Monopolies and Disruptive Business Models

I have been spending some time thinking about disruptive business models and how they surpise monopolies and how monopolies then respond to the disruptive threat. We can see this is a wide variety situations but lately I have been seeing it in the telecom sector (naturally), cable television (naturally) and satellite television (wait really how do they have a monopoly? I'll go into that in a moment) how monopolies handles innovation that might be threatening their traditional business model.

Before I get too far in this post a few things need to be defined. Most of the monopolies are not national monopolies but rather regional monopolies. For some reason people seem to think that if a competitor somewhere in the country exists for a product , that it's not really a monopoly. They have the strange idea that a monopoly means a 100% market share. Where they get this idea I don't know but I suspect it's the complete lack economic education in our society (at least judging by the huge pile HELOC funded credit card debt the average American has).

Monopolies are quite often regional. For example cities were giving out monopolies to cable companies as an incentive to wire the city. As a result most cable companies are local monopolies and this has lead to a serious case of monopoly think. One of the basic rules of a monoply is that innovation is to be feared at all costs. It's far too disruptive to your current business model. In VC terms this is often called "knifing the baby." It should be more properly called killing the golden goose, as all the revenue flows from this goose. This leads to a risk aversion that is quite stunning in it's scope. It entirely blinds management, leading them to think "inside the box" as it were. Let's take a look at the recent moves by AT&T with their Project Lightspeed as it highlights this sort of thinking.

A recent Salon article hightlighted AT&T attempts at Lightspeed to turn the Internet into cable TV. (Good luck with that guys). And in traditional monopolist fashion Edward Whitacre, AT&T's CEO declared,"What they would like to do is use my pipes free, but I ain't going to let them do that because we have spent this capital and we have to have a return on it," he said of Google and Microsoft. "Why should they be allowed to use my pipes? The Internet can't be free in that sense, because we and the cable companies have made an investment and for a Google or Yahoo or Vonage or anybody to expect to use these pipes [for] free is nuts!"

Well Edward you built those pipes for your customers and so you can sell them access to someone else's content. I haven't noticed that AT&T has suddenly bought a movie studio's back catalog in the last few years, so you really don't realize that you are the tail on the dog. The Internet isn't free but it is largely paid for on both ends of the connection.

Of course the attempt to add this intelligence layer to the Internet to prioritize traffic isn't new, it's something that a non engineer, management type thinks is a good idea. It actually is a vary bad idea. First off a network with too much overhead like the overhead generated by an traffic manager proposed by AT&T would make for a very brittle network. User network usage is difficult to predict on such a network, but you can be certain that users are going to use more bandwidth than you expect them too and are going to use their connection in new and interesting ways. Let's call the Brian's 1st law of network usage - Users will routinely consume 200% of your available bandwidth.

Additionally the overhead of managing these packets doesn't really get you anywhere - it doesn't improve the user experience and strangely it doesn't improve overall network performance. From the Salon article,

"Gary Bachula, vice president for external affairs of Internet2, a nonprofit project by universities and corporations to build an extremely fast and large network, argues that managing online traffic just doesn't work very well. At the February Senate hearing, he testified that when Internet2 began setting up its large network, called Abilene, "our engineers started with the assumption that we should find technical ways of prioritizing certain kinds of bits, such as streaming video, or video conferencing, in order to assure that they arrive without delay. As it developed, though, all of our research and practical experience supported the conclusion that it was far more cost effective to simply provide more bandwidth. With enough bandwidth in the network, there is no congestion and video bits do not need preferential treatment."

That's the strange thing. People assumed that the priotizing the traffic would result in an performance improvement. It didn't.

AT&T wants Lightspeed to become more like a on demand television with phone traffic. While that's certainly an interesting project goal - I am not certain how much consumers are actually demanding movies on-demand. With the advent of the DVD, most consumers have an on-demand library. I had StarZ On Demand in Pasadena and I used it once. But movies on demand has been a goal of the cable industry for decades now. I just suspect that technology in the DVD fill the market effectively enough that demand for these services will be slack at best.

What AT&T highlights about these monopolies is the immediate tendency to control what you fear. In satellite television, Dish Network charges $5.98 per month for a DVR if you have a DVR connected to the system. Imagine for a second a VCR fee and how silly that sounds. Yet repeatedly I have been told by customer service that the DVR fee "allows me to pause live television and record shows," which of course it doesn't. DVR is a new technology so Dish simply made up a fee to monetize something they really don't have any business charging for since they provide NO services for it. (Incidently this fee recently went from $4.98 to $5.98. It's kinda of funny, I am used to prices dropping over time, not rising. That's another thing that monopolies like to do - rise prices. It's why MS Office is $499.)

