Economies of scale and specialization in giving thanks

Today is the day that Americans give thanks for (as President Lincoln first proclaimed in 1863) “the blessings of fruitful fields and healthful skies.” Over the next 150 years, 28 successive presidents issued their own proclamations marking this most American of holidays.

When we lived in Silicon Valley, five years ago we hosted a Swedish researcher and his wife visiting Stnaford through the beneficence of a Scancor post-doctoral fellowship. As a homework assignment, I assigned him to “Consumption rituals of Thanksgiving Day,” an exemplar of interpretivist consumer behavior research that I was assigned to read in my PhD marketing seminar. (One of the four students from my cohort became a scholar in this tradition, writing “Religiosity in the abandoned Apple Newton brand community” that earned more cites more quickly than the earlier paper.)

Today we are hosting the extended family’s Thanksgiving feast, with our household of four being joined by 23 others, representing a total of 11 households. Five of those households are singletons (and thus some don't cook) so we have seven households bringing side dishes, desert and other items.

I jokingly said in an email this morning that we’d crowdsourced Thanksgiving dinner. Upon further reflection, that’s not strictly true because we’re not leveraging the “wisdom” of crowds. Instead, it seems more of an example of economies of scale and specialization.

Yes, it’s more work for my better half to cook 30 lbs of turkey than 15, or to make 123 rolls instead of 30. However — from watching my mom make the whole scratch dinner for years — it is far less work if you don’t have to make the mashed potatoes, salad,and (especially) pie the same day you’re making turkey.

So here with our family pot-luck we’ve re-derived the basic principles of barter and trade that were developed by human society thousands of years ago. We will give thanks for the economic and material comforts that such exchange has made possible for us, both in our own family, and in our community, nation and the global economy as a whole.

Trading one good boss for another

Today, the Minerva Schools at KGI announced its two new latest academic appointments:

The Minerva Schools at KGI, offering a reinvented university experience for the brightest and most motivated students from around the world, today announced the appointments of Dr. Eric Bonabeau as Dean of the College of Computational Sciences, and Dr. James D. Sterling as the Director of Minerva Labs and interim Dean of the College of Natural Sciences. The two join Dr. Stephen M. Kosslyn, Founding Dean, and Dr. Daniel Levitin, Dean of the College of Arts & Humanities, as key academic leaders at the Minerva Schools at KGI.

An entrepreneur and expert on adaptive computing algorithms, Bonabeau’s book Swarm Intelligence is one of the sources cited by Michael Crichton’s novel Prey. (Ironically, my former KGI co-worker Christoph Adami is also credited).

But it’s the other announcement that’s the big news at KGI:

Dr. James D. Sterling, previously Dean of the School of Applied Life Sciences and current Vice President for Academic Affairs at Keck Graduate Institute (KGI), will serve as Director of Minerva Labs, and has also been appointed interim Dean of the College of Natural Sciences. Dr. Sterling holds an M.S. and Ph.D. in Mechanical Engineering from California Institute of Technology, and is an alumnus of Texas A&M University where he earned a BS degree in Mechanical Engineering. As a founding faculty member of KGI, Dr. Sterling developed the engineering coursework that prepares students to work in the development of laboratory research tools, laboratory automation, and micro-bioanalytical methods. In addition, Dr. Sterling serves as chair of the academic dean’s committee of The Claremont Colleges consortium.

“I’m thrilled to be joining Minerva and creating a new kind of university experience for undergraduate students,” said Dr. Sterling. “I’m particularly excited and intrigued by the educational innovations we are developing and look forward to leveraging Minerva’s learning platform and new methods in laboratory automation to educate students in the College of Natural Sciences."

Neither Minerva nor KGI mentions that Sterling is co-founder of one of KGI’s first spinoffs, Claremont BioSolutions.

Jim Sterling, Minerva CEO Ben Nelson
and KGI President Sheldon Schuster

Jim was my boss from when I joined KGI in July 2011 until last Thursday, when he stepped down as SALS dean. He was a great boss, one of the best in my entire career. For many bosses — including my first few years at my own company — being the boss is about the boss. Although very busy, Jim was always scrupulously fair to his employees — perhaps due to that engineering mindset that something is fair or isn’t.

We wish Jim well in his new position, and I’m confident he’ll bring great expertise and management skills to launching the labs, getting the college off the ground and helping the school prepare for its first class next fall.

My new boss (i.e. the interim dean) is KGI’s longest-tenured business faculty, Steve Casper, who taught at Cambridge’s Judge business school before joining KGI in 2003. In innovation studies, most people know Steve for his research on biotech clusters, particularly in Germany and California. Steve is the reason I’m at KGI, so I look forward to working with him on building KGI’s programs and opportunities for its students.

The war to end all wars

Today we celebrate Armistice Day (aka Veterans Day aka Remembrance Day) because 95 years ago today, the armistice was signed between Germany and the allied powers (at 11:11 CET), marking the end of The War to End All Wars.

I knew a lot about World War II since both my parents were active duty, and the history of America’s “Greatest Generation” was prominent when I was growing up in the 60s and 70s. But I had only fragmentary knowledge of WW I, other than a vague understanding of the combatants and how they were similar to (and different from) those 25 years later.

That has changed since I read July 1914: Countdown to War, a marvelous new history detailing the month that led up to World War I. Its author, Prof. Sean McMeekin, trained at Stanford and Berkeley and is now a professor in Turkey. He’s drawn upon the archives of the various combatants, with citations pointing to specific memoirs, cables and other internal documents.

Americans (of my and my parents’ generation) were trained to think of Germany as evil, whether under the Führer or the Kaiser. McMeekin paints a much more nuanced picture. In short form

• Austria sought to punish Serbia because its irregulars assassinated the emperor’s brother, but was incompetent to conduct either diplomacy or a short punitive war;
• Russia was ready and waiting for an excuse to destroy Austria and seized upon Austria’s threats against Serbia to do so;
• Germany felt it had to back Austria, without realizing how reckless its allies were and how perfidious its enemies were;
• France and Russia conspired to draw Germany into war — and lied about their intentions — even though Russia was the first of the European Great Powers to mobilize for war;
• All three powers sought to manipulate Britain to their side, but France was a better liar than Germany, and Britain was too incompetent to know what was really going on until too late.

As Scottish historian Hew Strachan put it: “most historians today believe that Germany did not deliberately plan to go to war.” The Russians and French were clearly more successful at prewar diplomacy — particularly in influencing the British (to join their side) and Italy (to not join Germany) which helped tip the odds in their favor.

It was also interesting to note that this was probably the last time in history where inherited monarchies played a significant role in the nature or timing of major decisions by European governments. The monarchs of Austria, Hungary, Belgium, Germany and Russia all figure prominently in their respective government decisions.

It’s impossible to determine whether war was inevitable, or whether a war under other circumstances would have ended differently. But by assassinating the Austrian leader, Serbia was rewarded by dismembering of the Austro-Hungarian empire and taking away Slovenia and Croatia from the Austrian territory. And Britain was drawn into a war where it had no real national interest, and lost nearly a million men for its mistake. Meanwhile, even before Lenin, Russian leaders sought influence and power through military might rather than economic growth and the well-being of its citizenry.

Overall, it appears that both Germany and Britain would have benefited — and found common ground — with more effective intelligence services that understood the intentions (and actions) of the other Great Powers. As with “weapons of mass destruction” decades later, faulty intelligence can lead to military disaster.

Semi-open Android getting more closed by the minute

From day one, I’ve remarked that Android is not really an open open source project. It promised openness but didn’t deliver, instead pursuing a strategy of semi-openness to gain market share against its proprietary rival. That Google tightly controlled the Android community shouldn’t be surprising since — for any firm — the point of funding (and controlling) a sponsored community is to gain benefits not available to other firms.

