Mobile

There’s only going to be two winners in mobile OS

Jack Welch had a famous rule that GE would only be in businesses where they can be number one or number two.  In the industrial businesses GE was in, the scale that biggest players could achieve gave cost advantages that allowed for much higher profitability than the smaller players could achieve.  Software is a world away from GE’s businesses but for platforms and operating systems, the number one or number two rule applies but for very different reasons.  Operating systems with small share can not attract the third party developers needed to make the platform successful.

The personal computer era showed how minor platforms do not make it.  Windows dominated the landscape for two decades with the Macintosh being the only viable competitor.  Many others came and went like OS/2 and BeOS.  NeXT which would later show itself to have the right attributes to be successful didn’t perform well in the market till Apple bought it and transformed it into OS X.

Android and iOS already have huge leads as application platforms.  One of them could stumble but with the momentum both have, this looks unlikely.   Even though the spoils are likely to be meager, there are several competitors for third place:  Blackberry OS, WebOS (Palm/HP), and Windows Phone 7.  Nokia had the good sense to take Symbian out of the race but made the peculiar choice of of Windows Phone 7.  Both RIM (Blackberry) and Nokia would be be better off switching to Android as it would would put them on a platform where there’s already a wealth of third party apps.  Neither RIM nor Nokia has ever proven themselves to be world class at mobile software.   RIM’s entire success was based on email and they could salvage their market position by bringing their email system to Android.

These kind of strategic mistakes always puzzle me.  I wonder if RIM, HP, Nokia and Microsoft have all convinced themselves they can become number two or if they believe there’s a profitable path as number 3 or 4.

Standard
Internet Industry

Thoughts on Facebook’s rumored entry to email

email icon

Image courtesy of husin.sani

I’m a bit surprised that Facebook is (rumored to be) entering the email market.   Partially my surprise is that consumer email feels like a mature market and I expect Facebook to be concentrating on areas where more innovation and value creation is possible.   The rest of my surprise is why Facebook book wants to enter a space that’s not a great business for any of the incumbents.  EMail is essential to Yahoo and AOL for the recirculation opportunities it provides to better monetizing channels but in and of itself, email does not move the needle for anyone today.

Here’s my take on the pros and cons for Facebook entering the email market:

The Downside

1) Free consumer email is a tough business

Being an email provider is expensive because you have store to an ever growing amount of old emails essentially forever even though they are rarely, if ever, viewed.   Being rarely viewed means it’s impossible to monetize those petabytes of messages eating up storage space in the data center.   In the old days before GMail changed consumer expectations forever, storage space for free accounts was sharply limited and additional space meant highly profitable premium revenue.

Compounding the problem, email page views monetize poorly compared to other types of content.  Partially this is because the incumbent providers (Yahoo, AOL, Windows Live) with exception of GMail do not target using email content.  My suspicion is even targeting off of email content does not help that much anyway.  Advertising is valuable either when the purchase intent is high (where search is king) or there’s value in brand affiliation (full page New York Times ad).   Email has neither of these characteristics and is likely getting worse on purchase intent.  No one emails anymore to ask which camera, laptop, cell phone they should buy since it’s easier and hipper to ask in a Facebook status.

2) EMail does not fit well into the walled garden model of Facebook

Facebook messaging today is an unpolluted stream where messages are almost certain to have been sent by person.  There’s no outside spam.  EMail is the exact opposite both due to its history and the expectations around it.    EMail started off with no way to verify sender identity and thus invites spam and scams.  There have been some technical fixes (DKIM, SPF) but at the end of the day you really do not know who is sent a message.   It’s also expected to be ubiquitous and completely interoperable thus removing the option of excluding bad actors from the system.

In contrast, Facebook can kick anyone out of their network.  The Stuff White People Like article on Facebook is humor but its underlying point resonates with me.  The nice, safe neighborhood feel of Facebook is a key part of its success.  Most people over 30 were never going take to the generally messiness of My Space.  Opening up your Facebook account to email, is almost like inviting the world to come by and litter on your front lawn.  And there’s no way to “de-friend” someone sending you email.  None of this is to say email is not an essential method of communication in the modern world.  I just don’t see adding email fits with the positioning that’s made Facebook so successful.