For example there is NO mention in the Lightspeed project about P2P networks and BitTorrent which are the largest portion of traffic on the Internet now. AT&T wants to reign in the chaos created by users and replace it with a regular monthly billing schedule they can understand. The reason that AT&T wants Lightspeed to look like a new cable service is that is the business model they understand. It allows them to keep prices artificially high and monetize every single usage of their network and degrade the service of their competitors. It's abad idea for consumers everywhere.

WalMart and Free Software

Walmart and Free Software

Walmart is know for it's "every day low prices." Through ruthless supply chain management and aggressive negotiation with its suppliers (suppliers are supposed to reduce their prices by 10% annually to Walmart). Naturally WalMart has quickly adapted to outsourcing taking advantage of the cheaper labor markets for manufactured goods in China and Indonesia. In fact WalMart's suppliers almost have to go overseas because of the aggressive annual price cuts that WalMart demands. This means that WalMart through shear size is able to drive down prices on retail goods until they are completely commoditized.

What's WalMart have to do with free software? Well they share several things. The free software ecosystem has always taken advantage of the global labor market. Since free software is indeed free in price, it allows someone to simply download and use the software. This means for years now open source software has taken advantage of the Internet and Internet development best practices (mail lists, wikis, distributed version control systems, distributed program management).

Furthermore since free software is free as in price and free as in source it has the effect of commoditizing software. For proprietary software companies this is extremely corrosive on those incredibly high margins. What's interesting is that free software is slowly climbing up the corporate software food chain, taking things that previously had value and reducing them to a commodity and then eventually to a free item.

Let's take TCI/P stacks. Once upon a time this was something that you actually paid money for. Eventually it was incorporated in the Windows operating system (please note that MS used the BSD stack - they didn't actually write their own). Now every os is expected to have one without too much effort.

Recent moves by Oracle indicates that they understand that MySQL is beginning to move into the lower end of their market. So they purchased InnoDB which provided MySQL with a transaction engine. They are still attempting to purchase JBOSS - although it sounds like from my sources that the JBOSS guys want FAR too much for their company (although since they are profitable - it's probably a good negotiating position to stake out).

Since Free Software is a global group of developers, it means that even if free software development is stopped in the United States, it will continue in the global software marketplace. In the end this is a good thing for consumers of software as free software represents a great competitor to the older way of doing things. Commoditization is a good thing. After all does a Office Suite really need to cost $499? The answer Constant Reader is no.


Sorry for the delays when posting early this month. I was doing some landscaping when I dropped a 150 pound rock on my hands which made typing nearly impossible.

Java Clean Room Development

Software Development has an article covering the fact the JVM has nearly been completely reverse engineered and they have a clean room implementation

According to leaders of the Apache Software Foundation project to create an open version of the core Java Standard Edition components, Eclipse is now running in a clean-room JVM developed under the project.

This is a pretty big step forward for Java which while being relatively open still suffers from the fact that it's controlled by Sun Microsystems. This means developers seeking to use Java technology in new ways are dependent on Sun's goodwill and ability to develop a JVM for their environment. With a clean room implementation you can expect to see additional development of the Java platform in new ways. A clean room implementation that is Apache license compatible gives developers more flexibility to do something new.

Having a true free software solution can often act as a magnet for developers, especially if there is a significant amount of work that has already been done. The Harmony is certainly such a project as a reverse engineering of the Java Virtual Machine is well beyond the scope of most single developers even if they are Java developers. Reverse engineering is an art in and of itself that most developers are not familar with. There aren't college courses in it but it's certainly one of the great engines of growth in SIllicon Valley. The creation of the commodity PC market rested largely on the reverse engineering of the bios of the first machines. Without it I imagine that customers would still be locked into the single vendor systems, each with their own proprietary parts with systems regularly costing between $3,000 - $5,000.

Commoditization is a powerful force in driving down prices and driving innovation through increased capacity at a decreased price. It's one of the things that the free software movement does to traditional proprietary software vendors that makes the economics of free software so compelling.

Artificial Scarcity and Web 2.0

I was looking at Joel Krause's new company JotSpot. Jotspot is a company that offers online wikis, project management a blog and more. Jotspot is a fairly typical web start up in a way. Joel is a former founder of Excite who obviously understands the importance of web collaboration. In fact since founding Jotspot his blog posts have dropped down to nearly nothing. I hope that doesn't mean things aren't going well. Most people tend to use their blogs to promote their companies. He's had the same post up since June 2005 and it's highly relevant to my current post and it notes something about the trend in hardware and software that cuts against the expectations of many VC firms.

