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.