Memo to AT&T: Help Me Help You

This summer I wrote about AOL and how widespread service failure can actually be a bullish signal for a company, if the company responds correctly.

This week, AT&T Mobility Chief Executive Ralph de la Vega disclosed that AT&T was considering "incentives" to encourage customers, especially data-guzzling iPhone users, to reduce the amount of wireless bandwidth they consume. To which, Dan Lyons, in the persona of Fake Steve Jobs, responded in a typically humorous and profanity-laced post:

"So let’s talk traffic. We’ve got people who love this goddamn phone so much that they’re living on it. Yes, that’s crushing your network. Yes, 3% of your users are taking up 40% of your bandwidth. You see this as a bad thing. It’s not. It’s a good thing. It’s a blessing. It’s an indication that people love what we’re doing, which means you now have a reason to go out and double or triple or quadruple your damn network capacity. Jesus! I can’t believe I’m explaining this to you. You’re in the business of selling bandwidth. That pipe is what you sell. Right now what the market is telling you is that you can sell even more! Lots more! Good Lord. The world is changing, and you’re right in the sweet spot."

This is the "America Offline" problem all over again. Consumers on a flat-rate bandwidth plan with a choice of 100,000 apps to run on their iPhones want to take advantage of all the cool stuff they can do with what is essentially a pocket-sized computer. When it faced a similar problem, AOL responded by aggressively adding bandwidth and signing up 27 million households at its peak. True, things eventually went south for AOL... but come to think of it, if AOL had figured out how to offer even more bandwidth by offering its customers a migration path from dial-up to broadband, it might not be the shrunken colossus it is today.

It's been a rough week for AT&T. Mr. de la Vega's disclosure of AT&T's thinking absent any specific proposals led to a groundswell of online suspicion, complaints and rants about AT&T's wireless service at a time when Verizon is aggressively attacking AT&T's 3G wireless coverage in a series of pointed and amusing ads. What's worse, when Dan Lyons (half?) jokingly suggested that subscribers should engineer a "chokehold" on the AT&T network by using bandwidth-intensive applications at a coordinated time, the meme spread via Twitter and Facebook and was picked up by the mainstream media, ensuring that by the end of the week, every sentient American was aware, at a minimum, that lots of other people thought AT&T's wireless service sucks.

The Verizon marketing guys are undoubtedly enjoying an extra round of drinks at happy hour this evening.

AT&T, here's what I'm willing to do to help.

Send me one of those 3G Microcell devices you've announced but seem to be testing only in Charlotte, North Carolina. I'll hook it up to my home network and it'll route my iPhone calls from my home over my DSL service instead of your wireless network.

Admittedly, this isn't going to free up much existing bandwidth on your wireless network, because -- ahem -- I don't make too many calls from the one window on the third floor where I can actually get two bars of service. But at least my cell phone will work in my house and you won't have to put up another tower in the vicinity, so we'll both be ahead.

Oh, and when the 3G Microcell arrives, I don't want to pay $150 for it, nor do I want to pay an additional $19.99 or even $9.99 per month to use it on top of the $100 per month I already pay for my cell phone service. After this week, do you really want to deal with the PR implications of that pricing model? "Unhappy with your cell-phone service? Now you can pay more!" Trust me, you really don't want to go there.

But I'm a reasonable guy, so let me know what your marginal cost is for the millionth unit you manufacture, and I'll pay that.

Now comes the good part. If you build appropriate security into the device, I'll let strangers in my neighborhood route their calls through it too! That will free up bandwidth on your network, provide more coverage and save you money. Even better, you could offer the same deal to my neighbors and pretty soon, you might not see any wireless traffic on your network at all in this neck of the woods. Hell, if y'all want to have some real fun, pay me to switch to Comcast high-speed internet and together we'll route your traffic over their network. This net neutrality stuff is delicious with irony if you just work at it a little.

Admittedly, I didn't think this up all by myself; engineers and entrepreneurs have been talking about wi-fi mesh networks for awhile, but now you have an economic incentive, a user base and a compelling business reason to make it happen.

Rarely in business do you get an opportunity to see the future so clearly because the past provides such a compelling example of how to act.

Let's make this happen, whaddya say?

Can Newspaper Ad Revenue Recover in 2010?

This is a short excerpt of a longer post I am preparing on newspaper print advertising trends, but a post today by Alan Mutter encouraged me to publish this small excerpt.

Mutter expresses skepticism about the rosy advertising scenario presented by U.S. newspaper executives in a survey conducted by Kubas Consultants. As this table from the Kubas report shows, newspaper executives are hoping for flat advertising revenue in 2010, with a 15% increase in online (approximately 10% of 2009 revenue) offsetting small declines in every print category.

I am particularly curious about the poll's findings regarding retail advertising, which after the steep declines in classified advertising over the past few years, will account for just over 50% of total print ad revenues in 2009, making it the biggest driver of the overall results.

The following graph (click to enlarge) plots retail ad revenue per subscriber against per capita personal consumption expenditures (PCE) for 1952 - 2009. Both the ad revenue and PCE data have been adjusted to constant 2008 dollars using the consumer price index (CPI-U).

Presumably there is a relationship between the amount of goods and services companies sell to consumers each year (represented by PCE) and the amount those companies are willing to spend to reach each consumer or household by advertising in newspapers.


And indeed there is a relationship, or more accurately, several relationships. From 1952 through 1990, newspapers sold retail advertising equal to about 1.76% of personal consumption expenditures on a predictable basis. Coming out of the 1990 recession, however, there was a clear downward shift in the relationship and for the next decade, retail ad sales ran at about 1.52% of personal consumption. (see note 1).

After the 2001 recession, there was another shift down in the relationship between ad spending and personal consumption; and for the next five years, retail ad spending in newspapers was basically flat in real terms. It's worth noting that in real terms, retail ad spend actually peaked in 2000.

Finally, since 2006, real retail ad revenue has plummeted as the recession took hold (in December 2007) and consumers abandoned their free-spending ways.

Recessions often act as antidotes to inertia by making households and companies (link added 04/15/10) reassess how and where they spend their money. Advertisers almost certainly used the past two recessions to reassess their spending in newspapers, and it's a fair bet they'll do the same as the current recovery unfolds.

A slavish reading of the most recent trend suggests that retail ad spending will simply continue to plummet like a rock falling off a cliff. This could happen, but I doubt it. Ad spending, even in newspapers, should respond to an eventual recovery. But making economic predictions around recessions and recoveries is notoriously difficult since prior recessions and recoveries provide limited relevant precedent. To paraphrase Tolstoy, if periods of prosperity are all alike, every recession unfolds in its own way.

