ConocoPhillips
First, I’ve got a new post on Huffington Post – I know Arianna will be sending me a check when the transactions closes – and you can read it here.
Now, let’s start with this article about what’s going on at ConocoPhillips. No, wait, let’s stop there for a second – don’t you love the company names you get after mergers? You know, combinations of the names of the participants that get slammed together like those run-on German nouns -- like OLTimeWarner, or PriceWaterhouseCoopers. It’s like the kids in my neighborhood who have hyphenated names. Many of the kids with these portmanteau-like monikers were in the Bethesda-Chevy Chase Baseball league in which I spent six years coaching; they’d come to the plate with their names strewn over their shoulders from labrum to labrum, and I don’t mean guys with legit scapula bridges, like Doug Mientkiewicz or Jason Isringhausen, or Jared Saltamacchia. I’m talking about Michael Horowitz-Murphy, or Brian Reynolds-Benedetti, guys whose unis were more autobiography than athletic garment. I used to wonder, as I’m sure many of you did, what would happen if these guys one day had children with a hyphenated-named partner , which world leave them with the choices of, 1) a four-component name, like Horowitz-Murphy-Reynolds-Benedetti, 2) dispensing with one of their original names, and thereby defeating the whole purpose of the enterprise (at least I see it), or 3) an acronym! -- the aforementioned Horowitz, et. al. progeny could be renamed Homurebe, for example.
Well, whatever.
OK, back to ConocoPhillips, and the good news is that they’re not going to merge with ExxonMobil. In fact, they’re going to break themselves up – not into Conoco and Phillips, the component parts that constitute the merged entity, but into one company that explores for and produces oil, and another than refines it into products and distributes and sells it.
Over ten years ago, I was the speaker at a conclave of energy industry executives, investors, and other interested parties hosted by a leading private equity firm which I will not embarrass by naming. I did a great job, in that virtually nothing I said would happen in the oil market happened, particularly when I provided to them this astonishing prediction – that the rationales for the vertically-integrated oil “majors” – the Seven Sisters, Exxon, Mobil, BP, Shell, Chevron, Texaco, and Gulf -- had disappeared, and we would soon see dis-integration of the integrated majors into separate companies focused on exploration, refining, and maybe marketing.
I wish I could somehow convey to you the sea of confused expressions that greeted me. But there was a general consensus that my thinking made as much sense as if I had said “Alligator riboflavin besmirched Herkimer unicycle.” Yet now, a decade later, thanks to vision of ConocoPhillips CEO Jim Mulva, it’s coming true.
Why is this happening now? At one level, the more interesting question is why hasn’t it happened already? The different activities involved in an integrated oil company involve dramatically different skills. Exploration is about geology, accumulated experience, and now, the use of technology. Computers can now go way beyond the old, analog techniques of seismic refraction to map underground geological structure and find the sedimentary traps in which hydrocarbons accumulate. They make the information needed for exploration cheaper, deeper, and more accurate. (But, seismic refraction has left behind a legacy for us – the underground vibrations that provided the data from this technique led to better reel-to-reel, magnetic tape recording, which in turn improved studio music recording – the ability of the Beatles to work in four-track and make records such as Rubber Soul, Revolver¸and Sgt. Pepper was
an off-shoot of the search for oil by way of Ampex. In fact, it’s not really conjectural that the need for better analogue recording devices for oil exploration ultimately led to the recording equipment that allowed Flatt and Scruggs to record The Ballad of Jed Clampett. I’m told that the amazing Bela Fleck plays
banjo on the version used in the subsequent, eponymous movie, but whoever made a lousy movie out of a magnificent gem like the original Beverly Hillbillies can rot in hell, Fleck or no Fleck.)
And exploration has nothing, and progressively less than nothing, to do with refining. Aside from its basis in chemical engineering, refining is evermore an exercise in regulatory compliance – the most successful refiners are those who best manage he regulatory challenges of effluents, lead, flare gasses, and so on. And then there’s marketing, which requires the logistical ability to move product to where it’s needed and to establish brand differentiation once it gets there.
How did these things all come together under the same aegis? The answer derives from a central fact of the oil industry that is quickly becoming a fiction – oil was cheap, and its supply was concentrated in the Middle East. Middle East oil still dominates the world market, but not as it once did, and the cost of lifting it is no longer the determinant of the world price – if it was, we’d be back in the days of $3 barrels. At that time, “exploration and production”
meant being an Aramco partner and gradually exploring for an planning extensions of the major Middle Eastern oilfields.