Here is JotSpot's pricing page (Which as of this posting is down - So much for outsourcing my wiki to them.) In many ways it's fairly typical of a web startup these days. It has four different pricing levels from free (which includes 100 pages) to an corporate edition which runs $199 per user per quarter. One question I always ask myself is "Why such a convoluted pricing structure?" The answer invariably comes back to the VCs attempting to penetrate the Fortune 500 market in order to REALLY make their money. This is a new mistake in the new economy and here's why.

Here's Joel's original post on why it's a great time to be an entreprenuer (Also judging by the number of spam posts to his comments section I can certainly say the blog is dead - or at least not actively monitored.) Joel notes that the decreasing cost of hardware 1/100th the cost, free infrastructure software (LAMP), search engine marketing (SEM) combined with the access to the global labor market means that launching a start-up is easier than ever. However these same trends also mean that the cost of providing these services such as Jotspot are also significantly lower. Furthermore the marginal cost of adding additional pages to a wiki or additional services is so close to zero so as to be not measurable. This is the real problem with Jotspot's pricing. The initial free wiki has been so limited as to be useless. You should simply offer the same set of features to each user. Limiting the feature set for premium users is often a bad idea as people are not drawn into your product. You could offer the free users the same set of features as you corporate users, because the marginal cost is so low as to be zero.

I also realize that in many ways you are letting users self select their own pricing level - but that's not exactly true. What is very common in many of these VC funded companies is that they are trying to create an artificial scarcity of features in order increase revenue. What many of them don't realize is that Moore's law and forces Joel notes in his post are pushing in the other direction, namely to offer the greatest number of features at the lowest possible price (Ah the power of the free market). So the artificial attempt to segment a web service like Jotspot into varying feature sets and varying degrees of functionality is really a bad idea. Instead of users getting addicted to all your features, you are only offering a sub-set of the full functionality.

Since it doesn't actually cost anymore to offer additional service/functionality/features in a web service, offer you intro users the full feature set helps insure that they will be more likely to continue to use and spread the word on your software. Additionally instead of membership fees (always a dubious thing) you should rely on advertising such as Google Adsense. Despite the low click through rate of Google Adsense, you are better off capturing more eyeballs. While this might sound like an early dot-com business plan, it's important to remember, launching a start-up is much less expensive than it was 10 years ago. Everything is much more cheaper and more powerful. Let's also be realistic about start-up costs. If you are worried about covering a $100/month hosting bill on the entry level - I suggest you get some more money before you start.

So if I were in Joel's shoes, I would make sure that I get as many users as possible and then flip the company to Yahoo or Google. Just don't spend too much money advertising and rely on users word of mouth to help sell your web service. After all Google has never bought a television, radio or print ad - yet they are the world leader in search.

The fights are public

One of the differences of open source software is that is frequently ignored or missed is that disagreements, like the code are public.

In a typical company many of the same disagreements occur between principals but it's never seen. The open nature of free software means that every almost always airs their laundry in public.

Let's face it engineers often have strong opinions of certain things. Typically they will express their opinions straightforwardly. This can sometimes lead to conflict.

For example Richard Stallman is a man with a strong set of opinions. While I don't always agree with his approach (I agree with many of his ideas) he is certainly a figure who often finds himself in one spat or another with a another member of the free software movement. For example his current disagreement with Linus Torvalds over licensing the kernal under GPL3 is just another in series of what is relatively small disagreements in the free software movement.

Since these spats occur over publically available mailing lists, they are much more visible than the debates that occur at Sun Microsystems, Microsoft or Oracle. These debates occur at these companies - we just never see them.

As result the free software movement seems more contentious and argumentative. While this seems like a straight forward result of the free software community, peopleoften assume that these same debates don't occur at closed source software companies.

Many of debates occur at closed source companies (direction, engineering approachs, code styles, source management all are debated pretty vociferiously) including one that is noticabily absent from the free software community.

One debate that you will not see is the tension between marketing and engineering. As many free software users are also users of their product - they often have a better understanding of their product. Additionally developers are also often the sales staff. Most free software projects are still small enough that they are intimately connected to their users in ways that developers at private source companies are not.

Microsoft for example has developed procedures for project managers and other customer relation people to be actively soliciting feedback from users. This process developed because it was no longer feasible for developers to do this. Scale has it's problems.