But I'll take a stab at it. In a related analysis, I have compared changes in retail ad spending to changes in PCE on a quarterly basis. This analysis suggests that it will take real growth of 3.2% in per capita PCE just to keep retail ad spending per subscriber flat. It would take a sharp "V-shaped" recovery to reach that level of growth, but the WSJ has published a consensus estimate of 3.8% for GDP growth for 2010.

If GDP does grow at 3.8% and per capita PCE matches this growth, retail ad spend per subscriber could come in at +1.5% in real terms. Add 2.0% for inflation if you believe that newspapers will have any pricing power, then subtract 3% for subscriber attrition and you get 0.5% growth.

More pessimistically, if you assume GDP growth (and PCE) come in at 1.7% (the average from the 1992 and 2002 recoveries), retail ad spend per subscriber could come in at minus 4.0%. Assume no pricing power and subscriber attrition of 5% and overall retail ad spending would shrink by 9%

The precision of the numbers should not mislead about the confidence of the forecaster, but for my money, I think a range of flat to down 10% for newspaper print advertising feels about right.

note 1. A more precise, but likely less clear statement about the relationship would say, "From 1952 to 1990, for every $1,000 increase in real consumption expenditures per capita, spending on retail ads (per subscriber) in newspapers increased by 1.76% of this amount, or $17.60." For each of the regression lines, the intercept terms are small enough to make me comfortable with statement in the text.

note on data sources. Annual retail ad spend and paid circulation data comes from the Newspaper Association of America website. Personal Consumption Expenditure data, Consumer Price Index - All Urban and Population data are from the St Louis Federal Reserve Bank's FRED database.

Rupert Murdoch has penned a refreshingly sensible post on his blog, The Wall Street Journal op-ed page.

Mr. Murdoch makes four generally agreeable points:

• Newspaper publishers should stop whining about technology and figure out how to use it.

• Quality content is not free.

• The old ad-supported newspaper model is "dead", so paid content is the future.

• Government funding of newspapers is a supremely bad idea.

There's more of course, and publishers without the breadth of News Corp's resources may find Mr. Murdoch's prescriptions for success elusive or unattractive.

True, Mr. Murdoch's Wall Street Journal successfully charges for its online content, but it's the exception that proves the rule. And when Mr. Murdoch writes, "media companies need to give people the news they want," I can hear some publishers harrumphing he's got it backwards: real journalists want to give people the news they need.

I wholly endorse Mr. Murdoch's sentiments regarding government funding of newspapers (Is there anyone who remembers Pravda as a model of independent journalistic achievement?) I'm even sympathetic to his predictable plea for less media regulation, although he's so wrapped in the flag of his adopted thirteen colonies as he calls for relaxation of the FCC's cross-ownership rules his detractors will undoubtedly recall Samuel Johnson's observation about patriotism and scoundrels.

Mr. Murdoch's candid acknowledgement that the old business model for newspapers is broken is a welcome change from the chorus of "blame Google" laments that have turned "Future of Media" confabs into the conference circuit equivalent of Japanese Noh theater.

But Mr. Murdoch is not prepared to let bloggers and online news aggregators off easily. He writes:

"[T]here are those who think they have a right to take our news content and use it for their own purposes without contributing a penny to its production. Some rewrite, at times without attribution, the news stories of expensive and distinguished journalists who invested days, weeks or even months in their stories—all under the tattered veil of 'fair use.'"

"These people are not investing in journalism. They are feeding off the hard-earned efforts and investments of others. And their almost wholesale misappropriation of our stories is not 'fair use.' To be impolite, it's theft."

"Right now content creators bear all the costs, while aggregators enjoy many of the benefits. In the long term, this is untenable. We are open to different pay models. But the principle is clear: To paraphrase a famous economist, there's no such thing as a free news story, and we are going to ensure that we get a fair but modest price for the value we provide."

In a nutshell, Mr. Murdoch asserts the same argument made by Supreme Court Justice Mahlon Pitney in the 1918 case International News Service v. Associated Press. In that case, a 6-2 majority upheld a lower court injunction prohibiting International News Service from "bodily appropriation" of freshly published Associated Press news stories, which were often telegraphed westward and published simultaneously in competition with AP-affiliated newspapers on the U.S. west coast. In the case, Associated Press prevailed on a theory of unfair competition (copyright was not an issue because it was generally unavailable to news stories at that time) in a case that established "misappropriation" as a form of unfair competition.

Over time, the force of International News Service v. Associated Press with regard to the original issue has faded, in part because subsequent jurists and legal scholars concluded that the formidable dissenters in the case, Justice Holmes and Justice Brandeis, had the better arguments, but also because of changes to copyright law in the intervening decades.

Lately, however, David and Daniel Marburger have circulated a paper advocating an amendment to copyright law that would effectively reinstate publishers' rights to enjoin aggregators from republishing without consent. What's more, current Associated Press CEO, Tom Curley, has been floating the notion of a licensing "head start" for cooperating publishers and aggregators, a central theme in the 1918 case. This idea seems to be gaining traction among publishers, and the threat may be partly responsible for some of Google's recent conciliatory gestures toward the publishers.

But in a wonderful irony, while Mr. Murdoch's argument reads like the majority opinion he favors, his words echo Justice Brandeis's right up to the conclusion:

"Plaintiff further contended that defendant's practice constitutes unfair competition because there is 'appropriation without cost to itself of values created by' the plaintiff, and it is upon this ground that the decision of this Court appears to be based. To appropriate and use for profit, knowledge, and ideas produced by other men without making compensation or even acknowledgment may be inconsistent with a finer sense of propriety, but, with the exceptions indicated above, the law has heretofore sanctioned the practice." (emphasis added).

For a fascinating, detailed and eminently readable overview of the case, I recommend University of Chicago Law School's Douglas G. Baird's "Property, Natural Monopoly and the Uneasy Legacy of INS v AP".

Murdoch's Sun Encourages File-Sharing, Deep Linking

The theme's been done before, but News Corp's tabloid, The Sun is running an advert touting the paper as "The UK's Best Handheld for 40 Years."

The spot is cute, if a bit predictable; but what struck me was the message, "This is how easy it is to share content with friends" (at the 0:38 mark).

Newspaper Circulation

The Audit Bureau of Circulation's report last month showed daily newspaper circulation plunging 10.6% from year-ago levels, a dramatically steeper decline than the historical trend. Not surprisingly, many commentators see the accelerating decline as the end (or at least the terminal stage) of the newspaper format. And they'll be right in less than a decade if circulation continues to drop by the current pace of 4-5 million subscribers per year. On the other hand, Daniel Gross over at Slate is not so sure and he recommends that we all just "chillax". In Gross's view, the recent decline may be largely explained by general economic conditions.

