Very thought provoking and clear thinking at how things might begin to shake out in the transformed music industry: Music Mid-market Musings. I’m reminded, a little bit, of the concept of rent stores. The landscape metaphore has some serious limits; but even so… the parrallels between the disruptions that gave rise to suburban sprawl (increased personal moblity via the automobile) and the displacements triggered by the Internet (increased findablity and decreased distribution information costs) are striking.

The chart above shows that poor nations steal more software than rich nations. It appears in a wonderful paper by Hal Varian that illuminates the nature of markets for information goods.

Is that chart an indictment of the moral fiber of poor nations?  Or, is it a sign of skillful  differentially price their goods?  Is the Chinese spending the same percentage of their GDP on goods from Redmond and Hollywood as the English?

Maybe this is about network effects.  Popular movies and operating systems have strong network effects. Firms selling such goods ignore large, but cash poor, markets at their peril. If all of China don’t adopt the products of Hollywood and Redmond then something will arise in their place.  What ever that is, it will become a problematic competitor. To paraphrase the aphorism: when it comes to network effects idle markets are the devil’s play ground.
Ok, so today in the WSJ we see them ragging on China:

“High on the list of irritants are discriminatory regulations, rampant piracy of American software and movies, and barriers that keep U.S. banks and other service companies out of China…. “

I was first reminded of that chart, but secondly I was amused to note: “Be careful what you wish for.” China might be able to use strong enforcement against piracy to create a trade barrier that helps assure that their home market for goods with strong network effects is, in fact, harder for overseas firms to enter.

I found an idea in this piece on Social Entrepreneurs provocative. Let’s accept that entrepreneurs are a class of people who create value in a manner that is both creative and destructive. (An idea usual credited to Schumpeter.) The social entrepreneurs do a similar thing in the sphere of social value. Some people get all fixated on the destructive side of the equation, the way that a successful entrepeneur often seems to destroy the vested interests – i.e. Microsoft (and the desktop PC) displaces Digital Equipment (and the mini-computer).

I found that provocative since recently I was reading a some stuff about small wins which are a design pattern for political activism. The theory of small wins is that a successful social movement gets that way not by kicking the shins of the giant of vested interests but rather by a series of small wins. Each small win has a positive feedback effect on the movements self confidence. It that creates cohesion for the group that both strenthens and enlarges it. Focusing on small wins allows the group to be light on it’s feet – cherry picking successes. The focus on small wins also decreases the chance that the immune system of the vested interests will mount an effective response. First because the wins are often small enough not to trigger the immune system. Secondly because the creative cherry picking makes the movement’s next act hard to predict.

One of the reasons that folks that have been successful in large companies employees often fail to thrive in entreprenural settings is that they are used to having and executing on longterm big plans. In a very small entrepenurial firm the plan, the product, the market, the customer often change once or twice a week. The small firm is actively searching for a series of small wins. That series will then deliver three key things: a team that has confidence it’s ablity to execute, an offering that has adapted to the market, and possibly most importantly a proof that the niche exists where other market players won’d eat you alive.

At first I thought these ideas were already familiar. Long long time ago I learned a species of problem solving techniques, what Simon and Newell called ‘strong methods’, that could be applied to any problem. For example you can always solve a problem by generate-and-test: you generate an solution, test if it works, repeating that until you find a solution. This method is strong in that it works for absolutely any problem. It is, of course, a lousy method because it may take an infinite amount of time and expense to generate enough solutions to find the one you need. At the other end of the spectrum from the strong-methods are the weak-methods which only apply to a limited range of problems: for example that to avoid getting bits of egg shell in your breakfast you should crack the egg on an a flat surface is both a weak but extremely effective method. Evolution is a strong, but lousy, method.

One of the weak methods (well almost) is hill climbing. You start with generate and test and then you modify it slightly by scoring your successes and then when it comes time to generate the next possible solution you try something that seems to head in the same direction as the solutions that got good scores. You try to climb up hill to the peak score; where presumably you’ll find the solution. This obviously won’t solve all problems; your not likely to get to the top of Mt. Everest by just walking up hill from where every are.