This wasn’t just my opinion, but was supported by a detailed study by Liz Laffan of Vision Mobile, a European consulting firm. (I thought the study was a clever idea — not just because it leveraged my typology of firm-controlled open source communities — and the press did as well). In comparing the governance of mobile open source communities, Laffan found Android was by far the least open of eight mobile-related communities. She concluded:

Android’s success has little to do with the open source licensing of the public codebase. Android would not have risen to its current ubiquity were it not for Google’s financial muscle and famed engineering team. Development of the Android platform has occurred without the need for external developers or the involvement of a commercial community.

Google has provided Android at “less than zero” cost, since its core business is not software or search, but driving ads to eyeballs. As is now well understood, Google’s strategy has been to subsidize Android such that it can deliver cheap handsets and low-cost wireless Internet access in order to drive more eyeballs to Google’s ad inventory.

More importantly, Android would not have risen were it not for the billions of dollars that OEMs and network operators poured into Android in order to compete with Apple’s iconic devices. As Stephen Elop, CEO of Nokia, said at the Open Mobile Summit in June, 2011, “Apple created the conditions necessary for Android”.

As Laffan notes, the one way that Android was open was the provision of source code. But that's changed too, as Ron Amadeo documented Sunday on the Ars Technica website:

Google has always given itself some protection against alternative versions of Android. What many people think of as "Android" actually falls into two categories: the open parts from the Android Open Source Project (AOSP), which are the foundation of Android, and the closed source parts, which are all the Google-branded apps. While Google will never go the entire way and completely close Android, the company seems to be doing everything it can to give itself leverage over the existing open source project. And the company's main method here is to bring more and more apps under the closed source "Google" umbrella.

There have always been closed source Google apps. Originally, the group consisted mostly of clients for Google's online services, like Gmail, Maps, Talk, and YouTube. When Android had no market share, Google was comfortable keeping just these apps and building the rest of Android as an open source project. Since Android has become a mobile powerhouse though, Google has decided it needs more control over the public source code.

For some of these apps, there might still be an AOSP equivalent, but as soon as the proprietary version was launched, all work on the AOSP version was stopped. Less open source code means more work for Google's competitors. While you can't kill an open source app, you can turn it into abandon ware by moving all continuing development to a closed source model. Just about any time Google rebrands an app or releases a new piece of Android onto the Play Store, it's a sign that the source has been closed and the AOSP version is dead.

In some ways, this is looking like IBM’s WebSphere. IBM has a proprietary software package layered on top of an open source Apache HTML server engine: yes, the engine is useful, but it’s not complete for the commercially important applications. (BEA’s — now Oracle’s — WebLogic plays a somewhat similar role). However, IBM was open about what it wanted: in our 2006 paper, Scott Gallagher and I noted how IBM was quite open about its partly-open strategy.

What’s different here is the suggestion by Amadeo (this week) and others (previously) of an intentional bait and switch strategy:

Vic Gundotra, recalling Andy Rubin's initial pitch for Android, stated:

He argued that if Google did not act, we faced a Draconian future, a future where one man, one company, one device, one carrier would be our only choice.

Google was terrified that Apple would end up ruling the mobile space. So, to help in the fight against the iPhone at a time when Google had no mobile foothold whatsoever, Android was launched as an open source project.

In that era, Google had nothing, so any adoption—any shred of market share—was welcome. Google decided to give Android away for free and use it as a trojan horse for Google services.
…
Today, things are a little different. Android went from zero percent of the smartphone market to owning nearly 80 percent of it. Android has arguably won the smartphone wars, but "Android winning" and "Google winning" are not necessarily the same thing. Since Android is open source, it doesn't really "belong" to Google. Anyone is free to take it, clone the source, and create their own fork or alternate version.

The article documents how Google uses its APIs and app store to punish any attempt to fork the code. (Yes, the Kindle is a successful fork, but without the Google APIs it will only have a fraction of the 850,000+ Android apps.)

Amadeo concludes:

While Android is open, it's more of a "look but don't touch" kind of open. You're allowed to contribute to Android and allowed to use it for little hobbies, but in nearly every area, the deck is stacked against anyone trying to use Android without Google's blessing. The second you try to take Android and do something that Google doesn't approve of, it will bring the world crashing down upon you.

No accountability without choice

I went swimming this morning with a pro triathlete. It wasn't my intention, but there’s a triathlon in town tomorrow and a number of pro athletes are visiting and working out.

I got talking with her manager/trainer, who said they live in Florida. Because the triathlons are around the country (and the world), they can live anywhere they want. Like many athletes, they (and other triathletes) live in tax-free Florida, while others live in Texas.

The triathlon was invented in San Diego and popularized in Hawaii, and handful of professional triathletes still live here. But — between taxes and housing costs — most find it cheaper to live elsewhere and pay an accountant $5-10K a year to keep track of various state laws that require they pay the nonresident athlete tax for the days they work in high-tax states. The St. Louis Cardinals didn’t care whether the Tigers or Red Sox make the World Series, but clearly the Red Sox are better off playing three games in St. Louis (top rate 6%) than in Los Angeles (top rate 10.3%).

Pro athletes can arbitrage tax rates (for endorsements) and live where they want (off season). San Diego native Phil Mickelson was roundly criticized for the (factual) observation that he pays a 60%+ tax rate living in California and was considering living elsewhere.

Entertainers can also live anywhere also, and this should work well for musicians. However, it appears that actors still tend to cluster in Los Angeles and New York City, two of the highest tax jurisdictions in the country. I’d argue this is because while athletic performance is directly measurable, acting performance is not: do we care which 25-year-old starlet or 45-year-old aging acting star is cast in a big-budget movie? Probably not. Actors have to stay in the network, attending parties etc., so the decision-makers don’t forget them when casting the next movie, TV show or high-visibility stage production.

Still, other types of professionals and business owners lack job mobility. At one extreme, Silicon Valley is largely about access to venture capital (since it has no monopoly on smart people or good universities). At the other extreme, restaurants and dry cleaners can’t move to a low tax state and take their customers with them. With its unfavorable business climate, California will hold these two extremes and has been driving out the average business in the middle (such as manufacturing).

California is now a one-party system and the ruling party assumes it can charge what it wants. I have a fairly low salary for a b-school professor and I’m at the 9.3% marginal tax rate. This used to be the tops until they instituted two millionaire surcharges (bringing the maximum rate to 13.3%), the latest being including a retroactive tax increase passed last year to capture Facebook IPO gains.

Even worse, California taxes capital gains as regular income, and thus the long-term capital gains rate is higher than New York, France, Finland or Sweden (let alone notorious tax havens like Hawai‘i and D.C.) If you are a Google or Facebook founder, it isn’t going to change your standard of living, but trying to sell a $1-2 million business to retire would leave a lot less money to live on in your old age.

In a one-party system, there is no accountability for bad ideas — only for overt corruption. So if people can’t have a choice of economic policies, what remains is the option to vote with their feet ala Hirschman’s Exit, Voice and Loyalty†. Despite increasing centralization to the national government, the US — like Canada and to some degree Germany — has a Federal system that allows policy experimentation and competition of ideas.

New York and Massachusetts paid a price (in terms of employers and job growth) for their high tax policies — but apparently not enough of a price to cause them to rethink their policies. Like California, they have a small cluster of high end jobs (Wall Street and drug companies respectively), the immobile local jobs and have discouraged or driven away the jobs in the middle.

Since Hollywood’s business model is in decline, California’s ability to pay its bills seems tied to what fraction of the global tech economy remains in Silicon Valley. No matter how much you believe in Silicon Valley’s uniqueness, this is a bold (if not foolishly optimistic) bet on a small fraction of the state’s 38 million people. However, with term limits, politicians have a short-term mentality and are betting they will be long gone if something bad happens 5 or 10 years down the road.

† Writing in 1970, Hirschman (p. 84) assumed that a lack of voice would cause people to quit organizations but they cannot exit the “state” (i.e. national government). But this was before intra-EU job mobility and even the flight of jobs from the northeastern to the southeastern regions of the U.S.