The Upside

Facebook does have several things going for it in the email market:

1) Capability to run large scale operations at low cost

Facebook has the operational know how to run a email operation at lower cost than most of the incumbents other Google.  A cost advantage is always a huge competitive advantage in a low margin market.  It’s harder to leverage though in email since pricing to the consumer is already zero.   The price of an email account is really the amount of ads and Google has been able to effectively exploit their low costs through less intrusive advertising.

2) Good targeting data

Facebook already knows so much about their users they do not need to use email for targeting.  How valuable this makes email to them is a function of how much excess ad inventory they already have.  If Facebook ad inventory is already selling out at least for certain segments, adding email will be valuable simply by boosting ad inventory.  If they are already swimming in inventory which is going for fire sale prices, there’s not a lot of money to be made.

3) Keep younger users away from Google and Yahoo

Although the kids of today do not have much use email, they will get older and need to start interacting with the grown-up world which still largely runs on email.  At that point, they will need an email address.  Providing them though Facebook keeps those users from deepening or even creating their relationship with Google or Yahoo which may benefit Facebook in the long run.   However, that benefit is mitigated by the Google and Yahoo’s failure to be at all competitive in the social space.

4) Social Graph

Facebook’s biggest advantage in any area they enter into is their owership of all that social graph information.  Maybe they have found a clever way to leverage it with email.  I’m a bit skeptical because of the inherent identity problems with email.

I’m curious to see what Facebook has come up or if the rumors are even in the right ballpark.  However, I doubt I’ll be creating myself a Facebook email address.  GMail serves my needs really well today.

Standard
Politics

Meg Whitman Wants to Be President

Meg Whitman’s has spent what seems to be an insane amount of her personal money in her campaign to be Governor of California.  The Sacramento Bee reports that she’s already put in over $119 million:

Republican gubernatorial candidate Meg Whitman became the biggest ever U.S. campaign self-spender yesterday after putting another $15 million into her campaign, bringing her total contribution to $119,075,806.11.

Governor of California is not a very fun or glamorous job.  I’m sure it’s an ego trip for the first few months.  But by the time the governor’s first budget fight has rolled around, the job is no fun .   I’m pretty sure Governor Schwarzenegger will be relieved once his term is up.  He gone from grand plans:
Every governor proposes moving boxes around to reorganize government. I don’t want to move boxes around; I want to blow them up.
to struggling to get the legislature to tackle tax reform:
Now, here is what we need to accept. Our economy is 21st century and our tax system is 20th century. It is stuck in the wrong century.
The tax system in California is broken and I commend the Governor for trying to fix it.   Governor  Schwarzenegger’s tenure has made it clear that the trying to run a state hobbled by a century of an absurd initiative process is a difficult and thankless job and certainly not one worth spending $119M to obtain.
The only explanation I see is that Meg Whitman wants to be President of the United States and being a governor is historically the best path to get there..   Her failure to vote shows that her interest in politics is minimal.  The reason for Whitman spending this kinda of money to chase a difficult job is that she sees it as a stepping stone somewhere else.    If Whitman wins as governor, I’d be shocked if she didn’t run for president either in 2012 or 2016.
Standard
Internet Industry

Email Is Not Dying

email icon

Image courtesy of husin.sani

This week Facebook COO Sheryl Sandberg claimed email is probably going away. This claim is more self-serving marketing fluff than a serious prediction that’s likely to be realized. However, it does point to an important shift in electronic communication: the center of gravity of personal communication has shifted away from email and instant messaging to social media and text messaging. The providers of email and IM including Yahoo, Google and AOL will be hurt by this shift as users pay less attention to the older mediums. However, email is not going to disappear anytime soon.

