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Disruption

David Pakman's Blog
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A Few Lessons I’ve Learned

A young entrepreneur asked me a great question the other day, “What are some things you learned later in your career that you wish you knew earlier in your career?” I didn’t have a great answer at the time, but of course it got me thinking. There are a few key lessons I have focused on these past five years or so that weren’t part of my thinking early in my career. I’m not sure I would have cared for these thoughts back then, but I thought I’d share them.

Be comfortable being uncomfortable.

Most of the great things in life are hard. The circumstances that lead to great accomplishment are often uncomfortable — strange and new, out of your comfort zone, and filled with challenges. Getting your mind programmed to be comfortable in the midst of challenge, conflict and uncertainty brings you great benefit. You won’t shy away from the conflict or uncomfortable conversations often required to influence outcomes. Your mind becomes in control of your body. In physical challenges, your mind usually quits before your body does because it is opting to avoid discomfort. It tells you your body is failing before it actually is. Take control of this and get comfort around the fact that many situations in life are not comfortable, but you can still handle it. Hang in there. Be in control.

Develop an expert point of view earlier than the consensus.

By the time everyone agrees on something, it has already happened. You can’t innovate ahead of the curve unless you see a future that most others don’t yet see. You also have to be right about it, but not every time. You can change your view about the future when you see evidence that it won’t happen the way you thought it would. For me, I first try to become expert on something by going super-deep on the topic, learning everything I can about it, talking to many people about it, and using the technology or product in question as much as I can. Once I do, I usually find that many of the people talking about it aren’t truly experts. In fact, I believe many of the loudest voices are often the most wrong.

I remember in 1996, John Markoff, then the most senior and well-respected technology writer at The New York Times, called Microsoft’s Active Desktop, “the most fundamental change to personal computers since the machines were invented in the 1970’s.” To me, this sounded like not just silly hyperbole, but a fundamental misreading of where things were going on the internet. Given his vaulted position at The Times, many people believed Markoff and accepted his view that Microsoft would dominate the next phase of the internet. As we all now know, Active Desktop was an inconsequential product and a failure, and more than fifteen years later, Microsoft is still struggling to be consequential on the internet.

I work to develop my own point of view about where things are going. I work to validate that by looking for data or evidence. Then, if I feel passionately about it, I try to bet on this outcome. And in many cases, my point of view is different than most others. This gives me confidence that I might be on to something (or just be totally wrong). Consensus scares the heck out of me. Really loud voices tend not to be right. My job, as both an entrepreneur and a venture investor, is to beat the consensus long before it happens, but to be right that it will.

Be fact-based in your observations and beware of confirmation bias.

We live in a world filled with data, so use it to make observations. Don’t live life purely on your gut. I gain confidence in my point of view by seeking out research or data that supports my hypotheses. But I force myself to be open about the data I find, knowing that we have a psychological tendency to seek out data which confirms our preconceptions. In short, be honest with yourself about what you observe and challenge your point of view.

Figure out what you are good at and depend on it.

Are you great at reading people, generally right about their capabilities? Are you an astute observer of markets and trends, usually right about who will win or what will happen? Are you a product savant whose obsessiveness with simplicity produces outstanding experiences? Are you a natural leader, able to convince a room full of people to follow you into an uncertain future? Are you an outstanding sales person, able to convince people to part with their money? Or, are you a total introvert who wants to avoid interaction with people but can architect a massively scaleable web application? Maybe you are a mixture of these things? Knowing what you are good at and building your undertakings around that is a quicker path to success. Yes, you can improve in all areas of weakness, but certainly engineer the game to play to your strengths.

Be self-aware, know your short-comings, and find mentors.

We all suck at plenty of things. The only way to get better and to level-up is to first recognize our own limitations and to work with experts to teach us. Self-aware people recognize their short-comings, are not afraid to talk about them, and seek out experts to teach them how to improve. Asking for help is not an admission of weakness. It’s the path to improvement.

Big companies are slow, do not innovate and are unwilling to self-cannibalize.

When I was younger I thought this might be true but now I have seen it happen over and over and over again. Sure, there are exceptions, but in general, startups can move very quickly and innovate on the home turf of large incumbents. As organizations get bigger, executive pay structures often do not encourage companies to cannibalize their existing business even when they see a new technology coming that may impact them. And power is more fleeting these days then in decades past. Do not be daunted by the presence of large incumbents when you can capitalize on a technology shift and catch giants flat-footed. There are too many examples of this common cycle of disruption working time and again.