Pebble: it's about the apps

With a US ad budget approaching $1 billion, Samsung is now plastering the airwaves (including my Sunday football games) with ads for its $300 Galaxy Gear. Analysts say it’s a better ad than product.

My gripe is that it implies that Samsung invented the first practical smartwatch with its $300 Galaxy Gear. But any technophile worth his (or her) salt knows that the modern category begins with the record Kickstarter success story, the Pebble.

Still, Samsung’s ad barage is going to develop the product category and make people aware that this option is available. Today Best Buy gives online customers a chance to compare the various products side by side — and soon this will come to the physical stores, even if both products will be shut out of the Apple Store.

But what will the smartwatch pioneer do, with its $35m in outside funds dwarfed by the big boys? Pebble founder Eric Migicovsky says the story is in the apps:

The next step for us is how we can incentivize and encourage developers to hack on Pebble and create new interfaces. We’ve already started building them, but there’s a ton of hardware out there. There’s Fitbit and Jawbone and all this fitness stuff that’s really built on top of the exact same hardware that Pebble is built on, except those platforms are not open.

So with Pebble, say for example you’re a researcher working in a university on an accelerometer-based gesture app. Instead of having to build your own hardware, you can now build an app for Pebble and market it to the existing user base.

Not every potential platform attracts third party apps. If I were at Pebble hoping to be saved by apps, my first step would be to emphasize (and improve) the cross-platform compatibility against Apple and Samsung.

I'd also target the internal developers of big corporations. The major app vendors (e.g. iHeartRadio) will gladly do what it takes to provide compatibility separately with the Gear and (rumored) iWatch, but corporate developers would appreciate having one “watch” that supports both Android and iPhone clients.

Punishing your captive shareholders

Although public companies are not as accountable as they should be, in the long run failure or malfeasance has consequences. Managers who treat shareholders badly get fired, or people dump the shares — depressing them enough to bring in a raider who will shake things up.

Unfortunately, nothing like that happens when it comes to accountability in government agencies, as this week’s semi-shutdown makes clear.

The Office of Personnel Management (an Executive Branch agency) encouraged agencies to shut off their websites when the shutdown came. The Census Department, NASA and Park Service are offline, although the Library of Congress and IRS (despite previous threats) are still functioning. Julian Sanchez of the Cato Institute referred to this as an online “Washington Monument Syndrome.”

For anyone who’s run a business and is IT literate knows that it costs more money to take down a site than to leave it up. How many sites have you seen that haven’t been updated in weeks, months or even years? For many sites, the government could be shut down for 3 or 6 months and the content would still be available and useful if they left the servers running.

At Reason, Brian Doherty notes the irrationality of this approach:

If the “inessential” public-facing Web pages are hosted on the same systems you’ve got to keep up and running for other “essential” back-end purposes—meaning you don’t get to save the security or electricity overhead— then the cost of having IT go through and disable public access to the “inessential” sites could easily be higher than any marginal cost of actually serving the content. But the guidance here seems to require agencies to pull down “inessential” public-facing content even when this requires spending more money than leaving it up would. In the extreme case, you get the bizarre solution implemented on the FTC site: serve the content, then prevent the user from seeing it!

Or, as my local paper quoted one expert:

To many, the website shutdowns have the feel of politics. Public relations expert Erica Holloway of Galvanized Strategies, who works with clients on their websites, said it makes no sense to shut down the sites otherwise.

“To withhold information from the public that the public has a right to have is wrong,” Holloway said. “And if there is no budgetary reason behind it, if it isn’t monetary, then it looks like what it is: A giant temper tantrum.”

But since the tantrum included hiring people to put up barricades at the World War II memorial —“to make life as difficult for people as we can” — I guess we shouldn’t be surprised.

In a parliamentary system such as our European friends enjoy, such tantrums have consequences: it's hard to imagine David Cameron or Andrea Merkel pulling such a stunt. But with a fixed-term (and term limited) executive such as in the US or Mexico, it’s apparently feasible (if not desirable) to punish one’s shareholders.

Unimaginable reversal of market share

As part of my job promoting our school and its programs, I visited three college campuses in Boston this week (plus two more schools related to research).

My last stop before flying home was Wellesley College, which I last visited in a previous century as an MIT student taking a music elective my semester prior to graduation. As with other stops, this took me to the science building. The Wellesley Science Center has a large open interior space that reminds me a little of the Hyatt Embarcadero in SF (only much smaller).

As I wandered through the common area, I kept noticing young women typing away on their Mac laptops. After a while, I decided to count. In the cafe area, library and other open area of the science center, I counted 22 laptops: 19 Macs, 1 HP, 1 Lenovo, 1 Dell. (This doesn’t include the Macbook Air in my bag).

Admittedly college isn’t representative of society or an expensive private college representative of colleges. Still, the numbers were stunning.

When my original dissertation topic fell apart in 1997, I decided to study how people were abandoning the Mac. Apple’s overall US share (nearly 15% in 1993) had fallen under 5%. Even in marketing organizations, Macs were being replaced by Windows (aided by Aldus and Quark who launched their businesses on the Mac but by then were platform indifferent).

To get started, I did an exploratory study of organizational (de)adoption decisions, which for access reasons included some universities. Most universities were pushing out Macs, by requiring technologies (such as email) that lacked a Mac client or refusing to support or fund Mac users. (I spent 8 years at UCI’s business school, which banned Mac purchases in the name of efficiency and standardization).

In 1996, I even started a website to keep track of stat software that was still being updated on the Mac — so that those of us who needed stat software could stay on the Mac. Stata stayed with us through the darkest days (and won my unending loyalty), but now most of the major math and stat packages are dual platform (with the exception of the troglodytes at SolidWorks).

Back in 1997, I wouldn’t have imagined it possible to find a pocket — any pocket — where Macs would be dominant again. The last one to bail from the platform was supposed to turn off the light, but instead people started flocking back and turning up the light. At some points the Macs will run iOS (instead of OS X or OS 8) but it looks like they'll be around for another decade or two.

Rewarding failure: blame it on the ex-wife

While Americans are used to paying large bonuses for failure, it’s not as common in Europe. Apparently Helsinki newspapers are alight with the controversy over the $25 million bonus Nokia plans to pay CEO Stephen Elop for halving the company’s market cap.

Elop’s failure has been long in coming. When Nokia announced its Windows strategy in February 2011, I (admittedly) mixed my metaphors:

Nokia CEO (and Microsoft veteran) Stephen Elop had already prepared the troops with his “burning platforms” memo, lambasting his new employer for how it failed to respond to the iPhone and Android challenge.
…
Elop has jumped off the burning oil platform into a ship that’s adrift and has a hold filled with water.
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The sign of a troubled company is multiple Hail Mary passes in a row. … Nokia needs to fix its execution rather than throwing more Hail Mary passes than even Doug Flutie ever completed.

Twenty months later, the results were even more obvious:

Still, let’s not put too fine a point on it: Elop’s gamble to bet the company’s future on switching to the Windows Phone platform has been an absolute disaster. … Nokia has been more successful at killing Symbian — by starving new releases — than getting people to buy Windows Phones. In fact, as late as Q2, Nokia was still selling more Symbian than Windows phones.
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[R]ealistic is the advice from former Apple Europe president Jean-Louse Gasée: fire Elop and switch to Android. If Nokia’s board believed in accountability, they’d lower the axe after the end of the Christmas quarter, but more likely they’re going to limp along until they can no longer deny the reality of Elop’s failed platform strategy.

Now the Helsingin Sanomat reports in Finnish and English that Nokia is begging Elop to reduce the bonus, but Elop is blaming his estranged wife for why he can’t (won’t) do so:

Helsingin Sanomat has learned that Risto Siilasmaa, Chairman of the Board of mobile telephone manufacturer Nokia, has held discussions with former CEO Stephen Elop on either cancelling or reducing his bonus of €18.8 million.

In the discussions, Elop has brought up the fact that he has filed for a divorce from his wife. If he were to agree to relinquish his final compensation of €18.8 million during the divorce proceedings, he might still be required to pay half of the value of the bonus to his wife.