"... there's nothing ipso facto shocking about a decline in patronage of 10 percent in six months... In case anybody has forgotten, we've had a deep, long recession, a huge spike in unemployment, and a credit crunch. Consumers have cut back sharply on all sorts of expenditures.... Many other components of consumer discretionary spending—hotels, restaurants, air travel—have fallen off significantly. Do we draw a line from trends over the last few years and declare that in 15 years there will be only a handful of hotels? I'm not sure why we would expect consumption of a purely discretionary item that costs a few hundred dollars per year not to fall in the type of macroeconomic climate we've had."

Gross also reminds us that many publishers took steps that predictably reduced circulation, including raising prices and discontinuing home delivery to outlying suburban areas that could no longer be served economically.

Extrapolating from two data points is a highly uncertain business so Gross is right to recommend caution, especially when current cyclical factors may greatly exaggerate secular trends. For his part, Gross declares, "At some point in the future, newspapers may disappear. But count me in the later rather than sooner camp." But a peek at longer-term trends suggests that difference between "sooner" and "later" may be shorter than one might think. The chart below plots total daily circulation from 1940 through 2009 (the shaded areas indicate recessions).

(click chart to enlarge)

These circulation numbers come from the Newspaper Association of America (spreadsheet available here). For 2009, I have reduced the NAA's 2008 statistic by the Audit Bureau of Circulation's estimate that April-September 2009 average circulation was down 10.6% from the prior year period, resulting in an average daily circulation estimate of 43.4 million for 2009. (Over at his Newsosaur blog, the estimable Alan Mutter extrapolates a 2009 estimate of 39.1 million, but without his underlying data, I cannot reconcile that number to the NAA historical estimates, which are probably counted differently from the ABC numbers anyway).

The long-run trend is unmistakable. Circulation peaked 36 years ago, in 1973 but remained relatively stable until the 1990's when it began a steady downward trend, which accelerated in 2003, and appears to have accelerated even more in 2009.

The data provide some support to Gross's thesis: in the 1974 slowdown and the 1980-82 "double-dip" recession, circulation declined temporarily, but rebounded with economic recovery. By my calculations, those recessions caused circulation to decline about 2.2% vs. the trend from the five years preceding the recession.

More recently, during the two relatively mild recessions of 1990 and 2001, if the recessions caused any decline in circulation, there was no subsequent recovery. In fact, the decline in circulation accelerated as the economy emerged from those two recessions. So I suspect Gross is right that the current recession has accounted for some of the circulation decline; but if past recessions are any guide, the measured 10.6% decline reported by the ABC might be only 8.0-8.5% in a healthy economy. This is hardly reassuring news for the industry and recent history argues against a significant post-recession rebound. Even ignoring the recent plunge, if the trend from the past five years (excluding 2009) were to continue, total daily newspaper circulation would fall to 33 million by 2020, which seems optimistic in light of the manifest challenges faced by the industry.

It's also useful to consider newspaper circulation per household. By this measure, newspaper circulation has been declining steadily since World War II with most of the decline coming from the near-extinction of the afternoon daily. Over half a century, circulation per household has declined by 1.4 percentage points per year with remarkable consistency.

(Click chart to enlarge)

No doubt the introduction of evening newscasts on television 50 years ago reduced the perceived value of the afternoon paper, but even in 1980, the year CNN was launched, afternoon circulation actually exceeded morning circulation. Since then, afternoon circulation has all but disappeared. Morning circulation, which trended up in the 1980's (presumably as afternoon subscribers switched) and was relatively flat during the 1990's, has been dropping steadily since 2000, around the time that household penetration of high-speed internet access began in earnest.

(Click chart to enlarge)

As with the raw data, extrapolating the current year's trend suggests that newspapers would cease to exist by 2017. This is the "breathless" conclusion Gross warns us against, and his caution is warranted because (if for no other reason) as marginal subscribers quit, the remaining subscriber base is, by definition, the most loyal to the medium.

Still, longer-term trendlines based on the full data set and the period since 1999 yield very similar predictions, namely that circulation will fall to about 20% of U.S. households by 2020 (I'm ignoring the fact that some households may take multiple papers). Against the backdrop of the long-term trend, and with the internet acting as an obvious catalyst for further declines, this prediction seems entirely plausible.

But even if a loyal subset of households want their morning newspaper, the bigger question is whether the business model will continue to work at decreasing scale. As I have argued elsewhere, the newspaper industry historically enjoyed enviable returns to scale. As the industry shrinks, it may fall through a threshold level of scale (call it the "Tripping Point") below which the model is irretrievably broken and the publishers themselves pull the plugs on the presses.

Where might this threshold be? The approximately 40% decline in advertising revenue over the past 18 months put many papers through a near-death experience. Even if ad spending returns to pre-recession levels, a 40% reduction in circulation from today's levels (which would occur in 2018 according to the long-term trend) might be unsustainable if it implies a corresponding 40% reduction in ad revenue.

Further, if only two out of ten households take the morning paper at some point in the next decade, can home delivery continue to be justified? At some point, route density starts to work against the industry and the paper-boy may go the way of the milkman.

Chicago Trib to AP: "Cancel my subscription"

The Chicago Tribune is testing whether it can live without Associated Press content.

Is Virtual Farming Bigger than Actual Farming?

The NYT has an article today that claims 62 million people have signed up to play Farmville on Facebook.

I am not one of these 62 million, so you'll have to read the NYT article (or ask any random 5 people in the U.S., one of them is likely a Farmville player) how the game actually works. But I am fascinated by the economic effort expended on Farmville.

According to the Bureau of Economic Analysis (see page 9) the total economic contribution from U.S. farming in 2007 was $137.3 billion. Dividing $137.3 by 62 million Farmville registrants equals $2,215 per user per year. Divide $2,215 by the current minimum wage ($7.25 per hour) and you get 305 hours. Divide 305 hours by 52 weeks and you get roughly six hours per week.

If Farmville players are spending six hours per week on this game, the opportunity cost of the Farmville economy may be larger than the actual U.S. agricultural sector.

And, no, I will not adopt your lost cow.

Monkeys, Typewriters and The Odds of the Governor's Hidden Message

Everyone's heard the theory that with enough chimpanzees, typewriters and time, you'd eventually produce "Hamlet."

Shakespeare it's not, but California Governor Arnold Schwarzenegger's office today released a letter to the California State Assembly vetoing Assembly Bill 1176. A number of commentators have noticed a sub-textual message composed by the first letter of each line. The governor's office has called it "unintentional" and a "weird coincidence."