Refining in this world was an annoying inconvenience on the way to market. But by controlling refining capacity, the majors had the ability to control and plan the flow of oil from its extraction to its final destination – no need for buffer stocks at refineries, no need for co-ordination with independent refineries, no need to worry about seasonal changes in product mix – gasoline in summer, distillate in winter, and so on. Oil majors controlled all of these stages much the same way that automobile producers made all their own parts – because that was the cheapest an easiest way to orchestrate all the moving pieces.
The initial OPEC shocks of 1973-74 changed the management philosophy of the Middle East fields, but not the lay of the land. By asserting their control over their own resources, the Saudi, Kuwaiti, and other Middle Eastern royal families substituted their (lower) rate of time preference for the (higher) preferences of the western oil companies – oil in the ground meant more to them than to the companies. The Western companies were happy to lift and sell all the Middle Eastern oil they could. But the royals saw extraction as a portfolio decision – why lift oil that might command a better price tomorrow, and why produce more revenue than the nation’s development effort could productively use? The resulting higher price of oil certainly gave added impetus to expanding Prudhoe Bay and Mexico’s Gulf fields, but the integrated majors still had access to the ace of trump.
Now, several decades later, Middle Eastern oil is locally controlled and its rents accrue to locals. And the industry now depends on complements to Middle Eastern oil, and those complements are increasingly found in remote locations and deep water. Exploration activity is more productive thanks to remarkable technology, but it takes more activity to find oil, and the oil that is found is characteristically in smaller concentrations. Moreover, as deepwater Horizon -- a rig that must have gotten its name for precisely these reasons, that it was positioned at the horizon of deepwater exploration
and production – no sin of hubris there – demonstrated, production is now far more complex than running the Saudi tap. Being good at both E&P and refining is like being good at painting and roller skating, or math and yoga – if you are, it’s almost an accident.
So the value chain has changed. Cheap and easy oil production meant that marketing was the throttle – you produced and refined so you could control the
flow to market. But now, the gating item is exploration; with oil seemingly perched near $100 for the foreseeable future, finding it is the trick. And if
you know how, refining it and selling it will follow.
And ConocoPhillips is coming to terms with this new set of realities. Moreover, since exploration and production is a higher risk venture than refining – I mean, ultimately, who the hell knows where you’re going to find a big pool of oil in the ground? – it commands a higher return. Refining is less risky, even if just as technical, and therefore more of a commoditized activity. And marketing is now the tail of the dog – does anyone doubt there will be fewer gallons of gasoline sold in the developed world ten years from now? The growth is in the rapidly growing economies of Asia and elsewhere, where it’s a more
competitive environment.
Moreover, every company that goes this route makes it easier for all the others, because each dis-integration creates a larger independent refining sector, which makes it easier for other integrated majors to imagine taking the plunge. The press reports of Conoco’s mitosis were quickly followed by the news that BP might soon follow suit. And from a risk management perspective, following Deepwater Horizon, they’d be wise to do so – their job is to focus
their risk management, not to spread it over a diverse set of activities. BP showed the world that being a production company is harder than it looks – one hopes they’ve learned that lesson themselves.
In the end, all of this activity is a symptom of the post-industrial era, in which scale is less important that specialization. In information technology, in
pharmaceuticals, in automobiles, and a host of other industries, the idea that scale – and in particular, vertical integration -- is the secret to competitive
success is being disproved. The press of competition forces firms to decide where their bets will be places. Information networks allow firms to disintegrate
and use zero-cost information to coordinate activities once orchestrated by internal pyramids.
ConocoPhillips’ decision reflects these changes. And before the story ends, all of integrated oil majors will be faced with the same circumstances, and will travel the same route. They will all break themselves up by stages. Refining will turn into a low-margin engineering service, and exploration a high-risk, high-reward enterprise where innovators will rule over the well-capitalized giants. It might take some time to get there, but time is only Nature’s way of making sure that everything doesn’t happen at once.
The FCC’s 15th Annual Report on Mobile Wireless Competition
The FCC just released their fifteenth annual report on mobile wireless competition. It does everything -- describes burgeoning data traffic, talks about how 80 percent of the population has access to three or more carriers, talks about how the industry invests $20-$25 billion every year -- but answer the question “Is the wireless market competitive?”