Siilasmaa does not want to comment on the matter.

AS CEO OF NOKIA, Elop travelled around the world constantly. His family lives in the United States, in Seattle, Washington.

Elop has an apartment in Helsinki, but most of his time has been spent on work-related travel. His family includes his wife Nancy and their five children.

The HS speculates that Finland might have jurisdiction over the divorce, but that seems unlikely. Instead, Elop filed for divorce Aug. 1 in King County (i.e. Seattle), and Washington State is a community property state, which means (barring other contractual arrangements) Nancy Elop is entitled to 50% of everything her husband earned during their 20+ years of marriage.

So now Elop’s failure as a CEO deserves to be rewarded because of the failure of Elop’s marriage? The one-good-failure-deserves-another warrants recognition for creativity, but not a $25.4 million (or $12.7 million) prize.

Leaks to HS are intended to put the Nokia board in the best light, by comparing Elop to his peer group — CEOs of other failed mobile handset companies:

THE PAYOUT to the CEO is exceptionally large by Finnish corporate standards.

However, compared with the golden parachutes of Nokia's international competitors in similar situations, Elop's bonus is not particularly large.

Motorola Mobility's CEO Sanjay Jha was promised a final bonus of €47 million when Motorola's telephone operations were bought out by Google.

Thorsten Heins, CEO of Research in Motion, which manufactures Blackberry telephones, is set to be paid €41 million if the purchase offer made on Monday by investors is implemented.

Tero Kuittinen of Forbes argues that Nokia’s contract with Elop gave him a powerful incentive to run the company into the ground:

According to changes implemented in 2010, Elop was entitled to immediate share price performance bonus in case of a “change of control” situation… such as selling of Nokia’s handset division. Curiously, his predecessor [Olli-Pekka] Kallasvuo had no such clause in his contract. This adjustment meant that unlike previous CEOs, Elop was facing an instant, massive windfall should the following sequence happen to take place:

• Nokia’s share price drops steeply as the company drifts close to cash flow crisis under Elop.
• Elop sells the company’s handset unit to Microsoft under pressure to raise cash
• The share price rebounds sharply, though remains far below where it was when Elop joined the company.

Should this unlikely chain of events ever occur, Elop would be entitled to an accelerated, $25M payoff. Through some strange coincidence, that very sequence of events actually did happen to take place between 2011-2013. Practically instantly after Elop was handed his contract. Can you imagine how Nokia’s board must have giggled when they realized what had occurred? They had created a strong incentive for the new CEO to drive down the company share price, sell the core business to Microsoft and then collect $25M – and this actually happened!

Will Microsoft ever grow again?

In the past year, the rapid decline of the PC industry has become undeniable. The fortunes of HP, Dell and Microsoft have suffered accordingly.

Last week “Lex” at the FT questioned whether Microsoft was properly valued as a legacy IT company:

The shares trade at 11 times this years’ earnings and a free cash flow yield of 9 per cent. Cheap? Those figures look a lot like those for IBM and Oracle, the other gigantic clanking technology relics. But it is hard to argue that they face mortal threats to rival Microsoft’s.

Those who hold the stock are betting that the core businesses will be surprisingly stable, and that investors will reap the rewards. That second point is important.

With the accelerating collapse of Blackberry, Microsoft’s quixotic acquisition of Nokia’s handsets has a better chance of gaining share. However, being #3 (with a 15% share) of a low margin business is hardly going to replace being #1 (with a 80-90% share) of a business that once yielded 90% gross margins.

For the benefit of us long-suffering Microsoft shareholders, Lex recommended two steps. The first would be to shut down the online services division — including Bing — after losses last year of $1.2 billion.

This would be a monumental admission of failure — in timing, strategy and execution — to profitably enter the only software business that’s going to matter in 10-15 years. Intelligence continues to migrate to the cloud and software as a service — not software as a package or download — will be the only business of large consumer software companies. Microsoft’s exit would leave Google the sole contender for the foreseeable future, with Amazon and Apple seemingly consigned to specific niches of the business.

Steve Ballmer can’t (and won’t) admit that failure, but his successor could. Growth with heavy losses is not something that any shareholder wants, but if online services are dropped, so are any hopes of online services providing growth.

The other Lex recommendation is to reduce share buybacks (since management “has done a terrible job” of recognizing when its stock is cheap) and shift that money to increasing the dividend. As someone who owns Microsoft for its dividend (as one of the 10 Dogs of the Dow) I’d heartily endorse such a plan. With revenues stagnant and declining margins, shareholders are unlikely to see any significant capital appreciation, so sharing (rather than squandering) Microsoft’s legacy profits is best shareholders have for a return on their investment.

Empowerment brings economic growth

There is no doubt that some are better equipped than others to navigate the challenges of the 21st century. Our purpose is not to fear or deny those inequalities – in resources, or skills, or confidence – but to understand and overcome them.

This is not a matter of more spending or more government. It requires putting members of the public in charge of their own destiny so we can prevent problems rather than just mitigating them. Such people-led politics is the way in which we save money and secure better outcomes for all. Radical and difficult to implement though it may be, it is the progressive future for which we fight.
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Education policy has been defined by an obsession with who is running schools, when our children need preparation for a digital economy where “jobs for life” no longer exist.
…
With the pace of change in the global economy, no one can take his or her job for granted. … As the economist Adam Lent argues, the means of production are increasingly in the hands of workers. Starting a business once required considerable capital outlay. Now broadband and a PayPal account will do. Our youth embrace this. In 1998, just 17 per cent of 18-to-29-year-olds wanted to start a business –now it is 30 per cent.

This ethos hasn’t been created just by the rise of the internet. The new enterprising spirit is no more defined by new hardware than the 1980s were defined by fax machines. This is a grass-roots, pioneering mindset – and it can be harnessed by the left.

Stella Creasy, MP (Labour) for Walthamstow
New Statesman, September 18, 2013

Another stumble in HP's recovery

S&P Dow Jones Indices LLC announced Tuesday that HP would be among three stocks dropped from the Dow Jones index. As the WSJ reported in today’s paper:

Alcoa, a Dow component for 54 years, will be replaced by athletic-gear maker Nike Inc. Payments company Visa Inc. will replace H-P, which joined the index in 1997, and securities firm Goldman Sachs Group Inc. GS will supplant Bank of America, which spent five years in the blue-chip benchmark.

The changes take effect Sept. 20.

That a metals company would be dropped on its 125th birthday is not all that surprising. It is similarly unsurprising that a highflying New York investment bank would replace the Charlotte-based NationsBank (dba BofA), which is still struggling with its decision to buy Merrill Lynch and Countrywide near the peak of the financial crisis. (As a BofA shareholder, my attempt to bottomfish BofA in the fall of 2008 is still looking pretty stupid; if they hadn’t grabbed these two boat anchors, it might have turned out better — but then how could I know that the government would order BofA’s CEO to destroy shareholder value.)

But banks come and banks go. Hewlett-Packard is a Silicon Valley icon, by some measures the founder of the cluster — certainly the first significant Stanford spinoff and the role model for Apple, among others. The end of its 16 year run in the Dow is another sign that it’s just another struggling commodity company in a mature industry. As Bloomberg reported:

HP Exit From Dow Jones Industrial Signals Revival Challenge

Hewlett-Packard Co. (HPQ) is being removed from the Dow Jones Industrial Average, a sign of waning confidence in the company’s turnaround efforts amid an historic slump in the personal-computer industry.

The exit, announced today as part of the biggest reshuffling of the index since April 2004, delivers another blow to Chief Executive Officer Meg Whitman’s quest to revive growth at the storied PC maker.

Blogger Arik Hesseldahl notes the irony of the timing, since HP shares are up 57% this year. He won the standard non-response:

HP remains confident that we are making progress in our turnaround. We have delivered financial performance in line with or better than our expectations throughout this fiscal year, and remain focused on delivering shareholder value. We are already seeing significant improvement in our operations, we are successfully rebuilding our balance sheet, our cost structure is more closely aligned with our revenue and we have reignited innovation at HP.