How weird? What are the odds that seven lines of a note could just happen to spell out this particular message? Would you believe less than one in 2.7 billion?

The math is surprisingly simple. Assume that each of the seven important lines of the letter have to start with a word (no hyphenation) that itself begins with a specific letter. The odds of randomly coming up with the Governor's message is then the product of the odds of each of the seven letters occurring as the first letter of all the words in the English language.

Surprisingly, a quick scan of the web didn't uncover a complete list of beginning-of-word letter frequency for English (how 'bout some help here, Google?) but I did find this top ten list.

Letter	Frequency
T	0.1594
A	0.1550
I	0.0823
S	0.0775
O	0.0712
C	0.0597
M	0.0426
F	0.0408
P	0.0400
W	0.0382

Source: Top 10 Beginning of Word Letters

So here's the math (using < 0.0382 for "u", "k" and "y" which don't make the top ten.

f = .0408 x
u < .0382 x
c = .0597 x
k < .0382 x

y < .0382 x
o = .0712 x
u < .0382

<= 3.693 x 10^(-10) or approximately one in 2.7 billion.

Some coincidence... the governor may have some especially talented chimps on his staff.

Does Barry Diller Watch "The Office"?

Barry Diller, a very smart guy and CEO of IAC/Interactive Corp, once famously dissed "user-generated content" (a progressively meaningless phrase) by suggesting that there's a limited audience for videos of "... a cat throwing up on your grandmother."

A few minutes ago, I finished watching NBC's one-hour episode of "The Office" featuring Pam and Jim's wedding, now, no longer, again available at www.hulu.com. It was, as always, charming and brilliantly executed. But most notable was the closing five minute sequence which was a lovely homage (fair use?) to "Jill and Kevin's Big Day" on YouTube, which features Chris Brown's song, "Forever".

Here's "The Office" version.

Art and reality reflect each other in infinite recursion. And tonight's episode of "The Office" may cause Mr. Diller to re-think his cat vomit thesis. Somewhere out there in UGC-land, Jill and Kevin had an inspired idea, arguably violated Sony BMG's copyright, choreographed five very special minutes of their lives, posted it on the internet, and created a sensation (28 million views!) Now that NBC has picked up the theme (in a show that ironically poses as documentary) it will probably drive another 50,000 iTune downloads for a guy currently serving six months of community service in Virginia.

Is this a great country, or what?

P.S. Even if you don't usually watch the show, check out the opening 1:45 below. For a more ham-fisted use of the vomit theme, check out Microsoft's online ad (since pulled) for Internet Explorer 8.

Lost in Transition?

The WSJ website has a nice interactive on the anniversary of Lehman Brother's bankruptcy, which displays the WSJ front pages from that momentous week. For those of us who followed the markets and the story, the series of images captures the urgency and drama of the Lehman collapse and its aftershocks in the financial markets.

But for me, what is most striking about these headlines is that until yesterday, I had never seen them. I'm a regular reader and have been a WSJ subscriber for twenty-five years, but gave up the print edition several years ago. Consequently, I consume my WSJ one story at a time and unless I see the print edition at a newsstand or on someone's desk, I generally don't see the front page the way the editors pasted it up.

One thing that newspapers do well (that Google hasn't automated... yet) is to make editorial decisions about how the day's most important or interesting stories are laid out, with subtle emphasis conveyed by position, allocation of space and type size. So it's somewhat surprising that as newspapers wrestle with the transition from print to online, their websites (well at least the WSJ, New York Times and San Francisco Chronicle) don't feature the front page more prominently on their home page.

As readers inevitably gravitate to the web, it would be a shame if we lose the shared recognition of those iconic front pages that mark the major news events of our lives.

What Hath Tech Wrought?

Here's a paragraph from today's WSJ that neatly captures some of the themes I've been exploring about technology's impact on business models, corporate life-cycles and investment horizons.

"Kodak spent $3.4 billion from 2004 through 2007 converting the bulk of its 129-year-old business from high-margin film to more competitive electronic technology. It is in the midst of cutting 3,500 to 4,500 jobs, which could reduce its work force to a 1930s-era low of 19,900 from a 1988 peak of 145,300."

It's worth noting that the enterprise value (equity value plus net debt) of EK is a little under a billion dollars today (at roughly $3.00 per share.) Including pension liabilities of $2.4 billion in the net debt calculation increases the enterprise value to roughly $3.4 billion, equal to the amount Kodak invested over four years to convert from a film-based to an electronic imaging company.

Under the most generous interpretation, the market is valuing Kodak's 129-year history at zero right now, despite it's highly recognized brand and long tradition of technological innovation.

Steve Jobs' Health is None of My Business

Bloomberg today reports the non-news that, "...disclosures about Steve Jobs’s health remain under scrutiny by U.S. Securities and Exchange Commission investigators over how his condition went from 'relatively simple' to 'more complex' in nine days" according to an unnamed source.

It must be vacation season if Bloomberg is trotting out a "situation remains the same" news story, which then recycles lots of commentary from legal experts not involved in the situation and doctors not treating Jobs. Predictably, nobody actually involved in the situation provided any on-the-record comment.

For the ultimate phone-it-in vacation season news story, go read this parody by Andy Borowitz. Like Mike Royko's traditional New Year's Day column or the Wall Street Journal's annual Thanksgiving editorial, Borowitz piece deserves to be republished every July 4th and Labor Day weekend.

Back to Steve Jobs' health.

Here's a simple fact that seems to get overlooked by the breathless journalists on this story: Like every other CEO I've ever met, Steve Jobs is mortal. Presumably rational investors in Apple factored this into their investment decisions years ago. Bloomberg is especially aware of this fact, having already published an obituary for Jobs back on August 28, 2008.

Here's another simple and widely reported fact. Steve Jobs announced to Apple employees that he had been diagnosed with islet cell neuroendocrine cancer of the pancreas back in 2004. Investors in Apple who previously overlooked his mortality probably factored this into their investment decisions then.

Now here's a more complex fact. Cancer, in all its forms, remains a complex disease. Nobody, including Steve Jobs and his doctors, knows what tomorrow will bring. As anyone who's had a close friend or relative battling cancer knows, the prognosis can swing from high to low and back again in mere days. Any near-term prediction about the course of someone's cancer is inherently speculative and as likely to mislead as to inform. If this were any other risk factor and any other company, it would suffice to include boilerplate language in the 10-K along the lines of "We maintain key man life insurance on certain of our senior executives but there can be no assurance that recoveries under these policies would fully compensate the Company for the loss of the executive's services."

