Category Archives: business modeling

Paying for Features

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This posting is about two things. I can’t or I uncomfortable with teasing them apart. One part is about how a firm blocks out the choice to add a feature versus how an open source project makes the same choice. For example if we have the bundle of software used to run a handheld computer and are are trying to decide about adding a Postscript viewer to the bundle.

The second aspect is about network effects. In our example if the viewer is added to the base system it will create a much stronger network. That results in an interesting tension in the community around our example handheld. One camp would love to see the addition of a viewer while another camp is ambivalent. Call these camp A and camp B. The tension arises because it’s a lot more fun for camp A if the entire community gets the new feature. If camp B doesn’t get the viewer then camp A won’t be able to casually exchange their Postscript files with the entire community.

Rereading Oz Shy’s wonderful little book on network effects triggered this posting. He outlines a market failure where a firm fails to reach customers with a cool feature because the firm can’t figure out how to structure their pricing so that camp A pays for the viewer while camp B doesn’t.

I’m often asked by clients if open source can help them create a network they desire. So I got to wondering about the analogy between Shy’s example and open source scenarios.

So let’s try to map his example onto an the analagous situation in an open source project.

The commerical vendor does a cost/benefit calculation. It costs so much to add the feature, and so they need to raise prices or market by a certain amount to justify the effort. The analogy in open source is that you need to find a team, call it team X, who desire the feature sufficently to cooperate to add the project.

In Shy’s example the two camps are have different willingness to pay for the feature; i.e. we have a demand curve with a step function. One camp has high willingness to pay and the other has low or zero. Team X, in the open source, case is analagous to camp A; but different.

When I read Shy’s point about how the firm has a pricing problem my first thought was: “Ok, what’s the demand curve really look like? Are there some extremely desperate folks in camp A?” Because if there are just a few desperate folks they may be willing to pay for the firm to do the whole work and then give it away to the entire installed base. For example it is possible to image a handheld firm finding a single fortune 500 company that would be willing to write them a check to do the work. That depends on the shape of the demand curve.

Folks unfamiliar with open source often assume that Team X is an extreme form of camp A. They assume team X must be really desperate since they are willing to build it! That’s not entirely true, rarely true in my experiance. In many cases Team X is unique not in their willingness to pay but rather in how easy it is for them to build it. They have extreme talent (of a very narrow kind) as a substitute for extreme desire.

That’s important. It means that your drawing the members from team X out of a population distribution that suprisingly independent from the one that was simplified into camp A and camp B.

Either high desire, or low cost increase the probablity that a member of the project community will join a collaborative attempt to add the feature.

The standard way to visualize willingness to pay is a demand curve and we can draw a similar picture for talent to implement (and other skills that increase the chance that team X succeeds). Unlike your typical economics text book these curves are not straight lines. The forture 500 company above illustrates that. I suspect these curve are typically power law in form.

You still get failures analagous to Shy’s pricing problem. First you get failures becaue getting Team X to form is hard – i.e. finding elite members of the desire population and the talent population isn’t trivial. The open source project provides a point of rendezvous but it doesn’t necessarilly engage in directed search for oportunities with the same focus that a firm is assumed to.

The second stage of the analogy comes from returning to the issue of the network effect. Members of team X desire a large network as do members of camp A. They are seeking a distribution channel that can give them a means to that end. The open source project offers the option of getting that. Gaining a chance to try and exercise that option pulls team X together. This substitutes for the commerical firm’s directed search for features that will make them money.

For the commercial firm a feature with network effect is a pricing problem; for an open source project a feature with network effect is a team builder.

You are surrounded!

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I’m sure there is some executive at Apple who’s bonus is based on how many spare power adaptors they sell. The damn things are about as reliable as an American car back when Ralph Nader wrote “Unsafe at any Speed.” These things have a half life of about 4 months and they cost a bit under a $100 each to replace. What a scam.

Once you have a loyal customer the devil is always tempting you to insist that he buy some add-ons, spare parts, etc. The more captive he is the more you can pile on this kind of abuse.

The hotel I checked into at the end of a long day recently had a “manditory resort fee.” No, it’s not a tax from the local municipality it’s just an extra charge they throw onto everybodies bill. Now isn’t that hospitible of them? Of course the room had trays of food layed out with a prices list next to them. The lobby had a booth, just in case you wanted to buy one of their beds.

At the dentist’s office yesterday they attempted to sell me a hundred dollar electric tooth brush. Three extra brushs for $30 dollars. This was urged on me by the dental hygienist as something they strongly recomend. It’s not like I can do my own dentistry. So I go and place myself into the hands of a proffesional. Having handed the responsiblity over to this professional his agent then attempts to upsell me some accessories. I wonder if dental hygienist school now includes additional training on how to upsell the customer.