 

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Brian Williams and Abundance vs. Scarcity in Media

The physical world’s native economic basis is scarcity. Value is determined by demand for each item produced. If I make only five gold Ferraris and thousands of people are just dying to have one, the value of those will increase.

In the digital world, we live in a world of abundance. We can make infinite perfect copies of anything produced without significant marginal cost. We can satisfy pretty much all the demand for digital goods, so it’s hard to drive value by limiting quantity.

The same shift is occurring in media. In the legacy media world of newspapers and TV shows, tons of scarcity exists: editors can only fit eight stories on the front page of a newspaper, cable companies only have capacity for a few hundred channels, and TV networks can only offer 24 hours of programming a day. In media governed by scarcity, editors and programmers must make hard decisions about who and what to talk about and hope their audience cares for their choices. In the archaic world of television news, the choice of an “anchor” really mattered. After all, each of the three terrestrial broadcast networks could only have one, and this anchor was going to appear on TV each night for 30 minutes or so. The investment in anointing a single personality around which your network’s entire credibility was built was significant, and made sense.

Consider now the digital media companies of the present day. The most valuable ones are platforms, not programmers. Facebook, Twitter, Pinterest and YouTube, for example, are platforms for expression through the sharing of content produced by, or curated by, their users. All of these are built natively for abundance. They have infinite inventory, can support an infinite number of creators and users, and make no decisions about which content or which personalities are “right” for their audience. The audience decides entirely whom to friend or follow, what to “like”, and what to ignore in their feeds. (Algorithms can help make this process easier.) In this model, platforms are not reliant on a few editors or a few personalities to represent their brand. And they are immune to the inevitable rise and fall of the popularity of people and topics. In fact, they welcome it.

Excitingly, early adopters of these platforms are motivated to figure out the essence of what makes them work. They produce and refine lots of content on them and watch audience engagement until they master the platform. There are now millions of creators who are great at YouTube and Vine, Instagram and Twitter. More of these platforms will emerge, and more creators will blossom. Abundance.

Traditional media, by their selection of what to cover and feature, confer an artificial sense of importance to anything or anyone appearing in their pages or on their programs. I heard an NPR story the other day featuring someone whom the reporter profiled as “a great tweeter.” According to whom? And why this person? It was classic scarcity media — anointing one to speak for many. There are millions of great tweeters in the world and featuring one as an example of what Twitter is like is kinda silly. This person’s true relevance on Twitter is indicated by the engagement metrics around their tweets, a topic not discussed in the story.

So how does this relate to Brian Williams? Well, the reason we know about him is because NBC chose, in a scarcity-based media world, to build their entire news brand around him. And now he has significantly tarnished this brand. This will have a real economic effect on NBC as a result. Brands built in the age of scarcity take significant risks when they use celebrities (or any one individual) to act as a proxy for their products. Endorsements bestowed upon athletes carry the same risks — unnecessary in a digital world of abundance. On digital platforms, brands are built by the stories brands tell and the content they share. They rise and fall based on their ability to engage us and capture our attention in the streams. We care about them when they do, and often ignore them when they hire a celebrity spokesperson to speak on their behalf.

The age of abundance in media requires a more democratic approach to programming. In this world, platforms take little risk in the inevitable imperfections of humans. They cherish it. Because when it happens, they are the places where we all go to talk about it.

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A Sensible Approach To Net Neutrality by the FCC

Today, FCC Chairman Wheeler announced a sensible approach to ensuring that the internet will remain an open platform. Many folks in the traditional telecom and cable industries have described the use of Title II as a blunt and archaic tool not appropriate for the internet. And others have derided the very notion of internet regulation as anathema to free markets and the internet more broadly.

Most of us who have lived on the internet since its early days feel strongly and personally protective of its level playing field. In order to protect this openness, it became necessary for the FCC to step in. And once that moment came (prompted by some previous court decisions), the FCC had a choice on how best to maintain the openness and freedom to innovate so important to both our society and our economy. When presented with this choice, it became clear to me and many of us who build internet companies that classifying the last-mile internet as a telecommunications service rather than an information service was the best way to maintain the essentially openness of the internet. That is why I supported the use of Title II (with the appropriate forbearance of non-relevant regulations) in this case. I am pleased that Chairman Wheeler and his staff listened carefully to the millions of comments which poured in — most in support of these important protections. And I am also thankful President Obama and his staff took such keen interest in this issue and shared their point of view with the public.