Surely the SEC staff has better things to investigate, journalists can find more newsworthy stories to report, and we can all just say a silent prayer for Mr. Jobs and his family and leave them alone in this difficult time.

Buzzword Beat -Mark Cuban on "Free"

Mark Cuban has published a new post on his weblog entitled,

When you succeed with Free, you are going to die by Free.

In the post, Cuban argues,

"Lets look at the rule that eventually KILLS all freemium based content plays:

There will always be a company that replaces you. At some point your BlackSwan competitor will appear and they will kick your ass. Their product will be better or more interesting or just better marketed than yours, and it also will be free. They will be Facebook to your Myspace, or Myspace to your Friendster or Google to your Yahoo. You get the point. Someone out there with a better idea will raise a bunch of money, give it away for free, build scale and charge less to reach the audience. Or will be differentiated enough, and important enough to the audience to maybe even charge more. Who knows. But they will kick your ass and you will be in trouble."

Any thesis in the sphere of economics that includes the words "rule", "kill" and "all" is inherently suspect, and Cuban's post reads like a breezy attempt to join the buzz-fest around the publication of Chris Anderson's new book, "Free, The Future of a Radical Price". The giveaway is Cuban's strained "BlackSwan" reference from Nassem Nicholas Talleb's book of the same name.

(Anderson's book is an expanded version of this Wired magazine article.)

As a number of commentators have already noticed, Cuban's thesis says nothing about "free" or "freemium" business models that is not equally applicable to any business. Yes, business is a hyper-competitive sport, someone will eventually -- no time frame given -- come up with a faster, better, cheaper version of what you do and "kick your ass." A vague and generally agreeable prediction -- hedged by the inclusion of "eventually" so not falsifiable in the abstract or the concrete -- is not worth arguing about.

Here's my take.

"Free" business models like Google's search engine, MySpace and Facebook are predicated on low, arguably zero, marginal costs. Facebook can afford to be the digital bulletin board for 225 million worldwide users only because the marginal cost of storage and bandwidth is very small. Equally important, the capital costs of storage and bandwidth decrease predictably in general accordance with Moore's Law. So even as Facebook's user base explodes, its technology costs (per user) are likely dropping by 15-20% annually.

What Cuban should have said about "free" business models is that the low marginal costs and declining capital costs of these technology-intensive businesses go hand in hand. And if the infrastructure cost of MySpace or Facebook declines by 15% per year, a competitor can replicate that infrastructure four years later at 52% of the original capital cost. With half the capital cost, a new competitor is tempted to compete on price (more, better stuff for "free") and win away the business. Even if the new entrant fails, it will likely compete away some of the incumbent's profits.

In his article Cuban seems to be thinking of social media businesses -- Friendster, MySpace and Facebook-- although he includes Google (which deserves an asterisk if only for its multi-year history of handsome profits). What's economically interesting about these social media businesses, allowing them "to raise a bunch of money" is often explained in terms of "network effects", a popular buzz-phrase for what economists call a positive externality.

According to Wikipedia, the concept of "network effects" was introduced in the early 20th century in the context of emerging telephone systems. The positive network effect (you have a phone, making it more valuable for me to have a phone) helps drive adoption of the new technology. But in the early 20th century, adding those additional phones meant stringing expensive wires to each house or place of business. And after the first entrant incurred that sunk cost, there was little incentive for a competitor to incur the same cost to compete for the same customers with the same service. Even if some of the installation costs declined over time (cabling, electronics, e.g.) the costs of rights-of-way, telephone poles and labor likely increased, allowing the first-mover to build a long-term competitive advantage based on network effects and sunk costs. This is why most telephone systems in 20th century became regulated monopolies.

Facebook's current membership, at 225 million registered users, testifies to the potency of network effects in social media. And with the physical infrastructure of the internet already in place, a network that would have taken decades to build in the last century can arise in mere months today.

That's what's frustrating Rupert Murdoch as Facebook has surpassed MySpace in popularity. It probably keeps Facebook CEO, Mark Zuckerburg, up at night as well. Network-effects businesses on the internet generally don't enjoy the additional competitive advantage of high and rising capital costs to keep new entrants on the sidelines. And the glue that holds the network together and preserves its value may be nothing more than "community," an economic intangible that's as fragile as it is powerful. If a new entrant gains sufficient traction through differentiation or well-funded patience (think Microsoft), it too will eventually enjoy network effects. As users defect from one community to another the winner's positive externality is the loser's negative one. If your friends have stopped updating their MySpace profile in favor of Facebook, you'll probably stop looking for them on MySpace. If your friends start posting their updates on Twitter, you'll spend less time on Facebook. After enough defections the market may reach a "tipping point" (buzz-phrase alert!) as yesterday's market leader becomes tomorrow's also-ran.

Clever entrepreneurs understand the fragility and potentially transitory nature of their competitive advantage if it's based primarily on network effects. Successful ones use their early competitive advantage period to build potentially more durable advantages based on technology and intellectual property. This is an important point where Cuban and I disagree, especially with regard to Google. At December 2008, Google's 20,000 worldwide employees included more than 7,000 engineers. Not a lot of venture capital money is flowing into startups to take on that army of programmers. Google's R&D investment strikes me as a rational strategy while Cuban sees it as a costly act of desperation.

Chris Anderson seems like a smart guy, so maybe he's covered all this in his new book. I'll have something to say about that when it's available at my public library where I'll check it out... for free.

Clueless in Chicago --Unraveling Newspaper Economics

Major newspaper publishers met last month in Chicago in a not-exactly-secret, but definitely closed-to-the-public meeting to discuss the future of the newspaper business. More specifically, it seems, the meeting was convened to share ideas about how to more effectively monetize newspaper content on the web as traditional print subscription and advertising revenue plummet.

(As an aside, since most newspaper content on the web today is free, "monetize" must mean a price increase. Imagine if any other industry convened a closed meeting to discuss a price increase. What would the press have to say about that?)

As an avid reader (and paying subscriber) of several newspapers, I'm hoping they'll figure out how to survive. Sadly, I think the meeting must've been terribly disappointing.

A copy of "Paid Content - Newspaper Economic Action Plan" produced for the meeting by the American Press Institute (API) has been published on the web in several place including here. A quick read of the document cannot inspire confidence. The action plan recommends that newspaper publishers experiment with micropayments, subscriptions, and more ominously, coordinated industry and maybe government pressure on companies like Google, Yahoo and Microsoft to share search-related ad revenue. This last bit is called the "Fair Share Doctrine" described as "Negotiate for money, a lot more, from Google and online news aggregators for a 'fairer' share of the profits from linking and ad sales."