The primary shift is in personal  communication. Status updates substitute for emails or IMs. Picture sharing is easier and more satisfying by Facebook than by email. The broadcast nature of social media means it takes less effort to keep friends and family up to date. And even when person-to-person communication is desired, the context rich nature of the social media means a Facebook message is often preferable to an email. Some of the best evidence of the size impact is Neilsen’s recent study in the UK showing that instant messaging has has dropped from 14% to 5% of internet usage time.

Email is not going to disappear though. Email is an asynchronous messaging medium thats private, addressable to a particular person and ubiquitous. Such a medium provides enough value that it won’t disappear without one with similar properties taking its place. EMail is needed for notifications for everything from my credit card bill is ready to there’s a sale at my favorite retailer. Conceivably these could move to another mechanism with similar properties like Facebook message but then my Facebook inbox would be just overflowing as my email inbox. Today, part of the value of social media messages for person-to-person communication is that the channel is free of spam and relatively uncrowded. If Facebook opens up it’s messaging to these business-to-consumer communications, it becomes just another crowded channel and while I may care what my friends are up, I really care very little about what bank did today so the inherent advantages of the social mediums no longer matter.

The other reason that email won’t disappear is that there’s no viable substitute for business communication. An email replacement for business communication requires both ubiquity so anyone can talk to anyone and the ability to keep the communication within an organization both private and secure. There’s nothing on the horizon that meets these requirements. Google Wave is a contender but the slow adoption thus far is an strong indicator that it’s going to be really hard to get people change their established behavior. Additionally, Google Wave’s complexity is hindering its diffusion outside of the earliest adopters.

Sandberg’s thesis is what teens do today is predictive of the future and since only 11% of teens check email daily, email is going to disappear. The flaw in this argument is that teens don’t have the needs that drive email usage. They don’t need to get notifications from their bank or cable or cable company that their bill is ready.  They have no business communication needs. They only communicate person-to-person or person to small group and that’s the area wher the shift away from email has happened.

A big impact of the center of gravity shifting will be on marketers who have been effectively utilizing email. Without personal communication, the value of email to users is lower since it’s now all notifications or stuff that only might be interesting. Lower value means less of the mental attention that email marketers and advertisers on email services need to connect with audiences.  It’s akin to the difference between scanning the news headlines to see if there is anything of interest and reading an article in depth. There’s less mental engagement and less time spent on a scan.

The long run solution for marketers will be the same one Sanberg advocates which is add social media to the  marketing mix. But there won’t be a dramatic death of email, at least until there is something it supersede for notifications and business communication.  The teens of today will start using email when grow up an have the need for it.

Standard
Mobile

Why Do Unlocked Phones Cost So Much?

My two and a half year old Blackberry Curve that I’d subjected to a hard life finally died a few weeks back when it’s USB connector came loose and won’t charge. While I waited for my new phone that I bought off of EBay to arrive, I’ve discovered that hoarding old electronics some times pays offs since I can use my old 8700c as a battery charger. The process of buying a new phone got me wondering why unsubsidized phones cost so much.

I can buy a 8GB iPod Touch retail for $199 which has every component that’s need to build a smart phone minus the cellular radio and mic. iPod TouchSeeing as how a basic cell can bought in the third world for less than $40, these components can not be that expensive.  Apple has some of the highest margins in the electronics industry. The latest teardown I can find for the iTouch is for the 8GB touch introduced in in 2007. iSuppli put the cost at $155.04 and at introduction that 8GB iPod touch retailed for $299 which puts the gross margin at 48.1%. In an accounting sense, the gross margin is probably slightly lower to transport and distribution costs which will appear under Cost of Goods Sold on the income statement. But as benchmark for makes a for a very profitable electronics business, materials cost at 48% of retail is a good one.