We don’t want ISPs and cable companies being kingmakers on the internet. We want the users — all of us —to get to try every product or service no matter who provides our last-mile internet connection and to vote with our attention and our money as to who wins and loses. The FCC’s new rules will require ISPs to stay out of the way and not to allow or demand companies pay them for faster traffic. This is a great development for the internet as we know it and love it.

While it’s true that any regulation can bring unintended consequences, the other choices of either (a) doing nothing or (b) continuing to use Section 706 as a means to enforce these protections both, upon closer inspection, are worse options that will likely lead to an uneven internet.

Here Is What Happens When Your Brand Doesn’t Know Its Customers

Watch the video, then click to see the hundreds of comments…

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The Artist’s Share

There is a commonality in the Hachette/Amazon and Spotify/Pandora/Recording Artist debates and it looks something like this:

  • By not paying enough royalties to the licensor (book publisher, record label), authors and artists are being starved.
  • We are told this is critically bad for authors and artists who can no longer earn a living.
  • Thus, creators won’t create, and art and culture ultimately suffer.

None of us want there to be fewer books or songs in the world. But frequently lost in this debate is a discussion of the presence, or perhaps obsolescence of the middleman and the amount of revenue they keep. Spotify, Pandora, Amazon and the other licensees of ebooks and music are ultimately just retailers. Their job is to acquire and retain customers, and sell them as much music and books as they can. They license their content from book publishers and record labels. The terms of the license are set unilaterally by the publishers or the label as they have exclusive authority over the titles they represent. The publishers and the labels form agreements with their authors and artists. These agreements dictate how much of the money received from retailers gets paid out to the creators. Spotify, Pandora, and Amazon have no control over the terms of the relationships between the creator and the middleman publisher or label.

For every dollar spent on books or music, we know how much retailers keep. In the case of Spotify, more than 70% of every dollar they collect gets paid to record label and music publisher middlemen. In the case of Amazon, we see from their gross margins that they pay out about 70% – 80% of every dollar they collect to the book publishers. Pandora pays out about 55% – 60% of the revenue it receives. Apple, the world’s largest retailer of music, pays out 70%. Most retailers of media, through both analog and digital eras, squeak by on about 30% gross margins and pay about 70% to the middleman. (Apple, in their AppStore, keeps 30% of app revenue and pays 70% to developers.) The argument is often made that “these retailers build their businesses on the backs of the creators and should keep a relatively small share.”

Fair enough. Except how much of the money collected by the book publishers and record labels makes it back to the actual authors and artists—the creators without whom there would be no art? And in a changing digital landscape, are the analog legacies of these payments appropriate for the digital world?

In music, the deals between record labels and artists have two types of royalty structures: a) a percent of revenue paid to the artists for recorded music that is sold (a CD, a digital download) and b) a different percentage for music that is licensed (for use in a film, or perhaps a digital streaming service). Different artists have different deals, and massive superstars can demand better terms, but on average, revenue sharing for music sales are in the 15% – 18% range. That is, the artist receives only 15-18% of the wholesale payments the record label receives from sales. In real dollars, for a $1 download, Apple keeps $0.30, pays $0.70 to the label and the label pays $0.10 – $0.13 to the artist. That is a shockingly low amount and helps explain why artists often feel bitter about digital music sales. If retailers only keep 30%, why do the record labels keep more than 80% of the money they receive?

Traditionally, they claimed they served an invaluable role in the creation of music. They advanced money to the artists to live, they paid for studio time, they guided the recording process and helped select material, they manufactured the records and CDs, they shipped them in their trucks to their distribution facilities and then to the retailers. They also paid for music videos and marketing activities. If the labels needed 80% share to cover all of these costs, that might make some sense. Except in record deals, the artist is actually billed for most of these costs and has to repay them (“recoup”) by allowing the record label to withhold royalties until their advance and many of these costs are recouped. Interestingly, the overwhelming majority of these activities are not needed in the digital age (trucks, manufacturing) or cost a whole lot less to perform (electronic distribution).