These ideas are neither novel nor untested. And they haven't worked so far. One gets a vague and uncomfortable sense that when the API recommends, "... [using] technology, news-industry production protocols, influence and public policy to thwart piracy" what they really mean is "maybe some government intervention can help us survive in our current form."

The 31-page API report goes wrong in its second paragraph when it asserts, "The problem is that the online business model does not yet come close to compensating for the steep slide in the print business model that it is replacing."

Guess what, it never will.

For well over a century the newspaper industry has enjoyed handsome returns from the economics of bundling combined with enviably low marginal distribution costs. These returns became even more attractive as many cities (in the U.S. at least) became one-newspaper towns. Bundled pricing, low marginal costs and monopolistic (or at least oligopolistic) market structure is a wonderful way to make a living. It is, however, not a birthright. And the government has no role helping the newspaper industry compensate for its loosening grip on its historical monopoly.

Here's Warren Buffet, whose Berkshire Hathaway has owned the Buffalo Evening News since 1977 and is a major investor in the Washington Post Company, writing in his annual letter 25 years ago:

“The economics of a dominant newspaper are excellent, among the very best in the business world. Owners, naturally, would like to believe that their wonderful profitability is achieved only because they unfailingly turn out a wonderful product. That comfortable theory wilts before an uncomfortable fact. While first-class newspapers make excellent profits, the profits of third-rate papers are as good or better - as long as either class of paper is dominant within its community.” [emphasis added]

Twenty-five years on, Mr. Buffet has changed his view of the newspaper business. During Berkshire Hathaway's latest annual meeting, he said, “For most newspapers in the United states, we would not buy them at any price...They have the possibility of going to just unending losses.”

What's Changed?
The structure of any market in equilibrium is determined by a complex and recursive interplay of technology, economics, inertia (in the form of pre-existing business relationships) and sometimes regulation. In the short term, the last three factors are paramount; in the long-term, technology dominates.

Traditional Newspaper Economics
The Virtuous Circle


Historically, the market structure of the newspaper business enjoyed a virtuous circle as depicted above. Once the sunk cost of the editorial staff is incurred, the printing press paid for, and the distribution system in place (collectively representing yesterday's technology), the incremental cost of including an additional classified ad -- or any other feature -- in the daily newspaper is negligible. Hence, newspapers had incentives to bundle many forms of content in addition to their own editorial content: TV listings, horoscopes, movie schedules, stock listings, comic strips, classified ads, etc. A reader paid for the bundled product even if he used the classified ads maybe once a year, or never read the horoscope or used the TV listings (note 1). The high fixed costs, offset by the surplus economics from bundling and low marginal distribution costs gave rise to something akin to a natural monopoly. And in most U.S. cities, the market leader has seen its competitors fade away in the post-war years (note 2).

Now imagine you're a newspaper subscriber (maybe you still are). If you could disaggregate the horoscopes from the weather from the sports from the local news from the international news from the business news from the TV listings from the almost non-existent stock price listings, how much would you pay for the parts of the paper you actually intend to read? Probably less than the $10-$15 per week it currently costs at the newsstand. Probably less than the $6-8 per week it costs to subscribe.

Probably a lot less.

This is the problem faced by the newspapers. Bundling is a pricing strategy that delivers surplus economics to the supplier by enticing customers to buy more than they would if the bundled products were sold separately. By weight, the majority of your local newspaper (and its website) is information sourced from third parties (ads, stock listings, classifieds, lightly edited excerpts of corporate news releases, etc.) readily available elsewhere on the internet (note 3). By allowing readers to disaggregate the newspaper's traditional bundle of content, the internet may be exposing the market value, or to use the API's term "true value" of the original editorial content produced by the publisher itself.

As publishers experiment with revamped online pricing models they may find that the true value of their original content will give horrifying meaning to the term micro-payment. No newspaper has a monopoly on "the news." It certainly has no monopoly on the third-party information it republishes. The newspaper industry suffers from a notion that it should enjoy monopoly economics on content ("Hey, that's copyrighted!") when in reality its historical monopoly was control of a distribution channel and much of the profit was based on aggregating and organizing other people's content. In the internet age, that distribution monopoly no longer exists and others, like Google, do a pretty good job of aggregating third-party content.

Copyright should be respected. But if a reader can get his daily dose of international news as readily from the Washington Post, the New York Times or a foreign newspaper, copyright on a particular rendition of the news will not give rise to monopoly economics.

Like the music industry before it, the API's view of the newspaper industry confuses the surplus economics arising from bundling and distribution monopolies for the natural economics of their copyrighted content. Copyright does indeed confer a monopoly right to a particular form of expression, but in no way guarantees that consumers will pay handsomely for it, if at all. The music industry has spent the past ten years battling piracy when the larger economic problem has been the unbundling of the album format. It turns out that customers prefer to pay $1.29 for one song they really want rather than $14.99 for the twelve songs the label bundled on a CD album. Losing the additional $13.70 per transaction really hits the music label's revenue line. A twelve-year old kid downloading thousands of songs he can't otherwise afford does not.

If newspapers no longer command a monopoly on distribution and can expect no surplus economics from bundling third-party content -- including ads -- they may find that the ratio of the "true value" of their editorial content to their historical revenue approximates the 20% of the average paper that is made up of original content.

When new technologies completely undermine an industry's market structure, that industry needs to be rebuilt from the ground up. The newspaper industry will fumble along (much like the music industry) if it starts from the premise that its historical economics represent some kind of natural order.


--------------------

Note 1. It should be noted that subscribers to print newspapers generally pay less than the actual cost of writing, editing, printing and delivering the newspaper... often a lot less. What drove newspaper profitability in the past was advertising sales, but that requires the aggregation of a large audience, which requires aggregation of diverse content to appeal to a large, diverse audience to attract the advertisers.  Another virtuous circle... or vicious cycle if it starts running in the wrong direction.

Note 2. Noam, Eli M., "Media Ownership and Concentration in America"

Note 3. This morning's complimentary San Francisco Examiner landed on my front porch despite my wife's repeated attempts to discourage them from delivering it; I guess they need the circulation numbers to support their advertising rate base. The paper, including ad inserts, totals 54 pages. A quick inspection shows the content is allocated as follows:

Third-party content
Ads: 34.5 pages
Classifieds 4.0 pages
Movie listings 2.0 pages
Weather 1.0 pages
Games 1.0 pages
subtotal 42.5 pages

This leaves 11.5 pages of news content, but of course the "World", "Nation" and "California" sections (one page apiece) appear to be entirely made up of syndicated pieces by the Associated Press or others. So the actual original content produced by the Examiner comes to about eight pages, or about 15% of the total newspaper.

The Twitter Revolution?

