IDG. The main differences are that the program cost $1,500/year instead of $5,000, and that the service is increasingly automated (to improve scalability and reduce costs).

Obviously things have changed with the Nokia buyout, and it's not clear what role the program will play before or after the transition to Symbian Foundation (which will have its own similar or different program).

Still, the program may live longer than the predicted 6-9 months. Due to third party licensed code, Sun required much longer than anticipate to release OpenSolaris as open source, and among the 30 million lines of Symbian OS code similar problems are certainly lurking. So even with a Symbian Foundation, the disclosure of OS code may be covered under NDA for a little while longer.

There is also the question of whether Nokia really is in any hurry to release the code. Both Google’s open vaporware alliance and LiMo are today walled gardens rather than open source projects. And I don't know how much pressure there is for openness: LiMo has just swallowed its main European competition, LiPS, which agreed last month to be folded into LiMo.

Nokia also has thus far not understood open source software, at least at the level where decisions are made. There definitely are people at Symbian who do understand, and others in a position of influence who are trying to get it.

If/when Symbian eventually does go fully open source, it will be a very different world than today for the Symbian partner network. The current network is managed through contractual restrictions on access to source code — which are more generous than most proprietary software, but obviously less flexible than an open code repository like Apache or Eclipse.

Also, combining S60 with Symbian OS under one roof (and killing the other UIs) will bring together the entire Symbian stack, to compete directly with the integrated Windows and Linux stacks. Thus the platform (and the partner relationships) will look more like any other OS platform strategy (except of course for the open source part).

A new year

July 1 is the new fiscal year for most state governments. Alas, unlike Will Rogers’ firm hope, we get all the government we pay for in California, and so there are lots of new laws. But one law stands out — in terms of newspaper, TV, web coverage and even freeway signs. To quote the LA Times,

Unless you have been living in a cave, you are probably aware that California's hands-free cellphone laws go into effect at midnight.

However, the big July 1 news is up north in Redmond. Again, unless you’ve been living in a cave, you’ve probably heard that the IT industry’s richest billionaire is no longer at the firm he founded 33 years ago.

Finally, InfoWorld’s quixotic quest to save Windows XP has failed, despite 200,000 signatures for its online petition FedEx’d to CEO Steve Ballmer.