In the digital world, many artists have successfully argued that digital services are being licensed by labels and thus the licensed royalty amount should apply. Again, this is negotiable, but generally is about a 50%/50% split. That is, half of the royalties collected by the labels get paid out to the artists, subject to deductions and recouping of costs. In the previous iTunes download example, the artist would receive about $0.35 for every $0.99 download sold.

In book publishing, for eBooks, many book publishers pay out about 25% of royalties they receive directly to the author and pay out about 5% – 15% of the retail price (or about 25% – 30% of the amount the publisher receives) for physical book sales.

In their most recent financial statements, Warner Music Group indicates that they are paying out to artists about 52% of the revenue they collect, far less than Apple, Amazon and Spotify pay to record labels and book publishers. In the case of book publisher John Wiley & Sons, they pay out to authors only about 29% of the revenue they collect, keeping 71% for themselves.

If retailers “build their business on the backs of the creators,” so too do the record labels and book publishers. Are they entitled to the majority of profits of every sale? Are they even any good at the marketing skills required to excel in the digital age? With audience proving grounds like Kickstarter and IndieGogo, how much creative direction and marketing does an artist need in this new world? It’s time not just to revisit the very purpose of these legacy middlemen, but also to re-examine the amount of money they take for their services.

 

 

 

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Dollar Shave Club and the Modern Brands

Dollar Shave Club just celebrated its second birthday. In two short years, this modern men’s lifestyle company has captured about 9% of the U.S. men’s razor cartridge market, according to BGP Group. (This is a measure of market share by units.) It’s a remarkable feat for a young company in a very short amount of time and it shows how dramatically industries can be transformed by new entrants who reimagine a market an entirely different way than how incumbents think.

In the case of consumer packaged goods, most are manufactured by CPG behemoths who rely chiefly on two aging mechanisms for building consumer awareness: broadcast marketing and physical retail shelf-space. Dollar Shave Club, and similar modern lifestyle brands like Warby Parker and Bonobos, view these dependencies as a disadvantage and have turned the model on its head. Broadcast marketing, in the age of social media, looks as out of touch to digital natives as President George H. W. Bush looked to us when he was surprised by a supermarket price scanner . Now, brands are built by having direct conversations with your customers, not shouting at them, engaging them to provide real time feedback on your products and services and enlisting them to vouch for their satisfaction with your brand. Brands are now built by your customers, not announced to them. And because of this, product discovery is shifting away from physical shelves into the social streams we all follow. If your brand does not occupy meaningful share in the minds of your customers, it won’t move through the streams and allow influencers to introduce you to new customers.

Social marketing done correctly requires far less marketing spend in aggregate than broadcast marketing. This means brands built with the economic firepower of $100M+ traditional marketing campaigns end up pricing their products higher to cover their required marketing spend. This is why you see the modern brands able to offer their products at lower prices than the incumbents, creating a value gap in the minds of customers.

Traditional CPG has built big walls around physical retail distribution. They have leverage over the decisions physical retailers make as to which products to stock on shelves. But modern brands are born on the internet and sell directly to their customers, initially bypassing physical retailers, sometimes forever. They get to know their customers, they speak with them, they use social data to understand their influence and their habits. In short, they are hyper-informed as to who their customers are and what they want, and they have an easier time finding new ones. With so much of commerce moving online (14% of US holiday season sales were online in December 2013), customers prefer the convenience of direct-to-you product delivery and the low-friction of mobile commerce. Traditional CPG, like other industries who sell through complex multi-layer distribution, must allow for healthy distribution and retail markups and don’t get to know their customers. They are slower to learn when preferences shift or to react to the moves of competitors.

All of these differences add up to advantages for the modern brands built on the internet — price advantages, information advantages and most importantly, higher customer loyalty. Dollar Shave Club has received envious net promoter scores and, for the subscription part of the business, has extraordinarily low churn rates. About half of all of their new customers are added organically and not through paid marketing. Their products cost less and provide more value than the legacy brands. Legacy brands often cannot respond to these threats effectively. They can’t undercut their own retail partners on price, they can’t sell directly in any real volume, and most importantly, they don’t hold an authentic place in customers’ minds, so they tend not to have a strong place in the social streams. Their customers are not their partners.