The 48% hardware margin is steady for Apple as the 16GB wifi iPad has a teardown cost $259.60 according to iSuppi which at $499 retail puts the gross hardware margin at 48.1% By comparison, Nokia which sells many more feature phones rather smart phones had a gross margin of 34.3% in 2008. This is company wide and is probably boosted by non-phones but as a rough benchmark it’s not a bad place to start. Apple is also making money from iTunes store sales so and iPad and iTouch are even more profitable but nonetheless, but 48.1% hardware margins is still indicative of a very profitable business.

The question that puzzles me is why new entrants to the smart phone market do not sell unlocked phones cheaper. The Palm Pre costs $138 to build which at Apple margins would put the retail price at $265.9 but off contract the Palm Pre was $549 at introduction. A similar story for Google Nexus One which has a tear down cost of $174.15 which at Apple margins would have a retail price of $335.55 but instead is sold by Google for $529 unlocked.

I have no doubt the off contract pricing is set by the agreements the device manufactures have with handset manufactures. However, I have to wonder to the wisdom about late entrants (or in the case of Palm, re-entrants) following the established practice of very high unlocked contract pricing. Palm only sold 400,000
for it’s Dec-Feb quarter
and Nexus One sales are even worse.

I find Google’s decision to stick to the standard distribution model even more puzzling as Google has a history of upending the pricing and margins of the business it enters. Gmail’s 1GB of storage ended Yahoo Mail’s practice of charging for storage space over 4GB and forced the the whole free email industry to go to essentially unlimited free email storage. Google Map’s free API undermined the pay for access model that incumbent providers like MapQuest had built sizable revenue streams off of. Perhaps since Google’s number one goal to sell as many Android units through multiple handset manufactures as possible to establish Android as major mobile platform, it makes sense not to poke the cell phone carriers in the eye. Palm had no such motivation. Granted Palm probably got great terms on it’s exclusive Spint deal but those terms didn’t stop the meltdown Palm experienced which only ended with their sale to HP.

If I had been able to buy an unlocked Nexus One cheaper, perhaps I would have done that rather than a Blackberry from EBay. I was not in the mood to take a new cell contract so I was in the minority of shoppers who didn’t want to trade low upfront pricing for a 2 year commitment. But perhaps there are more people in this situation than meets the eye. Anyone who loses or breaks their phone early in their contract is in the same situation.  There’s really no good alternatives today for those who don’t want or are already in a contract since all smart phones follow the huge premium for an unlocked phone other than buying a used phone from EBay.

Standard
Financial Risk

knowing things is over rated

A professor of mine has a recent blog post where he wonders why executives take risks that academic finance has known for decades don’t add value:

Whenever I meet a senior executive from a company that got in trouble because of too much leverage, I ask (nicely, I hope) whether they know MM, which implies that investment decisions should not be made based on capital structure. Most say no, but they are very interested to hear about it.

This is stuff that has been known for a long time.

This got me thinking about the value of the knowing things. My visceral reaction is that learning through study and research has to be valuable, but sadly my post-MBA experience has largely shown otherwise. And when I say valuable, I mean in a career sense since to me knowledge has high intrinsic value.

There are several reasons while I think “knowing things” is not valuable as it should be outside of academia:

1) People prefer (over) confidence

Knowing something could be unwise or dangerous gets in the way of being supremely confident. Those who have no inkling that a particular action could be problematic can advocate for it without expressing any doubt. The persuasive ability of complete confidence has always seemed like a cognitive bias to me but I’ve seen it work over and over.

2) Tail risk pays off in the short run. Or maybe more bluntly put: The incentives reward stupidity

Let me start by explaining tail risk. Tail risk is the negative impact from a “rare” event in the probability distribution. The formal definition is a 3 standard deviation event. It’s easy to make money most of the time on tail risk. One can write a way out of the money call or put option and pocket the premium. Until the rare extreme swing to the stock happens, this strategy produces a steady stream of money. When the rare event happens, the loss can be enormous.

Overlevering a company has the same effect. Most of the time a company can service its debts. But a particularly bad downturn or other unexpected event can push the company to bankruptcy court. Since in most years we do not experience a bad downturn, the company’s returns look good.