In a way, it’s better that way. Unless you think through what it means for the mobile broadband market to be “competitive,” you can run yourself into a lot of trouble. For example, Douglas Holtz-Eakin, a conservative economist I know, like, and respect (even if he’s often wrong), recently was taken over the falls in a blog entry by Brad DeLong, a liberal economist I know, like, and respect (who’s more often right), in the following interchange, which Brad graciously entitled “Has Douglas Holtz-Eakin Completely Lost His Mind?”
Holtz-Eakin was advocating for the AT&T-YT-Mobile merger in the National Review (I’m untroubled by the merger, but am troubled by the National Review), and in so doing said this:
The DOJ’s “Horizontal Merger Guidelines” lay out a formula (the Hirschman-Herfindahl Index) for determining the state of competition and whether a monopoly exists. In this index, a value of 10,000 denotes a complete monopoly, while a value of zero indicates infinite competition. In the case of 1970s-era Ma Bell, the HH index was almost 8,000 (one of many reasons it was eventually split up by regulators). This merger, if successful, wouldn’t result in an index value even half as high as Ma Bell’s, especially when taking into account the varied Internet and local options for communications.
To which DeLong replied:
I mean, you can argue that the Herfindahl index is irrelevant because competition is moving very fast as technology changes and we actually want dynamic creative-destruction oligopolies here. But you cannot argue that 4000 is not an extraordinarily high Herfindahl index, can you?
And Brad’s right. Arguing that the post-merger mobile wireless market is “only half” as monopolistic as Ma Bell is like arguing that Muammar Gaddafi is only half as fascistic as Adolf Hitler or half as nuts as Idi Amin. It’s not really that strong a pitch.
At the same time, today’s mobile broadband market is infinitely more competitive than the Ma Bell regime, which was the Schumpeterian equivalent
of North Korea. So to reconcile its market structure (which is obviously dominated by a handful of firms) and its dynamic performance, we need a different theory of competition.
And I think that can be done. I’ve argued on various posts here that competition in the broadband market takes the form of a three-dimensional cage match, in which service providers, device manufacturers, application developers, and content providers compete for the attention and loyalty of
consumers, each attempting to be the “portal” through which the consumer enters the broadband world and assembles its various components.
Signal, devices, applications, and content are at once complements and substitutes. They complement each other in use, but they substitute for each other in terms of dividing up the total value created by their integration. Let me try a stripped down version of this argument on you, using an example that comes from my colleague Jeff Eisenach. I hope he doesn’t mind my appropriating it.
Let’s say that people go to bars for three things – they drink beer, eat pretzels, and listen to music. (They also go to fulfill their biological destiny, but this is a family-values analysis.) The bar puts these components together for the consumer in an attempt to win her or his allegiance.
Let’s say that one of these three components of the “bar experience” is the subject of an innovation. Maybe they serve a new kind of beer that makes you good-looking (although all beer does that after a while, I suppose), or come up with the most delicious pretzel ever invented, or decide to book The Strokes on Friday night instead of Tex Nebraska and the Turdblossoms.
I mean, do I even have to finish the analogy? If something like that happens in one of the components of the “bar experience,” then the value of the other two declines. The Piels distributor shows up one day with his kegs and the bar owner tells him, “I’m paying too much for Piels. I have these great new
pretzels and the Strokes are coming in, so frankly, I’m not all that interested in your beer – I can pretty much serve any old beer I come across, what with these pretzels and my new house band.”
Well, what’s the Piels guy going to do? He’s got a truck full of beer, it’s got to go somewhere. He relents, and lowers his price.
Of course, we live in a more dynamic world than that of this parable. For example, the Piels distributor might figure out that he’s going to have to deliver a better beer if he’s going to survive in a world where beer has been reduced to an incidental in the pretzel-and-band value model. Perhaps he does, which redistributes value back to him, and forces the pretzel guys to go back to the drawing board and the barkeeper to fire the Strokes and bring in Lady Gaga. In fact, each of the components of the “bar experience” is driven, in this model, to innovate and improve, if only to be the “hook” that brings people into bars. Pretzels and bands, in this world, compete with the beer as surely as other beers do.
Because that’s how “cage match competition” works – whether in the bar business or the broadband business. The pretzel innovators and the Strokes and the bar owner act – as if led by an invisible hand – in a way that competes with the beer distributor even though they’re not beer distributors themselves. Just like the service providers, handset manufacturers, application developers, and content poducers, the brewers, bakers, musicians, and bar owner are all in the cage, forming and reforming alliances, competing and cooperating at once. Maybe the beer distributor comes up with a pan to incorporate pretzels into his value proposition – buy my beer and you can have these innovative pretzels. Or, as AT&T said, “Use my network and you can use the iPhone.” Perhaps the pretzel guys will offer the Srokes as a house band for bars that make a commitment to their pretzels. Or, perhaps handset manufacturers will
attract applications developers to their patform. But the struggle in the cage match continues, with alliances and strategies completely forming and reforming – an ongoing, multi-dimensional competition between brewers, bakers, bands, and bars, just as between service, devices, applications, and
content.