Once established firmly online, modern brands do move offline. But you are seeing them do so in inventive ways. They tend not to just sell their products into legacy physical retail, they work to re-invent physical retail with their own branded presence (Apple Stores are the high water mark here, and Warby Parker has made some important innovations too). They do often expand to traditional ad formats like TV and radio, but they do it in a highly quantified and targeted way, with a holistic view of a customer across every channel and touch-point, able to see the online influence of a customer who hears a radio ad in Dallas and how many social connections of that person ended up visiting the mobile site of the brand itself.

Dollar Shave Club, like some of the modern brands in their cohort, has grand ambitions to build a multi-billion dollar lifestyle brand, in partnership with its customers. They have expanded into content such as podcasts and the hysterical “Bathroom Minutes” as a way to be even more present in their customers’ lives. They are launching many more products over the coming months to offer great value across many product categories to their customers (often in response to customers begging them to do so). Their growth is accelerating and they see a clear path to capturing double-digital market share in each of the product categories they enter. With more than one million paying subscribers and a fresh $50 million of new capital, they have grand designs on building a better bathroom. I am honored to be along for the ride and to have a front row seat.

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Venrock 7

My partners and I are thrilled to continue collaborating with fantastic entrepreneurs to help build enduring, iconic and meaningful companies. Last week, we completed the fundraising of Venrock 7, a $450M fund focused on disruptive early-stage tech and multi-stage healthcare companies. For many VCs, the process of raising a new fund brings a helpful opportunity for self-reflection — a chance to take stock of the world, the disruptive technical forces likely to bring change and a candid assessment of one’s abilities to thrive in this environment. While we are always observing the world around us and making adjustments to our areas of focus and investment strategies, every four years or so, we too go through a rigorous process of prophesy and self-evaluation. Like an entrepreneur presenting their company to a VC, we pressure test our strategy with LPs during the process of raising a new fund. We came away with some exciting observations about both ourselves and the world. I am pleased our LPs share our view of our abilities and have entrusted us with the resources necessary to help build some great companies.

At Venrock, preeminent among all of our abilities is a belief in the importance of a performance-oriented and supportive culture — internally and with our entrepreneurs. We believe we will not excel as a partnership if we do not truly admire and respect each other. We are good at listening not just to the entrepreneurs with whom we meet, but to each other, distilling each other’s wisdom and foresight. And we work hard to preserve this culture internally. Each day, I feel my partners are behind me 100% and are rooting for my success, as am I for theirs. Equally important, however, is a focus on performance. We are in this business to make money for our LPs, and that can only be accomplished by investing in great companies and participating in their upside. In my almost six years at Venrock, I have never been more excited by the team surrounding me, our expertise, our intuition, but mostly our deep mutual respect and support for each other.

Areas of Excitement

There are plenty of important trends to discuss in tech. Here are just a few areas that really excite me:

New York

shutterstock_114734815New York continues its ascent and importance to the tech ecosystem. As a firm that has been in New York for decades, we have now made a deeper and even more meaningful commitment to investing in early-stage New York City tech companies. We are doubling down in New York with a larger team and have invested in some of the largest and most important tech companies here. Appnexus, Dstillery, Smartling, Dataminr and a few others not yet announced represent what we hope to find in our investments — hungry, passionate, and brilliant entrepreneurs bent on creating enduring and very large companies, sometimes creating new industries themselves. As a firm, we are confident some of the greatest tech companies of the coming decades will be founded in New York City and we hope to find them and invest in them early.

AdTech -> Marketing Cloud

funnelTraditional adtech is evolving into the SaaS marketing cloud. We continue to focus on the highest-value layers of the adtech and marketing services stack as consumer attention continues its migration away from traditional to online media. Ad-supported business models continue to dominate the internet, are performance-based and offer brands better control and measurement of their ad dollars. Our unwavering belief in the long-term primacy of ROI-driven advertising leads us to seek out the most innovative and best-performing ad products and the technologies underlying them, especially as ad formats and consumer media platforms change from desktop web to social mobile stream to app to OTT video and beyond. We focus on the emergence of best-in-class tools for marketers to help them take control of the entire marketing funnel, from prospecting to conversion to long-term customer relationship management.

Blockchain

opengraphThe emergence of the blockchain may be one of the most promising technical innovations of the last five years. We see the highly inefficient and expensive legacy payment and money transfer mechanisms being pressured by the far lower-cost methods made possible by blockchain-driven solutions. We are excited by innovations in addition to Bitcoin that can be built atop the blockchain, especially contracts, IP transfer solutions, voting solutions, ticketing, identity, and eventually distributed computing.