How long before all the professionals do this? Doctors could sell bedpads. Surely we can find something for lawyers to sell you that will help with your day to day legal hygiene! What’s wrong with my plumber, he hasn’t even tried to sell me a powder that I must sprinkle into my drains once a week. I do love my pipes!

Shifting gears, a bit, these customer loyality/lock-in senarios are very similar to the variation on a public good; the club-good. Club goods are a scheme for addressing some of the failure modes of public-goods; for example overcrowding or freeriding. Your public swimming pool might become over crowded; so you create a club and use that to both limit access and to assure all the users are paid-up club members. In a sense what your buying when you purchase a hotel room is a shortterm membership in the hotel-club. Once inside the club the facilities behave just like a public-good – abundant and collegial.

The fence around the club helps to assure that we avoid the organizational problems of the public-goods – freeriding and overcrowding for example. But, if we are running the club – and we are feeling a bit evil – we can use that same fence to hold the members hostage and abuse them. Substituting the appearance of abundance for the reality, subtituting the collegial for the salesman’s bonhomie.

On the plane they charged $2 for a headset to watch the movie, and then called upon our solidarity with our our fellow members of the flight club to draw down the shades. They packed us in like cattle. So much for using the club idea to resolve the overcrowding problem.

I should probably mention that I had managed to get that hotel room mentioned above for about 30% of list price. Which only brings us around to taking note that one of the things the club owner can do if he manages the fence to his advantage is discrimitory pricing.

Make less, make more!

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Many years ago my father advised me to avoid antenna design – “Too much black magic.” I took that advice; but I seem to have fallen into a similar trap, i.e. pricing.

Consider this pricing problem. You sell a product which two classes of people. One class, 10 people, would be willing to pay 100$ a unit. A second class with 90 people in it are willing to pay 10$ a unit. So if the vendor charges 100$ he will make $1,000; if he charges 10$ then he will also make a $1,000. If the the first class is willing pay a bit more or the second class is willing play a bit less then the vendor will profit if he makes only 10 units.

That story is a bit bloodless so let’s put some adjectives on these classes. The first class is desperate if they are willing to pay so much. We might say the first class is very loyal to the vendor’s product and nothing else will do. We might say the first class is locked in.

Early in the Bush administration a handful of electricity vendors in California realized they were in exactly this situation. They could make money if they sold less electricity. So they shut down some generating plants. They called it maintenance and complained about excess regulation. The first class of buyers, unable to switch, locked in, and addicted to electricity then drove up the price to amazing heights. At the time experts knew exactly what what was going on but the regulatory organization had been entirely cooped by the industry and so nothing was done. Amusingly the Bush folks talked about how we needed more supply which was true, and suggested we should open up new oil fields which was irrelevant.

There is a picture in my local paper of a long line in front of a pharmacy down the street from me. Long lines are a symptom of a group of folks in the first. They were queued up to get flu shots. The supply of flu shots has fallen sharply. The price is up. Clearly this market is just like the one in the model above. There is a core of desperate buyers willing to pay a lot; as demonstrated by their willingness to wait in extremely long lines. I’m suspicious that it’s also an example of the kind of story shown above.

What’s fascinating about some of these scenarios is how the trigger of the mode switch could come from anywhere. For example an investor in firm A might strive to get firm B shutdown; say by reporting safety violations to a regulator. Then when the firm B gets shutdown and the large class of low price buyers go looking for an explanation the regulator gets blamed.

The California electricity debacle shown how deeply the pro-business Republicans have undermined the regulatory systems in this country and sadly it makes me terribly suspicious about the current flu vaccine situation.

Meanwhile the Bush administration thinks scientific fact is a special interest group, and certainly not part of their base.

Open Laszlo

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Cool, Laszlo has played the open card.

I am not surprised, but I am very pleased.

It’s tough creating the buzz of activity and complements around a tool like Laszlo. Worse, if you don’t create that good-olde network effect then your stuck. You maybe able to have a certain level of success but that even that’s not durable over time.

Laszlo is a very elegant work. For example: play with the examples of constraints that appear on this page in the manual.

Opening up Laszlo could create bloom of new UI. There are some huge pools of data out there that could get a new presentation skin. Google, eBay, delicious, movable type, word press, … it’s not a short list. There are early examples of this kind of UI out there. Go look at flicker for example.

I had been hearing VC talk about how flash was going to disrupt the client side; i had been discounting that – self interested speakers an all that. I need to revisit that chatter.

Putting on my health of the industry hat, or my paranoid CTO hat, the thing I notice about Laszlo is the dependency on Flash. It really is amazing that the folks at Macromedia have managed to get such a huge piece of real estate on the installed base of client side machines. How did that slip past the guards at Microsoft! Adobe tried, with SVG, but that certainly didn’t work out. I tip my hat to them!