Here’s what got me to thinking about this. In paragraph 154 of the report, the FCC says this:
(While Apple maintains rigid control over iPhone applications…) “Google’s Android operating system is made available free of charge to handset manufacturers and wireless service providers, and is available on multiple devices and multiple service providers. As a result, many service providers and device manufacturers have designed customized versions of the Android platform for their products. Some commentators have noted that, because
of this, it is difficult for third-party application developers to design and test products for use on a fragmented platform can vary by device and network.
Well, boo hoo! Don’t they get it? The proliferation of different platforms – Android, RIM, Apple, whatever else – is the reason why we have a cage match in the first place. It guarantees that there will always be this competitive tension among the different platforms, the systems that deliver them, and the applications and content they carry.
This back door whining about how hard it is to develop applications for different systems is, of course, another attempt by somebody over there to keep the dead horse of net neutrality on the track. Neutrality advocates have long argued that, technological difficulties notwithstanding, all devices should be interoperable – no exclusive deals, like AT&T’s with Apple.
But if you understand the cage match, that’s recipe for disaster. If you had total interoperability, you would end up with one dominant competitor in devices – let’s call them….uh, give me a minute…Apple. Imagine that government regulation required Apple to connect the iPhone to every network. Once they had established their dominance over devices, they would have a chokehold on all of mobile broadband. Want to offer service? Better pay our toll. Want to create an app? We’ll tell you the terms. It would be like letting Andre the Giant into a cage match with my daughter and her roommates.
And that’s the story of the FCC’s Annual Mobile Wireless Competition Report. It’s got lots of good data, lots of charts, and not much of an idea about what “competition” means. But it’s not alone – neither do the advocates who want it to wade into a morass of Internet regulation.
The Usual Bet
When I first joined Unisys – this is probably September, 1988 – I found myself in a discussion leading to a disagreement with our Chairman over where currency values were going. It went something like this: We agreed the dollar had been propped up during the summer and would drop against the yen. The Chairman thought it was in for a beating. I disagreed, and thought that policy would defend it and stabilize it. After all, one of us had been Treasury Secretary and the other was a schmuck who had just arrived from Washington. We agreed to disagree and commemorated our disagreement by betting whether the dollar would fall below 120 yen before Christmas – the winner would give the other a cigar.
By Thanksgiving, my wife, who is a resourceful and talented woman but whose grasp of currency goes as far as the ATM, knew where to find foreign exchange markets in the Philadelphia Enquirer. And the dollar got as low as – I’m not making this up – 120.4. Sure enough, on the day before Christmas, the Chairman called me into his office, awarded me one of the lovely Dunhills in his humidor, and told me, “I was right, but it’s a matter of when.”
I tell this story partly because it was a great personal triumph but mostly because when a guy starts in to alibin’, he ought to come clean, and that’s what I’m doing. In several previous posts, I’ve expressed my optimism that the economy was poised for recovery, and that a backlog of hiring created the possibility of a “jobful” recovery. On January 30, 2010 – that’s 17 months ago – I posted a piece here called “Jobs Are On the Way,” in which I announced:
Lincoln one told a story about an ancient King who asked his wise men to write a sentence that would be true regardless of time and place. Their answer was: “This, too, shall pass.” The economists who predict no growth, no jobs, no nothing need to go back to that sentence. Yes, the economy has been abused by tax cuts, wars fought but not paid for, and a financial free-for-all in the housing market. But it’s about to come back. Jobs are on the way.
Was that well-written, or what? And, it turns out, wrong. Or, as the Chairman said, it’s a matter of when. I can retell the economic history of the intervening 17 months and tell you why I was wrong, but I’d only remind myself of what Will Rogers: An economist’s guess is liable to be as good
as anybody else’s.
I’m wearing this hairshirt and standing in the snow at Canossa because I need to settle my accounts before I deliver this opinion:
The guys who want to cut spending dramatically are about to tank the economy.