Small wins and other tools of entrepeneurship are not just hill climbing. Because they must create a virtious cycle that feeds the strength and enthusiasm of the team, the movement, the organization.  By generate real value with each win, value that addresses the actual goals of the organization, that validates and strengthens the organization – they are social money in the bank. The process inherently search out the places in the problem space where the problem has some give, places where the vested interests are less likely to fight back.

All this tends to suggest that step wise is often a dominate strategy compaired to revolution. Which is curious since entrepeneurship is often cast as a revolutionary act. That’s true, it is revolutionary, but only if you get fixated on the destruction side of the value creation. You rarely revolutionize vested interests by taking them head on, usually you just quietly displace them.

I’m sitting at home so I can sign for a package containing a new expensive toy for me!

I paid extra for shipping so it would get here before I go for a long trip.

The package tracking isn’t working. It worked once. Now it says there are duplicate packages with the same tracking number and I should call customer service. What is customer service is willing to tell me? Exactly nothing. Well they are willing to tell me that the shipping I bought assures that my package will arrive sometime within a 72 hour period (this is called two day shipping of course) but then I knew that when I purchased it.

I’m very frustrated. At this moment package tracking is the only feature of the bundle of features that make up the shipping I care about. At this moment it looms large in my perception of the shipping. Why it’s 80%, 90% of the value of the shipping for me right now. I want my money back! Well, actually I just want customer service to be nice and apologetic.

That’s an interesting aspect to bundling. If you, the vendor, mess up one “minor” feature of the bundle how much of a refund does the customer deserve? What if that feature (which accounted for only 5% of your cost) accounts for 45% of the user’s valuation of the offering?

What’s a day out of the office worth?

Dating services, credit cards, game consoles, farmer’s markets, real estate agents all have something in common and thus the lover’s lament “he’s been too long at the fair.” Let me explain. Let me invite you to the fair.

The September ’03 issue of Review of Network Economics has an article by David S. Evans that I’m enjoying: “Some empirical Aspects of Multi-sided Platform Industries”. These “multi-sided platform industries” are a species of businesses that have particularly strong network effects.

I’ve heard it said that these business models have a butterfly shape. In an earlier paper Evans tells this story:

Dating clubs – typically bars or cafes – are an innovative way for men and women to meet each other in Japan. At one club, men and women sit on opposite sides of a glass divide. if a man sees a woman he likes, he can ask a waiter to carry a “love note” to here. Dating clubs sell patrons the prospect of making a match. Their business works only if they attract enough members of the opposite sex to their club to make a match likely. Enough men must participate to attract women, and enough women to attract the men. The club must figure out how much to charge men and women so that the club gets the right number and mix of patrons, while at the same time making money since most of these clubs are in business to turn a profit. One bar does this by charging men $100 for membership, plus $20 a visit, and letting women in for free. …

Pricing problems and startup problem make these businesses very unusual from a simple economic prospective. The paper talks about how various industries have tried to solve the problem of getting everybody to show up – what is commonly called the chicken and egg problem. The men won’t come if the women don’t, and visa-versa.

Another example is the commercial fair: flea markets, craft fairs, Comdex. IT people go to Comdex to see the vendors. The vendors go to Comdex to see the IT people. In the middle ages there were huge fairs for specific goods. For example to trade horses or clear letters of credit. Entire cities were taken over for weeks, much as Comdex used to take over Las Vagas. These fairs persisted until their industries had matured enough that other mechinisms replace them. Once a market matures the fair gets boring, vistigal. You don’t need to go to Comdex to find IBM or Microsoft.

Young industries have the fun fairs! Because then, only at the fair, can you see the newest coolest stuff Stuff you didn’t know was happening. Kick the tires. Find the interested buyers or the interesting sellers. At the fair you can start the fun collaborations.