Unlike leaving the S&P 500, the move has little practical impact on the shares since there are few index products built around the DJ.

Part of the problem for the three companies is that in formulating his first index in 1896, Charles Dow merely added the stock prices together (rather than using a market-cap weighting as in later indices). As the NYT notes

the Dow is calculated as a price-weighted index, so the stocks with the highest share price have the greatest weight. The three stocks that are being removed are priced in the single- or low double-digit range, putting them on the lower end of stocks in the index.

“They’ve dropped the smaller weights out of the index and replaced them with what they deem to be better candidates representing the way the economy is moving,” said Trista Rose, the global head of index strategy at UBS. “I wouldn’t say that it would have a noticeable impact on trading volume.”

For the same reason that HP at $22 is leaving the index, the world’s most valuable company won’t be joining the index. As WSJ blogger Steven Russolillo writes:

Last year John Prestbo, executive director for Dow Jones Indexes, told Barron’s that including Apple in the index would be “a methodological mess” and that Apple “certainly qualifies in every respect except one, price.”

Russolillo notes that the same argument for Apple (at $500) applies to Google (near $900).

Silicon Valley is represented by Cisco and Intel in the Dow, which also includes IBM and Microsoft and America’s two biggest telephone companies, AT&T and Verizon.

Handset sideshow doesn't solve Microsoft's core problems

Facing the expiration of the distribution agreement with its main mobile phone licensee, Microsoft bought Nokia. The deal fulfills Steve Ballmer’s ambition to recast Microsoft as the next Apple by allowing it to vertically integrate downstream into hardware.

Here’s the key passage from Ballmer’s press conference Tuesday:

The company I joined 33 years ago was a company focused on software for personal computers. And software is a great skill and will always be a core strength of Microsoft. The PC is an important device, the most productive device on the planet, and will continue to be so. And yet for us not only to grow but for us to really fulfill the vision of what we can do for our customers, we've evolved our thinking.

We need to be a company that provides a family of devices in some cases we'll build the devices, in many cases third parties, our OEMs, can build the devices but a family of devices with integrated services that best empower people and businesses for the activities that they value the most.

Like the dog who caught the car, now what? Microsoft under its next CEO will be a hardware company, but is there any evidence it will be a successful hardware company?

One of the problems is that Microsoft had more than a decade to offer a compelling mobile platform. Its smartphone market share has been falling since before the iPhone and Android.

Now with Windows Phone 8, it has a good product, but so what? Four years ago, another dying mobile company — Palm — brought out an innovative device to great reviews, but it didn’t matter. Less than a year later, the company — the US smartphone pioneer and onetime market leader — was gone, like Nokia bought up at a firesale price.

Microsoft has already had a chance to try its fully integrated mobile strategy with its Surface tablet, which enjoyed great reviews and a huge marketing push. In one year, Microsoft spend $900m to advertise the Surface and WP8, but generated only $850m in sales and took a $900m write-off on inventory.

Fortunately for MSFT shareholders, Nokia’s handset division is available at a firesale price, less than 10% of the company’s cash on hand. Unfortunately, the man who ran the division into the ground will be heading it for Microsoft and is now a favorite to become Ballmer’s replacement

The deal would also reward Nokia’s CEO Stephen Elop, the ex-Microsoft executive who torched Nokia’s Symbian platform in favor of Windows, and led the failed effort to regain share using Windows. (In mid-2012, Nokia’s Symbian platform had a higher market share than Windows had then or now). Elop has shrunk the company , cutting the company’s market cap in half from $40b to $20b.

Perhaps Elop won’t rewarded for his Nokia failures, but the early betting is that Microsoft’s board (a captive of Ballmer and founder Bill Gates) will pick a conventional leader who, as the WSJ put it, “won’t rock the boat.” Because of this influence, the article predicts the board will go for more of the same, someone who can run a large bureaucratic Fortune 500 company, rather than a visionary leader who will break free from the lost decade of stagnation under Ballmer. The company needs a Lou Gerstner but (at best) will end up with another Lew Platt.

The problem is, Ballmer has historically confused monopoly profits with premium pricing. People pay more for Apple products because they want to; people pay more for Microsoft products when they have to, and they don’t if there’s a good alternative.

While Nokia didn’t get software, they historically were a hardware innovator with screen, cameras, sensors and other features. Now Samsung has assumed that mantle — along with overall market share leadership — while Apple remains the software and integration leader.

The Nokia deal will reduce near-term EPS and long-term profitability ratios. The company hopes to save $600m annually, presumably by laying off 3,000-5,000 workers. I would expect most of those would be in Finland, where Nokia has for the past few year playing a shrinking role in the local economy.

Even if Nokia is a modest success, it will at best replace Microsoft’s declines in its slowly dying PC business. Buying the former market leader — which now longer even ranks in the top 10 in global market share — won’t transform it into a major player in the industry. Given its huge cash hoard, Microsoft’s phone business will last longer than Blackberry’s, but that’s not saying much.

As with all such mergers, the odds of actual success are large. Two quotes from this morning’s WSJ illustrate the problem:

When executives "can't figure out what to do, they go buy something, particularly when they have a lot of cash," says Jeffrey Pfeffer, a professor at Stanford University's Graduate School of Business. "It seldom works."
…
Juan Alcacer, a Harvard Business School associate professor who has studied Nokia, says companies with small market shares typically "are in a bad position for a good reason." Combining two of them, rarely works, he says: "Two bad companies don't make a good company."

The stock has given back the gains that it had with Ballmer’s retirement announcement. Hopes that Microsoft would fix its broken corporate culture, becoming faster and more responsive are now dashed. We long-suffering Microsoft shareholders own a utility, that pays out a fraction of its declining monopoly profits with no replacement in sight.

The ignominious end of Nokia's handset hegemony

On Tuesday morning (Finnish time), Nokia announced that it was selling its handset business to Microsoft for €5.44b. The payment includes €3.79b for the division and €1.65b for a 10-year (non-exclusive) license to the Nokia patents necessary to operate that business. The deal is funded by Microsoft’s offshore profits that (as with most US-based multinationals) it has been unable to repatriate due to the US tax law.

A PDF published by Microsoft summarizes the deal:

• Microsoft acquires Nokia’s phone business
• Microsoft acquires Nokia’s Qualcomm, other key IP licenses
• Microsoft licenses Nokia’s patents for use across all Microsoft products
• Microsoft licenses ability to use Nokia HERE broadly in its products
• Nokia retains NSN [Nokia Siemens Networks], HERE, its CTO Office, and its patent portfolio
• Nokia and Microsoft cement original partnership with this deal before 2014 recommitment date

As a Microsoft shareholder, this seems like a final failed effort by Steve Ballmer to make big strategic moves to distract from the failure of his efforts to execute on the core businesses he inherited when becoming CEO in 2000.

Want proof? In the same PDF, Microsoft projects in 2018 an “assumed market share” of 15% for the Nokia (or Windows Phone) business. Microsoft hasn’t had 15% share since 2005, and its most recently quarterly share (like Nokia’s) was under 4%. As with all of Microsoft’s mobile strategy since then, the deal is more about hope than feasible strategies.

About the only good news is that the troubled Microsoft is acquiring the even-more-troubled Nokia for a song. Three years ago, Nokia’s handset division was grossing more than €6 billion per quarter; two years ago, Microsoft paid 20% more to buy Skype, a company without a business model.

Meanwhile, what about Nokia? Basically, its current and previous CEO have panicked as they have driven the company into the ground. Since the 2007 introduction of the iPhone, bought full control of Symbian Ltd. (and then killed it), switched from the once-dominant Symbian to the also-ran Windows platform, and now is exiting the business. All this from the company that was the world’s largest handset maker from 1998 until 2012.