In reality, that bankruptcy risk is reflected in needing higher returns on the stock. The Modigliani-Miller theorem says the “savings” on the “cheap” debt is exactly offset by higher required return on the equity to compensate for the increased risk in other words: on a risk adjusted basis, there is no extra return for loading up on debt. Like all finance theories, there are assumptions like frictionless markets and no taxes that aren’t met in the real world, so in reality it’s not exactly offset and tax treatment favors moderate debt.

But in the short run, the equity returns look higher and these managers are likely to be rewarded for that.

3) It’s downer

Knowing what I just explained is a downer since most of the time everything is going well and voicing concern about over leverage, is not going to be unpopular. After all the risks pay off now most of the time, and explaining there’s no real value being created and those extra returns are not actually better in the long run just annoys those who don’t understand this. All this worrying about disaster sounds like Chicken Little.

The stories I’ve heard about the mortgages security practices in the great real estate bubble are even worse than this. The loan issuers and resellers knew the loans were extremely risky and a bad long run bet, but were making so much money issuing or trading them that they didn’t care. The resulting disaster was so bad that many of the businesses in this mortgage backed security chain went bankrupt in the bust due to their exposure to these assets they knew were bad. But when everyone is making huge bonuses taking these risks, anyone who points out the risks is probably making a career limiting move.

4) Over emphasis on prior experience

Both in hiring and in the decision process, most people over emphasize their past experience. The problem with this approach is that the experiences of a career span is not a full picture or as we might say in more technical language, a representative distribution. Even 30 years experience in a field is a short sample of possible risks. Understanding the full range of possible outcomes and thus risk exposure requires study, often of the academic kind.

The problem is even worse for rare events that don’t show up in the historical data since history based quantitative methods do not  account for those risks either. To understand those kinds of risks, one must take an approach based on theory rather than experience.

Standard
Internet Industry

Value of Twitter (vs Facebook)

There’s a lot of talk of whether Facebook can crush Twitter.  As I said in my post on the network effect, the only way for a smaller player to compete in an area where the network effect is prominent is compete in a way the bigger player can not match.  The major difference between Twitter and Facebook status is that Twitter defaults public and Facebook defaults private.  Public status has value and Facebook can not compete in the public status arena because it’s entire positioning is around privacy and user control.  Defaulting status message to public would undermine this positioning.

Twitter with its public status is the first time its been really easy to find out what people who you don’t know know are thinking.  Blogging does reveal what bloggers are thinking but it’s much higher effort to blog so only a amMW subset of people will do it.  Plus, even those who blog do not just drop passing thoughts into their blog.   With Twitter, tweets about a product being great or awful are much more common since the medium encourages those kind of messages with its 140 character limit.  In a tweet, there’s little pressure to say something profound or even meaningful since there’s so little space.

Public status allows for search which is an incredible tool.  I’ve personally used Twitter search to do in an hour what would have previously taken weeks and a big check to a market research firm to accomplish. Even just for entertainment, services like Twistori give a view into the thoughts and lives of others that previously was hard to find.

Even if there is plenty of value in consuming tweets, there still have has to be value for the authors.  Being a big Twitter fan, I like the easy channel to talk to the world.  I get replies from people I don’t know that sometimes contain useful information or are just though provoking.  None of this is possible with private status.

I won’t venture a guess as to whether Twitter will be a big financial success.  There definitely value for companies to use to as a communication and research tool and if Twitter can extract some of that value, it’s a viable business.  However, there’s no feature that Facebook can add that will make Twitter disappear.  The public vs. private status distinction creates value for Twitter than Facebook can not grab.

Standard
Internet Industry

The Network Effect

Of all the things I learned in during my MBA, the strategic importance of the network effect is the one I see most misunderstood in the tech industry.  The network effect is present when the value of the a product or service is in large part determined by the number of other users of that product or service.  EBay is perfect example of the network effect.  Creating an Internet auction site is not very difficult and is an extremely lucrative business.  EBay had a gross margin of 74% in 2008 because the business never handles physical goods and the cost of running any auction marketplace is low.