For years and years the GPL community was very careful to avoid standing on top of Motif because they didn’t perceive it as being sufficiently open. A similar careful critique should now be made of the Flash platform. We have suffered a lot because the client side fell into the hands of Microsoft; handing it over to Macromedia would be better but it wouldn’t necessarily be good.

Recently I have been looking at RDF. I blame Stefano. RDF strives to displace the HTML/XML as the canonical data model. That’s a tall order. HTML seized that turf because it was simple enough because it was presentation oriented. XML hides behind HTML’s success. RDF, well it’s not clear what “go to market” benefit is.

One of the wonders of the HTTP/HTML bloom has been how it created a huge amount of casual revealing of information. The presentation standard, HTML encourages casual revealing in a form that automation can swallow. This created the landscape (the platform) for the search engines. It’s not clear if that landscape will survive a transition to a richer presentation platform. Data hides behind UI. It’s not clear if that landscape will survive a transition to a richer data exchange protocol – particularly if it’s name is SOAP.

Data hides behind UI.

Aggregating the long tail.

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This article is important.

“…a digital jukebox company whose barroom players offer more than 150,000 tracks…”

“….The average Barnes & Noble carries 130,000 titles. Yet more than half of Amazon’s book sales come from outside its top 130,000 titles. …”

“… successful businesses on the Internet are about aggregating the Long Tail in one way or another. Google, for instance, makes most of its money off small advertisers (the long tail of advertising), and eBay is mostly tail as well – niche and one-off products. …”

Go read it.

King for a Day

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Will Pate asks and Tim Oren responds. A long fun Just So story. Maybe he doesn’t answer the question but at least he illuminates it. “So why do shareholders have limited liablity?”

The nugget in his story is that limiting share holder liability lowers the risk for shareholders of investing their capital.

Sounds like moral hazard to me. I.e. it’s an invitation to investors to engage in morally suspect behaviors because they know they can avoid the consequences of those behaviors.

Tim’s story is fun because he’s entirely honest that this benefit for investors came about because it was a benefit that King’s enjoyed. When kings take risks that bear foul fruit the peasants smile cheerfully and eat the fruit. When power began to devolve from the king into the hands of the wealthy the limited liability corporation was a way to get the same benefit for the corporation’s investors.

There are many models of what a corporation is. For example some folks think of a corporation as a knot of contracts. But clearly one model of the corporation is that it’s a license to investors take a risk and dodge the full liabilities there in. A chance to pretend to be king for a few days.

Of course risk taking is necessary part of economic growth; so it’s in societies best interests to make choices of where and how much risk to license.

To hear Tim tell it America – pause for a moment of silent respect – would not exist if not for this devolution of kingly powers unto the investor class. It’s a story that takes my breath away.

Actually, to be a bit more accurate Will’s question was “What is the best reasoning behind why shareholders have limited liability for a corporation’s environmental and social costs? …”

In my noodle that collides with Tim story of early english colonialism’s corporate roots. I find myself remembering things. after the european-asian germs wiped out most of the native populations. That the European earth worm spread across the continent and wiped out much of the ecology. The slave trade. The cod. The elm. The beech.

Nothing is simple.

Lord of the Rings at Boston Mueseum of Science

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I’m not a fan of the Hobbit books, but the movies are grand spectacles and quite fun. Far better than the Harry Potter movies, for example. So I was quite abivalent about going to see the exhibit at the Boston Mueseum of Science (flash) about the making of the movies.

It was great! There lots and lots of different ways you can enjoy this exhibit. I liked it much the way I enjoy visiting factories, or artist studios, or the way I enjoy thinking about the mechinism of a business actually works.

Modern movies are like the hybrid monsters of science fiction. A kind of bizzare amalgam of organic reality and digital machines. The assembling a movie is something right out of the lab of Dr. Frankenstein. Each pixel on the screen has a long ancestry that sooner or later returns to bit of the real world. A real object exists somewhere. I was taken aback by how many generations it maybe away from that physically real.

It’s a kind of displacement story. Here instead of a culture being displaced by some technological innovation it’s all of physical reality.

Certainly, the exhibit has lots of real artifacts. Models, costumes, props. These make better mueseum exhibits than disk drives or inanimate program listings. But, all around the edges, you can sense where the real money gets spent on a film.

In one exhibt shows how they make extremely high resolution 3D digital scans of each of the actors. For example they build extremely detailed models of just the faces. These digital actors become movie subroutines just as much as the digital monsters. In any scene were the actor’s detailed acting skills are unnecessary this digital version can then stand in. Walking into a room, moving across a plain, etc. etc. As the technology improves the range of scenes needing the real actor declines. They are displaced. They have already displaced all the extras.