Video

shutterstock_129089885Readers of this blog know of my passion for the disruption of legacy media companies. I am particularly excited by the changes underway to the video ecosystem. The emergence of mobile as both a video creation and consumption device is sucking attention away from the traditional TV screen but also democratizing the creation of engaging video. I believe changes in the traditional TV value chain are well underway and I look forward to finding more companies catalyzing these changes.

And More

We continue to explore the intersections of technology with education, financial services, branded commerce, enterprise software and, of course, healthcare and healthcare IT. As always, we believe in the power of entrepreneurship to bring progress, efficiency and new capabilities to markets and are thrilled to have fresh resources to invest in great entrepreneurs embarking on exciting journeys.

 

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Without Aereo, How Will Traditional TV Be Disrupted?

After yesterday’s Supreme Court decision
against Aereo, will traditional TV be disrupted?

The First Phase of Disruption Already Started
There has been a major shift away from appointment TV to on-demand viewing, beginning with the DVR, followed by Netflix, and now partially fulfilled by hundreds of OTT on-demand apps, from HBOGO to Crunchyroll. The cable networks, of course, only make their programming available OTT if you authenticate with your cable log-in, preserving MVPD economics. So the only part of the TV ecosystem feeling pressure from this trend is commercial advertising, since, with a few exceptions, the majority of on-demand viewing is commercial free. But this shift to on-demand insures that our kids fully expect all video programming to be portable and on-demand.

Will there be a cheaper cable bundle?
With the end of Aereo, it is unlikely we will see bundled economics of cable TV programming disrupted by a tech company outsider. The only way to offer traditional TV programming over the internet will be to license it from its creators or distributors. Those content owners set rates in such a way as to preserve traditional cable bundle economics. Sure, Apple, Google or Amazon could become an MVPD, but they would be unlikely to offer a cheaper or smaller bundle.

There is real pressure on the bundle, however. Remember, cable TV is really a bundle of bundles. If an MVPD wants ESPN, they must also license and pay for ESPN2, ESPN3, ESPNNews, etc. These mini bundles force MVPDs to pay for more channels than they may otherwise want and in turn must charge consumers more. But they have little choice. Even if you wanted to assemble a smaller, less-expensive bundle of programming, it is made nearly impossible by the imposition of these mini-bundles. And the costs of these mini bundles have been rising, which has led Comcast to buy NBC, Comcast to buy Time-Warner Cable, and now AT&T to buy DirecTV, all as attempts to create leverage against rising mini-bundle costs. This upward price pressure is creating a real problem, since the number of cable subs is now falling in this country. Rising rates, falling subs.

It is unlikely tech companies will be able to meaningfully change these core economics. For this reason, I believe the core disruptive force acting on traditional TV is coming from outside of the TV ecosystem. It is coming in the form of alternate programming being consumed largely by the youngest demographics. I’m talking about YouTube, Twitch.TV and many smaller video companies stealing kids’ time away from the tube.

The Second Phase
YouTube, for many years, was scoffed at by the traditional TV content owners as lacking in quality. But my eleven year old today watches 90% of his video programming on YouTube. CaptainSparkles and Crazy Russian Hacker are true celebrities to him, as big as Kevin Spacey is to me. With more than 6 billion hours of video watched each month, YouTube today reaches more people than any cable network and, even among adults 18-34, they are bigger than any cable network. Their growth rate continues unabated and in short order, YouTube may one day be bigger than all of traditional TV. By buying Twitch, they cement themselves as the overwhelming largest platform for video game content, one of the two most popular content types among kids. And newer entrants like Livestream and YouNow are building engaged audiences with long tail programming.

This view that TV’s competition comes from the bottom is not a new one. (Hunter Walk and I discussed this in this post.) What is new is the widespread shift to mobile devices. As smartphones hit scale, we carry with us both a video creation and consumption device at all times. The real-time web collides with the mobile video web and a new genre of video programming emerges, somewhere between broadcast and messaging. These new personal video formats will steal even more video viewership away from TV, particularly among youth. So if younger kids grow up consuming video away from TV, and TV’s response is continued rising prices of bigger channel bundles, something has to break.

Image credit: Denys Prykhodov / Shutterstock.com

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Taking the Other Side in the Amazon/Hachette Debate

This post is likely to be unpopular.