Changing the world 140 characters at a time. (Click to read)

Where'd You Get That Dress (Video)

A shout-out to Mr. Danny Montoya, kindergarten teacher extraordinaire and short subject film-maker.

Check out this link to his end-of-year video with my daughter's kindergarten class.

Where'd You Get That Dress?

Made Me Laugh

For more, click here

Candidate Change, Meet President Perseverance

The Wall Street Journal reports that President Obama is considering detaining terror suspects indefinitely.

While this continuation of the previous administration's policy may disappoint those who need to believe that every element of the Bush/Cheney foreign policy was evil or incompetent, it's not terribly surprising if you think about it for a clear-headed minute.

Nearly 3,000 civilians were killed in the 9/11 attacks.

Let's say you're the President and your military and intelligence agencies have managed to track down and capture a number of suspected terrorists. Under no duress, these suspects applaud the 9/11 attacks, claim responsibility (perhaps boastfully rather than truthfully) and pledge themselves to commit their lives to the further killing of Americans by any means possible. And just in case there's any doubt, they're all in favor of the extermination of Israel and maybe the overthrow of the kingdom of Saudi Arabia.

As President, would you release such suspects to threaten American citizens again? Remember, the 9/11 attacks on the Twin Towers were the second successful attack in eight years. So what's a President to do? He's sworn to protect, preserve and defend the Constitution, but as Commander in Chief he's also required to protect and defend the citizens. It would be convenient if these suspects could be tried, convicted and thrown in prison for life; but a civilian criminal trial may be a dicey proposition if the specific evidence is primarily confessions that may sound more like boasts.

In an era of rougher justice "...shot while trying to escape" would be one likely end to this awkward predicament. Or perhaps the suspects would be quietly extradited to a country whose legal system makes a specific judicial outcome more certain.

But we live in the current era. Meanwhile President Obama -- unlike candidate Obama -- is privy to the dossiers on these suspects and responsible for the security of the nation. He has a track record of respect for the Constitution and clear-headed, practical thinking. I'm prepared to give him the benefit of the doubt here. From the vantage point of the Oval Office, he seems to be doing the same for his predecessor.

Pruning Facebook

Interesting post on Fred Wilson's blog.

"... I started visiting Facebook every day and I found it way too busy. I was having a hard time finding the information I cared about inside all the other information there, most of which I was already seeing on Twitter."

Pretty much as I suggested a few months ago.

"Also, social networks in the real world rarely grow indefinitely and infinitely large. Maintaining relationships in the real world requires an expenditure of effort, which puts an upper limit on effective network size. As we move through the paces of our lives, we often prune the outer, less intimate branches of our social networks. On the internet, it's easy to "add a friend" and the maintenance costs (a little storage at pennies per gigabyte) are low and getting lower. But there is almost certainly an inverse relationship between the value of (personal) information shared on a social network and the size of the audience, which ultimately is a negative network effect."

Facebook vs. MySpace (Hilarious!)

A substantially less funny post by me (link)

Are You Smarter Than a Fifth Grader?Congressional Edition

From Politico reprinted in its entirety for non-subscribers:

Rep. cries foul over Nets naming rights

"Maybe they should just call it TARP Arena.

Rep. Bill Pascrell Jr. (D-N.J.), wary of taxpayer anger over the AIG bonuses, wants the New Jersey Nets to reconsider selling naming rights to the British bank Barclays for an NBA arena being built in Brooklyn.

Barclays received $8.5 billion in bailout funds from the Treasury Department, and Pascrell believes the $400 million it cost to have the naming rights for the soon-to-be Brooklyn Nets arena should be used, say, for lending to consumers instead. Pascrell was quick to make an exception for the new Citi ballpark the New York Mets are building, because that ball yard was already well under construction under the Citi name before the bailout money was approved.

“I believe that any further payments of taxpayer money, whether through TARP or the Federal Reserve System, be conditioned on the cancellation of any stadium or arena naming-rights agreements that may be in place,” Pascrell said.

It’s worth noting, of course, that Pascrell represents a lot of New Jersey Nets fans quite unhappy about losing their NBA team to Brooklyn."


Actually, Congressman, Barclays did NOT receive any "bailout" funds from the Treasury Department. Nor have they accepted any bailout money from the government of the UK, where they happen to be domiciled. To their credit, they have steadfastly resisted taking money that comes with governmental strings attached; and with each passing day and every congressional comment like yours, the wisdom of their strategy becomes more clear.

True, Barclays received $8.5 billion from AIG, presumably as collateral against or settlement of AIG's contractual obligations under trading arrangements. But to suggest that this is the same as a bailout is just wrong. To further imply that any organization that does business with a recipient of bailout funds is thereby subject to mindless Congressional meddling is either stupid or frightening, depending on how serious you are.

Oh, and Congressman, pretty much all "payments of taxpayer money" are made "through the Federal Reserve System." In fact, when you give a one-dollar tip to the guy who shines your shoes in the Congressional cloak-room, you're using what we in this country call a "Federal Reserve Note". It's actually printed on the top of the dollar bill in capital letters to help you remember.

Perhaps you'd like to regulate what he does with that too?

The Beginning of Wisdom...

"The beginning of wisdom is to call things by their right names" according to the Chinese proverb.

The chart above (click the chart to enlarge) shows the relative frequency of Google searches for "Troubled Assets" vs. "Toxic Assets" over the past 12 months. As the Treasury introduces "TARP 2.0" today, the change in the vernacular reflects a shift from a market view (or hope, really) that the problem was a temporary impairment of "troubled" assets to the acknowledgment that many of the assets at the center of the financial storm are permanently impaired or "toxic". If this view is widely shared, it may actually speed the recovery process as buyers and seller converge on valuation for the assets.

Contrarians may find a bullish signal in this verbal shift.

If you want to update this chart, click here and enter the search terms "troubled assets" and "toxic assets" separated by a comma.

Great Moments in StatesmanshipH.R. 1586

Photo credit Stephen Crowley/The New York Times

H.R. 1586The Law of Unintended Consequences

Well, they did it.

The US House of Representatives, apparently vying for the title of "The World's Greatest Retributive Body" passed HR 1586 - "To impose an additional tax on bonuses received from certain TARP recipients". HR 1586 was designed specifically for the purpose of taxing the bonuses of several dozen employees of AIG, the giant insurance company at the epicenter of the financial crisis.

Look, I'm no fan of AIG. AIG's reckless underwriting of credit default swaps has required a $170 billion injection of government aid to post collateral with counter-parties and extinguish obligations. And I will be surprised if AIG doesn't require more aid before this crisis is over.