Similarly the actors, when they perform, are rarelyy embedded in anything close to the real scene that the movie presents. Only the smallest fragments of any scene are actually constructed; the rest is filled in digitally. Most of the acting takes place surrounded by blue screen, one actor, alone.

One side effect of this Frankenstein laboratory is that the real objects, the physcial world inputs become rare. They are like the eye of newt, the tail of frog, in some witch’s brew. Each of them becomes more rare and at the same time more precious. If your going to create a new species of digital monster then you might as well spend a really large sum of money on the archtypical physical model that will then be digitally scanned and sent into the subroutine libraries for later animation, dupication, etc. etc. So while they don’t need to hire a few thousand extras, they do need to hire a some very highly skilled model builders.

And all these models, costumes, etc. are amazing, delightful, and really cool.

If your in Boston, I recomend a visit. I don’t think this exhibit is going anyplace else in the US.

Bee Hive

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I’ve been looking for years. A beehive! Bee Hive An example in nature of a two sided network effect! It provides brokage, exchange, or agency between two classes (pistil and stamen). It draws off a tax (honey) for the maintainance of the hub (hive). Since these kinds of hubs become more valuable as more and more particpants rondevous around the standards set by the hub I think we can assume that the flowers of the client population evolve to fit the exchange standards made manifest in the hub. I.e. they evolve to interface well with bees of a certain size et. al. of the dominate bee population. Overtime that should drive other polinators out of buisness.

Cool idea! Now go away.

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Tim Oren appears to be suffering from sympathy. An unusual affliction for a VC. A handful of reasons why, Mr. Entrepreneur, your amazingly cool new innovation isn’t going to get funding:

  1. Cool demo! Great price point, what a leap forward! Man making stuff like this dependable is really hard work. You probably can’t see that, having just moved so fast. You know the incumbent is always improving. Sorry, I think we’ll pass.
  2. Cool! – oh – It’s so cool that pretty soon it will be a ‘must have’ and the platform vendor will swallow you. No durable business here. Next.
  3. Neat! – oh – Sadly your customers are too smart. Even if you get past the damn designers (NIH etc.) you won’t get by the risk adversion of the project manager.
  4. Your customer’s too powerful and too slow. They take years to release a new product and they never leave any real money on the table for the component providers.
  5. Customers would love that! – oh – The channel’s doesn’t care. The channel sells by subscription: i.e. they want zero up front cost, sticky features, and value delivered in dribble. You don’t fit that model; your toast.
  6. Ha, that’s clever. The early adopters will love it. But, I just can’t see how the late adopters are ever going to see that as anything but added complexity.

Needless to say Tim put’s this all in a much more professional and accurate way.

Sticky, it’s not just data.

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I underestimated how sticky Moveable Type is.

Vendors love things that make their product sticky. If developers really appreciated this software products would be even more sticky. Instead developers hate sticky; they call it things like “backward compatiblity” or “legacy.” Maintaining the sticky bits is a pain. Platform developers have the worst of it because the software that stands on the platforms was written by very very clever dudes who find and depend on every curiosity of your API. The software those clever guys write is extremely brittle. The platform’s vendor has to work very very hard to maintain every bizzare detail.

When I switched to Word Press my web server logs suddenly blossomed in a torrent of broken links. I’d arranged to reroute the obvious links before the switch over. But, it turns out that my site’s users are as devious about finding interfaces into my blog as platform developers. It looks a bit like every URL that you could possible generate for reaching into the blog was used by somebody. This was particularly hairy for the various subscription feeds. I notice that a lot of subscription readers aren’t particularly interested in paying attention when my server notifies them that a resource has moved. So now I’m serving up the subscription feeds from the old locations. I wonder how many subscribers I lost during the service interuption?

The backward compatiblity breakage that I didn’t see comming was with Google. All my page names changed to something new and so Google’s model of what’s on my pages evaporated. All my Google ads suddenly became extremely lame. Imagine how sticky things would be if you depended on the revenue from such ads.

The third interface where backward compatiblity is turning out to be very rough is the blog author user interface. I don’t mind switching to a new user interface. Somethings are better, some are worse. But what about the other folks? The folks who’s blogs I host. I think they are going to hate it. In general they get to suffer the cost of changing but for them the benefit of the switch over is pretty obscure. In particular the photo upload in Word Press is much more tedious. Imagine if those people were paying me for their blog hosting?

I used to think that the #1 thing to worry about in buying software was that I would be able to rescue my data, retire the software, and adopt something else. Apparently in the modern world software embedded in the marvalously messy open platform that is the Internet it’s much more complex. We are all platform vendors now.