The economy appears to be slowing down. The number of jobs created last month, according to the BLS establishment survey, was frighteningly low, even when you accept that the survey has a downward cyclical bias. Housing prices have resumed their decline and further undermined households’ sense of stability. Demand is not strong enough to justify expansion of employment and continued weakness in structures – starting with residences – is undoing much of the improvement in other investment. State and local governments add drag.
The Fed’s quantitative easing program – QE2 – under which it would add $600 billion in liquidity to the economy – created some optimism back in
November, as well as criticism that Fed had lost, in order, its independence, the battle against inflation, and its mind. The first and third outcomes suffer from an absence of hard evidence, but the second has proved to demonstrably false. Beyond a food and energy price blip, underlying inflation is still at around 1 percent, below the Fed’s target. Bernanke says he’s not going to have a QE3, but what the hell else is he supposed to say?
So we’re left with this quandary – the economy is slowing down, and inflation is tame if not submissive. But the consensus position across the political system – from Speaker Boehner to the White House and through most of the Democratic majority in the Senate – is to cut spending dramatically.
Yes, the nation has a substantial debt – back to that later. But the debt is not going to be repaid without tortuous pain unless the economy can resume growing and creating income and employment.
We have two alternatives to achieve this goal. The first is the position found in a letter signed by 150 economists that Speaker Boehner recently presented to President Obama. Some are first-rate economists, others aren’t. But a position should be judged on its own merits, even if some of the people who hold it have said one loony thing or another elsewhere. And the position can be summarized by this squib from the Speaker’s office, noting that the economists in question call for immediate spending cuts to boost our economy and help create a better environment for job creation in America.
So, according to this view, the reason why the economy hasn’t created sustained growth and employment is that there’s too much government spending. The letter makes that clear:
Excessive government spending and borrowing is playing a central role in our economy’s ongoing struggle to create private-sector jobs – crowding out private investment, sowing uncertainty among small businesses, and eroding confidence that is critical to job growth. To help create a better envionment for job creation in America, we must reverse this spending binge as quickly as possible and free our economy from the burdens of excessive regulation, over-taxation, and runaway spending.
As The Emperor says at every occasion to Salieri and Mozart, “Well, there it is.” Too much spending is crowding out investment – there’s no money left for equipment, structures, and the rest, because the Feds are gobbling it all up. This, in turn, leaves business owners wondering what the hell is going on, which leads to uncertainty and loss of confidence. Then there’s the stuff about excessive regulation, but let’s at least agree that’s not a budget issue, before we consider whether what they mean by excessive is Dodd-Frank, cap-and-trade for greenhouse gasses, the health insurance reforms of last year (“government-run health care”), and whatever else.
Is federal borrowing choking off the economy? To me, there’s a simple litmus test – the interest rate. If the government is borrowing and money stays cheap, it’s hard to argue that its borrowing is the source of the problem; were we to see interest rates rising, then we’d have evidence that government borrowing was bidding away the supply of savings from other uses and we’d have to wonder why we were doing it.
Here’s a picture of the rate of interest on the ten year Treasury bond since 1992. From 1992 through 2003, the rate is declining on trend; first, because of the progress towards balancing the budget under President Clinton, who was that fateful combination of both lucky and good. He was good in that he took action against deficits, including higher taxes, despite Gingrichian – or Gingrinchian? – prophesies that he would trigger a recession. (I wonder to whom Newt gave the cigar when he lost the bet.) When Clinton departs, Bush gives away the surplus, but 9/11 coincides with a substantial market correction and the economy weakens, allowing the interest rate on the ten-year Treasury bond to fall further.
From 2004 through 2006, the economy is starting to grow again, so the bond yield takes a modest upward path, until the first housing quakes start to hit in 2007 and those investors who can get out – deleverage – do so. But by January of 2009, the yield has dropped to 2.884 – it had been over 6 in the middle of the decade and still around 5.0 in 2006, the last year the housing market spent on this planet before departing for points unknown.
Now let’s look at the last two years, close up. The Obama stimulus pushes the rate up in 2009, and keeps it there, a perfect barometer of expectations, until April of 2010, when the Eurzone falls apart and financial markets are thrown into the kind of uncertainty and eroded confidence that the 150 letter-signers fear. The rate, like the heart monitor of an emergency room patient, drops to 2.40 in early October of 2010, very close to the 2.30 it reached in January 2009, when the situation was darkest.
The Federal Reserve then stepped in, sensing the danger, and announced its program of quantitative easing – buying up assets from the banking system to put new cash into the economy. (It was advised to do so by many, including this sign, seen at the Jon Stewart March For Sanity rally that November.)