So why does EBay have no serious competitors in the US?  Amazon tried to break in to the auction space without success.  EBay’s competitive advantage is the network effect.  If I want to sell something, all the buyers are on EBay.  If I want to buy something, all the sellers are on EBay.  Moving to another site as a buyer or seller means I’d lose value since all the other participants are not there.  Thus an auction site could be better than EBay and cheaper or even free and still not succeed because the value for either party is driven by the presence of the other party.

The principle applies to Craigslist as well.  It would not be difficult for someone to build a classifieds site with better features than Craigslist which still looks circa 1999 .  Web technology has advanced considerably in the last decade but Craigslist is in a time warp.  When I look for furniture on Craigslist, it’s incredibly annoying that I can not see my search results with pictures without having to click through to every listing.  However, I do not use a more functional classifieds sites since the number of listings is too low to be useful even with better features.

Facebook also benefits enormously from the network effect.  Social networks are useless unless your friends are there.  Since Facebook is the largest and almost ubiquitous in some circles, the only general purpose social network it makes sense for people to join is Facebook.  Thus, social networking is very likely to have an industry structure similar to Internet auctions where one player dominates and the 2nd and 3rd place players are dramatically smaller.  To counter the network effect, the smaller networks like My Space have to carve out a defensible space where Facebook can not effectively play for some reason.

Standard
Internet Industry

Content Economics

A few months back there were a series of analyst reports and subsequent blog posts about how much money YouTube was losing for Google.  What struck me about this coverage was that many people seemed surprised that YouTube would be hemorrhaging money since they had a lot of users.  Since then I’ve realized much of the industry does not think about the economics of serving content.   The smaller content is in terms of the bytes the better off the provider is.  Large content like video consumes tons of bandwidth and storage both which cost real money.  User content like YouTube uploads is even worse since there is a lot of it store and much of it is rarely if ever used.  Even photo storage and serving is a significant expense.

To offset these costs, heavy content needs superior monetization and since consumers rarely pay for content on internet regardless of what the old media types want to believe, this means advertising.  Video has the advantage that video ads have much higher CPMs than standard display.  However, any user generated content suffers from the problem of much lower CPMs than editorially produced content since the brand advertisers are wary of associating their brand with such unpolished and potentially offensive content.

Profitability data on individual properties is hard to come by since most properties are part of the big providers like Google, Yahoo, AOL and MSN but if it were available, I’m confident that the ratio of revenue per view to bytes served per view would be a strong predictor of profitability. As an approximation, ad CPM / bytes served per view would work and ad CPMs are easier to estimate from the outside since the CPMs of most ad types does not have that much variance across similar properties.

At the other end of spectrum of the content, Facebook recently announced they are cash flow positive.  Most of Facebook’s content is the news feed which is very small in terms of bytes.  Facebook does have the challenge of keeping track and assembling small pieces of content which has its own expenses but from what I’ve read, Facebook engineers have been able to make that process reasonably efficient.  Facebook also had to invent a new type of advertising to get to positive cash flow.  Traditional display advertising has never been high CPM on user generated content.

I haven’t done enough analysis to know whether YouTube can be profitable on its current model.  Google has advantages of both scale and scope.  From their other businesses, Google knows how to run massive data centers cheaply.  Being a huge purchaser of bandwidth and infrastructure hardware surely gives access to rock bottom prices.  If Google does mange to make YouTube profitable, these other advantages will protect them against new entrants.  My guess is that without a new advertising model that raises their revenue per view, YouTube can not over come the costs of serving video for free.

Standard
Uncategorized

First Post

I’m intending to post thoughts and musings on the tech industry in which I’m currently employed and some economics in general.  I registered this domain during the first term of my MBA when I was taking  micro economics.  I liked the idea of being able to precisely determine the cost of the next unit of production even though I realized even then that it was more of an academic exercise since production costs are so lumpy.

Standard