The urgency of the deal for Nokia is evidenced by the key financial terms. Microsoft is “immediately” advancing Nokia €1.5b so it can keep the doors open until the deal closes — and Microsoft presumably assumes the salaries of 32,000 Nokia employees in the money-losing division.

It’s hard to see how losers buying losers (cheap) creates a winner. Yes, the mobile market is growing as Microsoft’s core business is dying. Yes, having a captive† handset manufacturer will justify keeping open the Windows Mobile division. But how will having a distant third place product with single-digit market share solve Microsoft’s numerous growth and profitability problems?

† Microsoft claims other licensees will continue, despite decades of failed licensing efforts by vertically integrated platform owners. Licensing didn’t work for Nokia with Symbian, didn’t work for Palm with Palm OS, didn’t work for Apple with Mac OS 8, and didn’t work for IBM with OS/2.

Who's killing camera companies?

The Wall Street Journal Tuesday noted the financial difficulties faced by the world’s two leading camera makers, Canon and Nikon, sold 44% of the world’s cameras last year — pocket cameras, point-and-shoot, and SLRs. For these Japanese makers, Q2 sales of “compact digital cameras” (presumably all non-SLR) are down 26% and 30% respectively. Revenues from SLR systems (cameras, lenses, accessories) are also down, but less sharply.

Author Aaron Black are right to say “there may be more pain to come.” I particularly worry about Nikon, and not just because 20+ years ago I switched from Canon to Nikon after my insurance company (with the help of a burglar) gave me a chance to replace my manual focus system with an autofocus one.

Nikon was once the pre-eminent maker of SLR cameras for professional press (newspaper and magazine) photographers, of which I was briefly a member. You don’t need to a front page headline on a dead tree paper to know that this is a declining market that’s never coming back.

More seriously, Nikon is far less diversified: for it, the WSJ says that cameras make up 78% of revenues for Nikon (which also provides semiconductor lithography equipment) but only 40% of revenue for Canon (which makes copiers, laser printers and medical imaging). So if stand-alone camera revenues go to zero, then there won’t be much of Nikon left. This may be delayed by attrition of its Japanese camera rivals — Olympus, Konica Minolta, maybe Sony — but the end result is the same.

My UCI students predicted 11 years ago that cameras would supplant video cameras and smartphones would supplant cameras as digital convergence took hold. But there’s more to this story than just smartphones. I think the camera makers bear their own share of responsibility, since they seem to have stopped the wave of innovation that drove camera sales for at least 50 years.

In the 1960s, interchangeable lens SLRs supplanted the earlier rangefinder designs, due to their inherent accuracy (particularly for wide and telephoto lenses). In the remainder of the century, it was computer-aided automation that made (technically correct) photos nearly effortless, as SLRs acquired zoom lenses while adding auto-exposure, programmed auto-exposure, auto flash, auto-advance and auto-focus capabilities. Ease of use both broadened the market to the average consumer, although the zoom point-and-shoot cameras gradually offered most of what people need for a fraction of the price.

In this century, sales were driven by the shift from film to digital, and then the increasing quality of the digital image. My first digital SLR, the (Nikon-compatible) Fuji FinePix S1 Pro, had a 3 megapixel sensor. Last week, a houseguest showed me his 36MP Nikon D800, which exceeds the detail provided by National Geographic’s 20th century benchmark, Kodachrome 64.

Most people don’t need better resolution, or at least won’t spend $500+ to supplant their 10MP camera with a 20, 30 or 40 MP one. Camera resolution seems to be increasing faster than the size of “hard disks” (i.e. solid state disks) on computers, fueled in part by a shifts from desktops to laptops, laptops to notebooks, and notebooks to tablets (and thus a reduction or cap on storage space). And smartphones will always be better for emailing, texting or tweeting photos than cameras are.

So what can camera makers do to cause people to purchase a stand-alone device instead of a smartphone? Or if they can’t beat ’em, can they join ’em, e.g. as a lens supplier to smartphones (as Zeiss has done in providing lenses for Nokia and soon Sony).

Over the next decade, I think it should be possible to drive one more round of upgrades. I predict than in 10 years, one (but not both) of these two companies will still be developing new products to sell to loyal (i.e. locked in) customers of its SLR systems.

To overthrow liberty, start with free speech

Excerpted from a post Friday at the Cato Institute blog:

Cato Makes Dick Durbin’s Enemies List
by Ilya Shapiro

As reported on the Wall Street Journal’s editorial page and picked up by the Chicago Tribune among many others, Senator Dick Durbin (D-IL) has been sending out letters to anyone he has determined to have funded the American Legislative Exchange Council since 2005.
…
Durbin … is now seeking to shame anyone ever associated with ALEC.

That includes Cato. Earlier this week, we received a letter from Durbin [similar to those received by companies] …

Our president John Allison has responded to Durbin with a letter that I’ll quote in its entirety:

Dear Senator Durbin:

Your letter of August 6, 2013 is an obvious effort to intimidate those organizations and individuals who may have been involved in any way with the American Legislative Exchange Council (ALEC).

While Cato is not intimidated because we are a think tank—whose express mission is to speak publicly to influence the climate of ideas—from my experience as a private-sector CEO, I know that business leaders will now hesitate to exercise their constitutional rights for fear of regulatory retribution.

Your letter thus represents a blatant violation of our First Amendment rights to freedom of speech and to petition the government for a redress of grievances. It is a continuation of the trend of the current administration and congressional leaders, such as yourself, to menace those who do not share your political beliefs—as evidenced by the multiple IRS abuses that have recently been exposed.

Your actions are a subtle but powerful form of government coercion.

We would be glad to provide a Cato scholar to testify at your hearing to discuss the unconstitutional abuse of power that your letter symbolizes.

Sincerely,

John Allison

The article says Sen. Durbin is a graduate of the University of Chicago Law School. It seems like he slept through constitutional law, or at least skipped that part about what the Founders intended when they created the Declaration of Independence, the Constitution and (especially) the Bill of Rights.

There are dozens of quotes available to illustrate the original intent of the Constitution. Here’s one from Ben Franklin (suggested by DaveG) as reported by Sourced Quotes.com:

Without Freedom of Thought, there can be no such Thing as Wisdom; and no such Thing as public Liberty, without Freedom of Speech; which is the Right of every Man, as far as by it, he does not hurt or control the Right of another …

This sacred Privilege is so essential to free Governments, that the Security of Property, and the Freedom of Speech always go together; and in those wretched Countries where a Man cannot call his Tongue his own, he can scarce call any Thing else his own. Whoever would overthrow the Liberty of a Nation, must begin by subduing the Freeness of Speech…

— Benjamin Franklin, July 9, 1722

Note to regular readers: due to the crush of work, I’m behind on blogging on key topics but hope to catch up soon.

Higher ed disruption: zig when others zag

It seems like every spring I write a posting about disruption facing higher education. It is a topic of interest to my coworkers and the many academics among my blog readers — and also an interesting strategy problem where I have a front row seat.

In the past year, one of the big surprises has been the large amount of private investment in tech startups targeting this market. They seem particularly concentrated in developing platforms to enable MOOCs, i.e. massively open online courses.

Stanford is front and center in the revolution. A friend (Chuck Eesley) has been leading the Venture Lab experiment at Stanford. Meanwhile, my previous employer (San Jose State) has been at the center of national controversy as faculty are attempting to fight an experiment with Udacity (another Stanford startup) because faculty (not unreasonably) feel it will someday put them out of a job. Meanwhile, Coursera (a 3rd Stanford spinoff) and edX (started by my alma mater) are also promoting MOOC efforts.

The MOOCs seem to tilt the scale on the longstanding efficiency vs. effectiveness argument. The US higher education is pretty effective for people who get in, who apply themselves and can afford to pay for it. However, it’s very expensive (and labor intensive): its efficiency (i.e. labor productivity) has shown few gains in 50 years.

Meanwhile politicians (esp. state legislators) see higher ed as a ripe opportunity to cut costs. There is a supreme irony that the pressures are coming from the leftwing legislators in California and rightwing legislators in Texas — who rarely agree on anything — who now agree they want to spend less on higher ed so they can spend the savings on something else (that presumably buys more votes).