With that in mind. Let me recomend ApacheCon. The conference of the Apache Software Foundation. Real people doing real work in new ways using really neat new stuff. Funky. No glass wall! No waiters. New opportunities!

You better register! Maybe you’ll bring home that “bunch of blue ribbon”.

Here’s a fine example of modern pricing practice. Notice how this forces the shopper to reveal (negotiate) exactly what price he’s willing to pay by setting up a cascade of barriers he must climb over to get the lowest price.

OfficeMax.com – Western Digital 120GB, 7200 RPM, 8MB Cache Hard Drive $69.98 After Rebates.

OfficeMax has the Western Digital 120GB Hard Drive Item# 20346127 selling for $139.98 with a $30 Mfg rebate (exp. 9/27/03 – original UPC) and a $20 OM rebate (#27 exp. 9/27/03 – copy of UPC). Start shopping with this $20 off $125coupon (exp. 10/05/03) and using the “Order by item number” link at the top of the OfficeMax homepage add the drive to your cart and check-out. Your cost just $139.98 – $20 coupon – $50 in rebates = $69.98 shipped to your door. You could add some free after rebate items to get over $150 and use the $30 off $150 coupon to get it for another $10 cheaper.

One aspect of this I find thought provoking is how the transaction is spread out over time. In a simplistic model the transaction is closed out once you have handed over you money, have your goods and you’ve left the cash register. No more.

What with return policies, rebates, warrenty, credit card warrenty extensions, firmware updates, etc. etc. transactions almost never manage to close out.

Some people in marketing call this a relationship.

There must be some way to introduce an intermediary into this. “Mr. Rebate: we do the work you get the money!” Maybe it could be a add on to the warrenty registration services some of the credit card companies provide. Maybe it could be one of those little mall cart based franchise businesses. Just once I managed to get the staff at a cell phone store to offer to do all the paperwork, including the envelope and stamp, as part of negotiating the purchase of a new cell phone.

Tim Oren turns his not inconsiderable pirate skills on the rich prize what is the dying music industry.

He makes a fascinating point that the Ticket Master monopoly might be the big winner in reshaping the industry. On the other hand the dollars may just go someplace else, never to return.

He points our that there will always be a top 40, the power-law curve is always there. I certainly agree, there will always be a top 40. But, three points temper that. One: The market share of that top 40 can decline substantially. Shifting the wealth out into the tail and lowering the slope (or exponent) of the curve. Two: The slope of the power-law curve depends on, at least, two things. The strength of the bottlenecks in the market, and the scarcity of information available to buyers. The net acts to undermine both these. This is true across the all the information industries. Third: durable are positions in the top 40? Saying there will always be a top 40 isn’t the same as saying there will be another Beatles.

Picking possibly winners, like Ticket Master, is a fun way to look at the problem. Maybe the winners are the equipment makers, maybe the platform vendors.

All this has reminded me of a story I find useful to revisit whenever I’m thinking about the role of DRM in these markets. It’s the story of what happen to the Font Foundries. They were almost innocent civilians, collateral damage, in the platform wars back in the 1980s.

A huge demand emerged for high quality fonts in the 1980s as the price of high quality printing fell. On the one hand olde font foundries wanted DRM on their IP. On the other hand there was an explosion in demand for high quality fonts due to the arrival of laser printer and it’s complements.

Adobe stepped in between these two and offered a DRM solution coupled with a bundle of other stuff. This solved the problem faced by the font foundries. Adobe needed access to source of quality fonts. But the bundle that Adobe offered threatened the platform vendors. The bundle that Adobe pulled together solved two problems. The print driver problem. Adobe really irritated the platform vendors with Display Postscript which offered to solve the display driver problem.

Technically, operating systems are not much more than bundle of device drivers – i.e. they solve the rondevous problem between hardware and application software. You can’t compete in markets like this without huge flexibility in pricing. When bootstrapping the network effect you desperately need to be able to match the price of the competing solutions. In software, where marginal costs are close to zero, that often means zero.