So I am as infuriated as any other taxpayer to read that AIG planned to pay out $165 million in bonuses, including bonuses to employees who worked in their Financial Products group, where the credit default swaps were written.

But the speed with which the House has wielded its most powerful weapon -- As Chief Justice John Marshall put it, "The power to tax is the power to destroy" -- is a truly frightening precedent. By levying a confiscatory 90% tax on bonuses paid by firms who have received aid under the Troubled Asset Relief Program, the House has undermined the compensation model of our leading financial institutions, not just AIG. More to the point, it will create a financial hardship for many employees whose banks may not have needed TARP funds, but were persuaded by former Treasury Secretary Hank Paulson to accept them in an act of industry solidarity designed to stabilize the crisis late last year. It will also create financial hardship for many employees who had absolutely nothing to do with mortgage securities, credit default swaps or crazy leverage ratios and who probably earned their bonus. For some, it may mean selling their houses into an inventory-clogged market. For all, it will surely mean a reduction in both their saving and spending, just exactly what we don't need in the current economy.

It was bad enough last month when Deputy Sheriff Barney Fife... I mean House Financial Services Committee Chairman Barney Frank... was chiding Northern Trust for honoring its commitment to sponsor a PGA event in Los Angeles. But HR 1586 is a breathtaking act of power, passion and political pandering that should give pause to any believer in liberal democracy. Look hard enough and you will find federal aid, if only in the form of freedom from federal tax, in almost every nook and cranny of our modern society. Will lesser forms of federal aid be used as a pretext for the House to follow its new precedent of hastily drafted confiscatory taxes to coerce private behavior?

Fortunately, the administration has expressed reservations about the House bill and the public outrage has encouraged some AIG employees to forfeit their bonuses, so cooler heads may yet prevail and this hastily drafted legislation may be rejected or modified.

If you'd like to see how your representative voted, click here.

A Lesson in This Recession?

During economic booms, certain publications and political parties can be counted on to point out that the growing wealth produced by the expanding economy is being inequitably bestowed upon various segments of the population. This (unsurprising) observation usually leads to journalistic hand-wringing, cynical campaign slogans and calls for a more progressive tax code and redistributionist spending programs.

The breadth and depth of the current recession provides an interesting opportunity to observe the results of an experiment no sane policy-maker would ever intentionally conduct.

Last week, the Federal Reserve released its latest triennial analysis of changes in family income and net worth:

Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances

Trust me, you probably don't want to read it all (I haven't yet either) but I'll share one of the authors' observations. The report is based on household surveys conducted in 2007 and focuses on changes in household finances since the 2004 survey. In light of the significant changes in housing and equity prices during 2008, the study's authors also make an attempt to estimate the impact of 2008's market meltdowns through October.

A number of assumptions are required, which can be found on pages A10-A12. The authors conclude, "...these assumptions imply large drops in median and mean net worth since the 2007 survey — 17.8 percent and 22.7 percent, respectively."

These numbers feel about right. From January to October 2008, the S&P 500 declined 34.0% and the Case-Shiller 20-city composite house price index declined 14.5%.

Many commentators get tripped up when confronting means and medians, and politicians are probably responsible for statistics being lumped together with lies and damned lies. So here's a little refresher (page A6) on interpreting means and medians that most students should've had by ninth grade.

"Where a comparable median and mean are given, the gain of the mean relative to the median may usually be taken as indicative of relatively greater change at the top of the distribution; for example, when the mean increases more rapidly than the median, it is typically taken to indicate that the values in the top of the distribution rose more rapidly than those in the lower part of the distribution."

This is equally true in reverse, i.e., when the mean decreases at a greater rate than the median, it is typically taken to indicate that the values in the top of the distribution fell more rapidly than those in the lower part of the distribution.

So by certain conventional measures of inequality, the concurrent meltdowns in the financial and housing markets plus the economic recession have increased "fairness" in the United States.

This is not a headline I expect to read soon.

I make this observation not in defense of the well-to-do compared to the less fortunate. To be sure, this recession is hurting every family at every level. And the hardship at the lower end of the income and wealth spectrum is undoubtedly more palpable and immediate. What's more, the magnitude of federal aid being provided to companies like AIG evokes uncomfortable echoes of the "Welfare Queens" who figured in class warfare debates of the '70s and '80s. It seems we all live in a glass house now; so maybe everyone should put down his stone.

But when this economy recovers, as it certainly will, maybe we'll have learned that although prosperity inevitably benefits the prosperous, it's better (for everyone) than the alternative.

Yearning for the Good Old Days When the Glass was 130% Full...

From today's WSJ (link)

"The rise in the stock market, even if it isn't always a reliable predictor of the direction of the economy, could offer a sorely needed boost to confidence. "What you're trying to do is reverse psychology," said Robert Barbera, an economist at ITG, a research and trading firm. "You're trying to get people to think of the glass as a third full instead of 97% empty. ..."

Are Investment Advisors Worried Enough?

According to a survey by discount brokerage Charles Schwab summarized here,

Fifty-five percent [of independent financial advisors polled] said it could take as long as three years for portfolios to return to their levels of last September..." (emphasis mine)

Assuming that the "levels of last September" are the Dow's closing price of 10,851 on September 30 and the poll was taken when the Dow was hovering around 7,000, that implies that 55% of the respondents think the Dow will recover 3,851 points in three years. That's a 55% return over the period, or a 15.7% compound annual return.

What are the odds?



The graph above is the distribution of rolling 3-year compound annual price changes for the Dow Jones Industrial Average since 1930, according to Yahoo! Finance. (This captures only the change in the index, not reinvestment of dividends). Based on the past 78 years of market history, the odds of a 3-year return of this magnitude are about 15-16%.

Which makes the following quote pretty hilarious.

“Advisers don’t have a GPS to guide them, but they have the experience and savvy to see that there are still potholes on the road ahead,” said Bernie Clark, senior vice president for Schwab’s adviser services, which supports 5,700 independent investment advisers. “Their long-term view, reasoned outlook and steady approach will serve their clients well in this environment.”

Despite the gloom in the economy and markets these days, sell-side optimism appears undimmed.

Bumper Sticker

Greenspan-o-Meter - Two Down, One to Go

On December 5, 1996 Fed Chairman Alan Greenspan famously wondered whether stock prices reflected an "irrational exuberance" on the part of investors. This afternoon, The Nasdaq Composite index joined the S&P 500 by closing below its level on that day more than twelve years ago. For its part, the Dow Jones Industrial Average is a mere 2.4% above its level that day, or about one day's volatility in this choppy market.

As it turns out, Greenspan was perhaps too modest about his abilities to spot a bubble. For earlier posts on the same subject, click here and here.