However, my suspicion (without any hard data) is that the marginal college students (without a lot of motivation or support network) will tend to fail in such an impersonal high-volume, low-touch setting. These are exactly the students that the California State University (the parent of SJSU) targets: every CSU faculty member can tell heartwarming stories about students who succeeded despite being the first in their family to attend college.

A few months ago, I met the executives of a Bay Area startup taking a different approach. Instead of a large-scale impersonal MOOCs, the approach of the Minerva Project is to cut costs by 2x (rather than 10x or 100x) but offer a high-touch online alternative to higher education. In other words, if everyone else is zigging — pursuing low-touch massively online solutions — they want to zag with high-touch smaller scale online courses.

The company landed $25m in Series A funding and numerous headlines about its plans to “be an online Ivy League university.” To be more Ivy League, it hired a 64-year-old former Harvard and Stanford administrator to be its founding dean.

The reason I met these execs was announced this morning:

Minerva Project and KGI Partner to Launch the Minerva Schools at KGI
San Francisco, Calif. – July 24, 2013 – Minerva Project, reinventing the university experience to develop global leaders and innovators across disciplines, and Keck Graduate Institute (KGI), a member of The Claremont University Consortium, today announced an innovative new partnership in higher education. KGI, an institution accredited by the Western Association of Schools and Colleges (WASC), is partnering with Minerva Project to launch the Minerva Schools at KGI, with the first class matriculating in the fall of 2015. The Minerva Schools’ unique undergraduate program will complement KGI’s current graduate-level offerings, expanding its portfolio and providing opportunities for student, faculty and administrative collaboration. The KGI-Minerva relationship and new programs are pending WASC approval.
…
The Minerva Schools, like KGI’s graduate programs, will help high-performing students become mature, confident individuals and put them on a path to meaningful careers and fulfilling lives. The highly selective undergraduate program will offer students from around the world the opportunity to learn from accomplished faculty versed in the latest teaching methodologies to ensure positive student learning outcomes.

“Minerva Project is pleased to have found in KGI a forward-thinking university partner whose philosophy and values align closely with our own,” said Ben Nelson, founder and CEO of Minerva Project. “As the most recent member of the pioneering Claremont University Consortium, KGI proved to be a major innovator in higher education when it created the first-of-its-kind professional science master’s degree in 1997. Today, more than 130 institutions have established nearly 300 such programs. By partnering with KGI, Minerva is following one of the established paths to accreditation as set forth by the Western Association of Schools and Colleges and strives to have a similar impact on higher education as a whole.”

It’s an interesting experiment — both because it tries to preserve some of the best things about higher education, and also because it’s so contrary to the conventional wisdom about online education.

It also seems consistent with the most insightful comment I’ve ever read about the future of online education, written last year by my friend (and co-author) Michael Mace in response to my blog posting:

universities bundle several services in that thing called a degree:
--Teaching the students
--Credentialing (ensuring that the students have learned the material)
--Giving the students social connections (Yale, Stanford)
--Helping young people turn into adults in a semi-safe setting

The MOOCs largely emphasize the first two points, and seem to be completely ignoring the value of the rest of the bundle. Meanwhile, Minerva promises to complete the bundle through a global cohort experience while saving money on buildings the way Amazon saves money on mall space.

As a college professor (and eventually a college parent), I believe the partial bundle is going to be less effective at preparing young adults for life — unless the missing pieces are provided another way — and also going to be less desirable for anyone who has a choice. Still, ala Clay Christensen, a disruptive innovation is one that appears inferior (but cheaper) at first and eventually displaces the higher quality solution.

I don’t have a financial stake in the success of Minerva, nor do any of my co-workers. Thus we can afford to be a bit more dispassionate than Nelson (and all the other entrepreneurs) attempting to remake the world of higher education. As with any disruptive innovation effort, it’s a high-risk, high-reward endeavor.

If I were 25, I would be terrified that my industry is heading the way of the landline, record store and the newspaper, but I’m expecting that the disruption will come slowly enough — and I’ll stay valuable long enough — to allow me to retire at the customary age.

Update 12:30 p.m: KGI has posted a press release from its perspective, and both EdSurge and GigaOM have articles on the news. Below is the publicity photo from the PR Newswire press release.

KGI president Sheldon Schuster and Minerva CEO Ben Nelson

Microsoft reorg: tragedy or farce?

There are many ways to interpret the massive “One Microsoft” reorg announced Thursday by Microsoft CEO Steve Ballmer.

One is as a corporate political drama. Mary Jo Foley (of ZDNet) and Sean Ludwig (of Venture Beat) report that winners include Terry Myerson (from head of Windows Phone engineering to all OS engineering), Qi Lu (head of online services engineering who adds Office) and Julie Larson-Green (head of Windows and Surface engineering, who adds Xbox and games). Losers are the presidents and CFOs of the five previous business units: Windows, Server and Tools, Microsoft Business Division, Entertainment and Devices and Online Services.

A second is as a plausible and sincere effort to revive Microsoft’s growth after more than a decade going sideways and now facing the collapse of the PC category that accounts for most of its OS an application profits. As the WSJ reported

Microsoft's restructuring follows a strategic plan, which began taking shape about a year ago, to shift its identity away from being a producer of operating systems and application software. Instead, the company wants to be known for devices—designed by Microsoft itself or by partners—and services that are closely tailored to work with that hardware.

The strategy shift, though it still relies heavily on software development, emulates the way rivals like Apple Inc. and Google Inc. have approached development of products such as smartphones and tablets.

The third way to view this is as reshuffling the deck chairs on the S.S. Titanic. JP Mangalindan of Fortune quotes an outside leadership consultant

"It's a great first step but won't get them to 'One Microsoft,'" says Randy Ottinger, EVP of the executive leadership strategy firm Kotter International. "The real question is what are they going to do post-reorganization to actually change the culture. The re-org will not change the way they behave and act because it's been years and years of doing business in a different way."

Similarly, Barb Darrow of Giga OM writes:

But it is crucial that the changes take direct aim at a long-running Microsoft problem: Fierce political infighting (see org chart diagram below.) When I covered the company day to day, the best way to get dirt on Office was to ask the Windows guys and vice versa. Clearly, after decades of that, and faced with huge and capable (and well funded) competition — Google, Apple, Amazon et al., Microsoft can’t afford to let that behavior stand.

and refers to a June 2011 cartoon contrasting Microsoft to Oracle, Facebook, Google and Apple (the latter updated after Steve Jobs’ death).

A fourth perspective is as an attempt to obfuscate a failed strategy by a failed CEO. As a Microsoft shareholder (NB: Dogs of the Dow), the only writer who seems to feel my pain is the anonymous Lex, writing 7,000 miles away at the Financial Times:

Everyone knows Microsoft’s challenge: its operating system and business software divisions account for 80 per cent of operating profits. These divisions’ core products were developed for personal computers. The PC is in decline, so those profits need protection or replacement. Investors deserve a clearer view of the strategy for doing that, and a reporting structure that allows them to see if it is working. While Microsoft’s overarching strategy has never been clear, its reporting structure has at least made it clear that, profit-wise, one product effort (server software) has been a smashing success while three others (online services, Xbox, phones) have been failures.

Any new structure must deliver at least that much clarity. And if Microsoft is committed to devices, investors should get systematic unit volume reporting. If software sales are becoming services sales, they should be told how the licence sales/subscription sales mix is shifting one quarter to the next. Failing this, they should assume the patient is unlikely to recover.

Most of all, I’m reminded of the Marxist saying that “History repeats itself, first as tragedy, second as farce.” Longtime Microsoft watchers are having a hard time in hiding the sarcasm in their skepticism. As the lead of the Business Week column observes

Microsoft Unveils Its Latest Reorg SpectacularBy Ashlee Vance July 11, 2013

Say this for Microsoft (MSFT) Chief Executive Officer Steve Ballmer: The man knows how to do a reorg, reorg, reorg.