However one point of contact with customers is often the sales/marketing rep. One problem that often arises is the promised feature. Rep A promises Customer B that Feature X is definately going to be in Release C. This leads to marketing making demands on engineering that they may not be able to make. This then often leads Creeping Featuritis which then leads to Security Holeis.

This of course can happen any time you deploy a sales force that doesn't have a sound technical knowledge. Since most free software projects haven't gotten to this size and most will never get to this size so it's not a problem you face in the free software community too often.

Of course the relatively small size of developer teams and their relative closeness to the customer means that you can often work with directly with an engineer on a project.

Chock one up for free software. When I started this post, I noticed a great piece on
project management principles, that not only talks about project management but also some of the strange foibles of corporate software development.

Telcos & Google's Revenue

I haven't written about the recent remarks by telecomm executives about Google "stealing" revenue that is rightfully theirs. It strikes me that this really a case of P/E envy but let's take a look at the comments and what they really reflect about the problems that the RBOCs face.

Despite the billions they raked in during the dot com boom, the problem is that telcos mostly sell (phone service) which is complete commodity. While they also sell leased lines and data centers, their profit margins are almost entirely found in their residential phone service. Consumers are paying too much for far too little service. Let's take my provider Qwest. We have two lines from Qwest - a line for my office and one for the house. Despite various bundling options our phone bill is regularly between $125~$150 per month. We don't have voice mail, or three way calling or a whole host of other features regularly pushed upon us by Qwest's telemarketing reps. I spent a whole lot of time on the phone with Qwest to figure out why my bill was so high. During that conversation one thing really struck me. My expectations of service and Qwest's were completely at odds. When I noted to the rep that my phone situation was hardly complex, her response was "Sir most people don't have two lines. You have more services than most of our customers. You have a pretty complex phone set up."

The strange thing I thought the number of services I derive from the phone company completely at odds with the actual cost. For example my high speed wireless connection is far more valuable to me than my phone and provides far more value. I regularly run Skype for phone calls. In fact I recently called London on Skype, to find out where a check was. When I queried about the call quality, the woman on the other end of the phone was surprised not only I wasn't in London, when she found out it was an internet telephony call she was downright incredulous. I would hesitate to guess the cost of making that phone call with Qwest. Certainly far too much as I found out when making calls to Canada. I have stopped using my phone for all international calling.

The problem of course is that telcos haven't kept up with customer's expectations. They are simply providing a connection to what people find really valuable, namely the Internet and the content contained therein.

Who provides that connection is completely inconseqential to the user. They want the content. The connection is a means to an end. This is why the current telco posturing is in it's own way too funny to believe. They are the tail trying to wag the dog. Their threats to degrade access or (even cut off access) to Google or Yahoo are laughable. Let's say (Telco A)degrades access to Google because they want a slice of Google's revenue. Google's response is simple. They can simple re-direct that telco's customers to page saying, "Telco A has decided to degrade your access to Google. This despite being paid by you for internet access. Please let them know you want full access to the Internet at 1800 Pissed Customers.Or simply try Telco B for internet access."

The problem is that telco's see the revenue generated by Google and Yahoo and figure they deserve a slice. They no more deserve a slice of revenue from Google than they do the revenue from a direct mail company that uses phone lines to take orders.

Telcos seem to think (quite mistakenly) that because they own the connection the customer uses to access the internet, they own the customer. This is false. If they were to provide degraded service to those customers on a per site basis, they would cease being their customers, fleeing to telephony provider who will provide the access that customers want. I cannot imagine what stick (other than regulatory) the RBOCs have to enforce a payment from Google or Yahoo. By hurting their customers (who will certainly view it that way), cannot they expect to have some leverage.

The problem with RBOCs is that they simply lack the ability to quickly innovate. Instead they really prefer to roll out new services slowly and bill them accordingly. For example, Google launched in 1998. Why wasn't there a phone company version of Google already out there? It's because they saw the scope of such endeavors is a far too limited fashion. The RBOC search engines (such as Athand) saw themselves as online Yellow pages and NOTHING more. With this sort of innovative thinking it's no surprise that Athand and telco attempts at seartch were complete flops.

The attempt of a telco to retroactively exert a toll on the internet is doomed in any free market environment. Indeed Google is poised to leap frog all that copper the telco has spent billions stuffing into the ground. I can easily imagine Google with all that dark fiber it has bought, and wireless access to simply start offering free internet telephony, along with internet access. It will be interesting to watch what will happen in San Franicisco's free wireless environment.