It’s hard to sell something at zero price if you have to pay a unit cost to some other vendor buy some random component part. In this story Adobe threatened both Apple and Microsoft in just this way.

This is one of the problems you can solve with industrial standards. Industrial standards allow components to be comoditized. So Apple and Microsoft got together and put forth an reasonably open standard for font encoding, and for the display. The display standard never took fire. But OpenType(r) did.

The platform vendors weren’t targeting the font industry. They were targeting Adobe. Adobe had somewhat incidentally solved the DRM problems of the font foundries. Adobe cared about high quality fonts. High quality fonts were pretty low on the agenda of the platform vendors.

I find this story fascinating because what happened next. Billions of fonts appeared in the market.

Good fonts had been scarce. The font industry saw to that. Suprise, good font designers were not scarce. Lots of talented font designers were hiding out in the art schools all over the planet. Their motivations to create new fonts? Well it wasn’t fame and fortune.

Out of the long tail of the power-law curve we saw billions of horrible fonts appear, thousands of good fonts, and occationally really really great fonts It was a font bubble!

That forced Adobe to back off on the DRM. Adobe couldn’t afford to lose the attention of the font designing community. They had to move fast to assure that font designers built fonts for their platform at least as often as they built them for the new OpenType(r) font platform.

To this day it’s still the case that the traditional font foundries horde the IP rights to some wonderful and beautiful fonts. That means that those fonts are rarely seen.

I see a very similar future in the cards for the music industry. I suspect we will see a bloom of new music from the long tail of the curve. We will see some moves by various players to try to keep up with the new more open distribution channels. Other players will cling to the old model. Much of 20th century music will become rare (loose market share, become more rarely played, etc.) just as many beautiful fonts are now rarely seen.

Locked up in the old business models.

This kind of displacement – margarine for butter – is a common downside of shifting technology and business models. You seem to have to just lump it. Those aspects maximized by the olde winners are rarely the same aspects maximized by the new winners.

Tim notes this and other things in assorted posting about how the movie industry seems more clueful, how there is some sign that alternate kinds of entertainment (video games?) maybe grabbing consumer dollars from the music industry, and how on some days it looks like content is just the necessary evil of a rising tide of communications.

This blog entry points to a paper on patents and draws out a few paragraphs. One of them I strongly disagree with:

Second, the number of citations received by the average patent has increased over the last couple of decades, suggesting that the social value of the average patent has increased.

I have no doubt that the increasing number of citations is due to two causes. The patent bar’s empowerment by technology. It’s just a lot easier for the patent lawyer to find related work and by citing that work he demonstrates he’s doing his job.

The second reason is the way that the patent bar has sold a bill of goods to universities. The patent bar has convinced the universities that there be gold in them thar proffessors and all you gotta due Mr. Adminstrator is get your self a half dozen members of the patent bar and pretty soon you’d be rich just like Yoyodyne University with their DNA transcription pattent.

Meanwhile no practicing engineer, in my experiance, reads patents as a source of ideas. Why? Because he’s afraid he will be tainted by the experiance. I have, multiple times, sat in meetings where members of the audience have strongly objected to one participant’s offer to explain some patent in the area where they are working.

Generally there are so many ways to skin a cat. Mr Engineer is confident he can just figure it out. But once he’s read the patents in an area he’s at risk that he will skin the cat using a patented method and then his product’s margins will be taken hostage by the patent holder.

The only people who would be tempted to read pattents for ideas would be those that believe that ideas are scarce and that the patents are of high quality. Those people haven’t done much engineering, and they certainly haven’t read any patents.

Very nice essay on why the music industry’s lashing out is just a further manifestation of the death of their current business model; in this case the key point being made is that you can’t run a business on that’s based on destroying value for your customers.

Then we have humor: RIAA Files Suit Against Share Bear.

The RIAA sue your customers and make examples of them strategy requires that people see it as rightous, rather than as a sign of weakness.