Or even more to the point, Nitrozac and Snaggy capture this at the “Joy of Tech” cartoon. For maximum effect, read the whole cartoon, but here’s the punchline:

And then 2,700 words later:

So if I had to bet on tragedy or farce, “One Microsoft” looks more like farce.

Note to regular readers: Sorry for the delay in posting this, but I’m teaching this week in the KGI business bootcamp for life science postdocs.

Cartoon credits: Org chart by Manu Cornet, Bonkersworld.net; Steve Ballmer as rendered by Nitrozac and Snaggy of GeekCulture.com

More on Samsung's un-FRANDly patent terms

With the release of the (redacted) ITC decision June 4 granting Samsung exclusion of older iPhone models, Munich patent attorney Florian Mueller published two follow-up analyses Saturday of that decision. Both excoriating the five member majority and concluded that only commissioner Dean Pinkert understood the full implications of the case.

In his first posting, Mueller wrote

I'm outraged. The underlying rationale of the ITC ruling is a serious threat to innovation and competition. Among other things, it represents a radical departure from well-established antitrust principles concerning the illegal practice of tying (in this case, a Samsung proposal that required Apple to license its non-standard-essential patents to Samsung in order to get an SEP license). This totally runs counter to the ITC's mission to protect the domestic industry. In fact, no U.S. government agency has ever taken positions on standard-essential patents that could cause a similar extent of harm to innovative U.S. companies of all sizes in other jurisdictions. Basically, the ITC has adopted a blueprint that would enable other countries to engage in protectionism of the most extreme kind, allowing their domestic players to extort more innovative competitors from the U.S. and deprive them of intellectual property protection, while being able to point to a U.S. trade agency's opinion.

The posting summarizes Pinkert’s dissent. Here are a few key excerpts. From Pinkert’s footnote to the majority decision:

Commissioner Pinkert … notes that Samsung does not dispute that it has made FRAND licensing commitments in regard to the '348 patent, and, as explained in his dissenting views, he has considered the evidence before the Commission in the current phase of the investigation and has found the weight of the evidence to indicate that Samsung has not made FRAND licensing terms covering the '348 patent available to Apple.

From his decision:

I note in this regard that Samsung has made no effort to demonstrate that the license terms it has offered Apple specifically with respect to the '348 patent, or specifically with respect to a portfolio of declared-essential patents that includes it, satisfy an objective standard of reasonableness, has not identified a methodology for determining whether they satisfy such a standard, and nowhere suggests an intention to make them more attractive to Apple.
…
As the U.S. Federal Trade Commission has observed regarding commitments to license on a reasonable and non-discriminatory (RAND) basis:

RAND commitments mitigate the risk of patent hold-up, and encourage investment in the standard. [Citation omitted.] After a RAND commitment is made, the patentee and the implementer will typically negotiate a royalty or, in the event they are unable to agree, may seek a judicial determination of a reasonable rate. However, a royalty negotiation that occurs under the threat of an exclusion order may be weighted heavily in favor of the patentee in a way that is in tension with the RAND commitment. High switching costs combined with the threat of an exclusion order could allow a patentee to obtain unreasonable licensing terms despite its RAND commitment, not because its invention is valuable, but because implementers are locked in to practicing the standard. The resulting imbalance between the value of patented technology and the rewards for innovation may be especially acute where the exclusion order is based on a patent covering a small component of a complex multicomponent product. In these ways, the threat of an exclusion order may allow the holder of a RAND-encumbered SEP [standards-essential patent] to realize royalty rates that reflect patent hold-up, rather than the value of the patent relative to alternatives, which could raise prices to consumers while undermining the standard setting process.

The second article focuses on the antitrust implications of tying. His language is even more harsh:

In its ruling on Samsung's complaint against Apple, this ITC majority has taken the notion of intellectual property as an exclusionary right to such an extreme that the net effect is... the expropriation of innovators by extortionists. Anyone wielding standard-essential patents (SEPs) could abuse his gatekeeper role by requiring everyone else, at the threat of total exclusion from the market, to grant a license covering his non-SEPs as a condition for being allowed to operate at all. So a right to exclude could be abused in order to force others to give up their legitimate right to exclude.

Later on, he notes a relevant passage (cited by Pinkert) from a recent article by two of the world’s leading experts on patent licensing, lawyer Mark Lemley (of Stanford) and economist Carl Shapiro (of Berkeley):

While the issue is not free from doubt, we think that an offer made conditional on the would-be licensee licensing any patents other than standard-essential patents reading on the standard at issue is not a FRAND offer.

As Mueller concludes:

I don’t know any example of a case in which an antitrust authority or court of law considered anything other than a cash-only demand to be a FRAND demand. Again, a FRAND demand made at the threat of exclusion is something different than a voluntary FRAND agreement.

Collision of mobile business models

It’s no secret that automakers are building fancy navigation and entertainment systems into their cars. The LA Times this morning has a great article about how they’re not doing so well in competition with cell phone makers, who have products that are better, faster and cheaper.

At least in the US, the automakers want to control the customer, selling them expensive add-on systems; the most successful recently has been the Ford Sync, and before that the GM OnStar. But today the consumers who might buy such systems all have smartphones that do most of the same features (and more). They also run headlong into some of the freemium Internet business models (Exhibit A: Google Inc.) that give away stuff that automakers want to sell.

Here are a couple of great passages from the article by Jerry Hirsch:

[C]ar companies are spending millions of dollars developing interfaces, voice recognition software and navigation systems. Many of these functions either already come loaded on phones or can be downloaded at the swipe of a finger. Honda Motor Co., for instance, charges $2,000 for a satellite-linked navigation and traffic system on the premium version of its popular Accord sedan. But Waze, a division of Google Inc., provides the same functionality in a free app.
…
"People today bond more with their smartphones than their car," said Tom Mutchler, the senior engineer at the Consumer Reports Auto Test Center. "Car companies are going to have to live up to the expectations that come with that."

The whole article is recommended and doesn’t seem to be behind a paywall.

The article points out two problems the automakers face. First, in a race of innovative software between Ford and Apple, or Honda and Google, who do you think is going to win?

Second, you keep a car for 10 years and a phone for 2. So for the average consumer, which one is going to provide the better experience?

But the third problem Hirsch misses is that (as any strategy professor will tell you) Apple and Google and Samsung have economies of scale, and the car makers don’t. 700 million smartphones were sold globally in 2012, most using one of two platforms. In the US, 16 million cars were sold, with in-dash entertainment systems fragmented among a dozen makers.

As I teach my students, R&D is a fixed cost amortized as (total R&D) ÷ (number of units). Apple sold 137 million iPhones in 2012 (not counting iPads and iPod Touch using the iOS). Assuming GM or Ford gets 17% share and half buy the fancy infotainment system, that means about 1.4 million Americans are buying each car-based platform. (Toyota, Fiat/Chrysler and Honda sell even less). Given that’s two orders of magnitude less than the #2 smartphone platform, no wonder carmakers have to charge $2,000 for their systems.

It’s clear carmakers are going to lose this fight. Obviously, if you can’t beat ’em, join ’em — which is what Honda, Toyota and Hyundai appear to be doing. The article refers to the Car Connectivity Consortium producing the MirrorLink standard, which includes these three carmakers, as well as Samsung and HTC. In addition to these car companies, the CCC website also lists Daimler, GM and VW as charter members, with Ford and Subaru (“Fuji Heavy”) as a non-voting “adopter” member (BMW, Fiat and Mazda have limited voting rights). Nissan and Kia are nowhere to be found.

Volkswagen was early in partnering with Apple, so they may continue to lead on iPhone connectivity. Android compatibility could be a good foot in the door for the 3 Asian carmakers. But from the article and their market actions, it seems like some automakers (led by Ford) Ford are stuck in the slow lane trying to sell overpriced, soon-to-be-obsolete dashboard systems as though they can dictate what options American auto buyers will use on the road.