In April of 2012, I wrote “Why Should eBooks Cost $15” in response to the news that the Justice Department was suing Apple over price collusion with the book publishers. In it, I discussed eBook pricing…

Readers of this blog are familiar with my many discussions on digital good pricing and price elasticity. There’s “Weighing In On the Amazon/Macmillan Pricing Debate” where I detail that the market can tell you your optimal (i.e., highest profit producing) price for digital goods. Each incremental digital good has no additional cost. The marginal cost of distributing it is zero. So you really want to maximize total profit by finding the price that produces the most number of copies sold. In these markets, you make a mistake when you set your price by looking at your legacy costs (which were designed for a physical goods market in pre-digital times). Digital markets produce much lower profit per item, since digital markets tend to have lower prices for goods. (See “As Big Media Goes Digital, Markets Shrink“.) In all the discussions about why book publishers demand that eBooks should be $15 and not $10, they say it is because they cannot afford to sell books at $10. That is, they cannot cover their legacy cost models on that number. Right. Which is why you must rebuild your cost structure for a digital goods industry with far lower prices. You start by paying your top execs much less than millions of dollars a year. Then you move your offices out of fancy midtown office buildings. Why should eBooks cost $15? Amazon is far more of an expert on optimal book pricing. They have far more data than publishers, since they experiment with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold. Amazon is pretty sure that number is closer to $10 than to $15. Yes, they want to sell more Kindles. And they believe that lower eBook prices mean more eBooks sold which means more demand for Kindle. The negative coverage of Amazon is centered on them selling eBooks below cost in order to reach the $10 price point. But that is a function of publishers setting the cost higher than $10. If the profit-maximizing price for an eBook is $10, then publishers must adapt to set a wholesale price lower than that, even if it means your legacy cost structure doesn’t allow it. And that’s the rub.

Now, more than two years later, we find ourselves having the same discussion. The Amazon/Hachette dispute (most of the journalists covering it have been sympathetic with Hachette) is largely over the retail price Amazon believes it should charge for eBooks. Hachette wants this price higher, Amazon wants it lower. Hachette seems to want to try to keep eBooks priced about the same as physical books. But why should it? eBooks have no marginal costs, and consumers therefore expect the pricing to be lower. Amazon agrees.

While the hardball tactics Amazon has used to force Hachette to lower prices have, somewhat uncharacteristically, inconvenienced Amazon’s customers, I believe their larger point is the right one. Many legacy industries who’s models were built in the analog world have trouble adapting to the lower prices of digital markets. (See the music industry.) Amazon’s pricing data likely shows they will sell more eBooks at lower prices. They want Hachette to price eBooks lower. In this new world, more copies can be sold, for lower retail prices, but with no physical costs. The profit might well be close to the same amount, or it may even be less per unit. But adapting to the increased competition for consumers’ attention/spend and the inevitable price erosion of digital goods compared to their physical peers requires prices to fall. Amazon is attempting to force the publishers’ hands.

Most of the emotion around this debate has centered on the effects of Amazon’s tactics on authors. I understand how a dominant retailer can hurt sales by temporarily refusing to stock titles or make them hard to buy. But the long term effects of Amazon fighting for lower eBook prices is likely to make the eBook industry healthier in the long-term. For that, authors should be supportive.

lanes

The FCC Decides to Eviscerate the Neutral Internet

Like many in the tech community, I was both shocked and dismayed at the FCC’s sudden about face on the basic principles of net neutrality.

“The principle that all Internet content should be treated equally as it flows through cables and pipes to consumers looks all but dead.” – The New York Times

FCC, in a Shift, Backs Fast Lanes for Web Traffic

If the FCC’s proposed rule-making goes forward, this will be the beginning of the end of the open and non-discriminated internet. This proposal so obviously favors large companies with deep pockets at the expense of new entrants and startups. An internet where all content is treated equally and routed without preference has served to create a culture of massive innovation and has witnessed trillions of dollars of wealth creation and millions of new jobs. Allowing giants to buy preferred access to end users will automatically diminish the quality of service of non-payers. On the internet, we know speed and responsiveness are necessary to deliver high-quality user experiences and to delight customers. This proposal would make it far more difficult for non-payers to deliver those types of experiences so essential for success. The FCC should immediately re-write their proposed rule-making and eliminate any notion of favorable treatment to any content or payer.

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