The announcement of this program, “QE2,” leads the nation’s pulse to rise, partly because they expect inflation to be set off by these asset purchases – although it hasn’t and they haven’t – but mostly because investors expect some response in the economy. By February the yield is up to 3.75 and there are signs of recovery, but these fail to take root and the recovery falls back, culminating in the recent jobs report and the news that household consumption of goods fell sizably in March and was flat in April after several months of growth. Thus, by this week, the rate has fallen back to 3.0 percent.
The collapse of bond yields gives the lie to the position taken by the 150 of the Speaker’s economist pen pals. Government spending isn’t crowding out investment, it’s substituting for it. Inflation isn’t rising, it’s at worst stationary, and possible falling now that raw materials prices may have crested. If fear of intrusive regulation is driving these numbers, then perceptions of their intrusiveness seem to be
changing regularly.
And yet, the Speaker and his allies have won the political battle to cut spending now, reminding us that nothing can match the power of an idea whose time has come, even if the idea stinks.
There’s an alternative view. It argues that while corporations and banks have been stabilized and more (as in the almost $2 trillion of cash sitting on corporate balance sheets ), households are the lagging element in the recovery. Companies are willing to invest and – for equipment and software – are already doing so at modest rates – but absent households having the wherewithal to buy goods, why invest and hire to make more of them? If there weren’t a burgeoning federal deficit, a direct stimulus would clearly be in order. The complication arises in reconciling the two.
Markets aren’t worried about the U.S. government finding enough quarters in the sofa to manage its debts – they’re worried that Greece may not have such a sofa, but not us. They are worried that, down the line, the U.S.’s costly promises to subsidize seniors’ medical care and (to a lesser extent) provide them with pensions, will break the bank. A foresighted political system would have addressed this, but ours lies just behind Iceland’s during the winter solstice. If Paul Ryan was “bold” and deserves “credit,” it’s for recognizing that this is the real problem, even if his “solution” -- to turn Medicare into a voucher program – was more meant to enfeeble the state than to provide the elderly with health care coverage. (Imagine the oldest person in your family trying to find health insurance they can afford. Now imagine 100 million of them trying. Next.)
So here’s the plan.
1. The federal budget should be designed to produce a deficit no larger than this year’s on a cyclically-adjusted basis based on its long-term trend growth rate. That is, freeze the level of the deficit, agreeing that it can go no higher, unless the economy grows below its long-term trend (of about 2.6 percent). On the other hand, if the economy grows faster than that, require some retrenchment (which to some extent is guaranteed if there’s less paid out for unemployment benefits and the like).
2. Address the root of the household consumption problem – the residential mortgage market. The feds should break up Fannie Mae and sell the pieces – or perhaps distribute them, once the true value of what they hold is considered – to a number of entities greater than the fingers on one hand. These “little Fannies” should be allowed to refinance existing mortgages at their face value – regardless of housing market prices – at a federal financing window for anyone who has made their mortgage payment for the last 24 consecutive months, at the least up to the level of existing “conforming” mortgages.
3. This wave of refinancings would give households more confidence and certainty, and would create income in the form of lower mortgage payments. The government’s exposure would be defined unambiguously, penalties for fraud would be clear and enforceable (fool me twice, shame on me), and the resulting assets would be held by the “little Fannies” and secondary markets in pre-determined proportions.
4. The two years imagined here would give fiscal policy a chance to reset itself, particularly since they would include the 2012 election, which would allow the public to speak about taxes, Medicare, Social Security, and other forms of spending and tax expenditures. My guess is that we will not have a debt default this summer because both parties want to have this issue dominate the 2012 election, even if one of them is proven wrong. The election would give us a direction about taxes – not just whether to raise rates and on whom – but the nature of the system itself. Should be shift it from income to consumption in various forms? Should we continue to have a separate tax on corporations as opposed to the people who own them? What do we do with the proliferation of tax deals – from IRAs to home mortgage interest to special treatment of oil and gas – that load so much burden on the tax code? Once we agree as to form, we can discuss the progressivity of the burden. I like progressivity. Others don’t. I’m right and they’re wrong, of course, but at some point we’ll have to agree.
5. Finally, social security and Medicare wage taxes paid by employers should be waived for net new hires over those next two years, but within the budget framework suggested above.
There are some other things I’d like to see as well – a national infrastructure bank, for example, but right now they seem secondary. The question is a larger one – where are we headed? Laying out a direction like this is a fool’s errand, so at least I’m qualified. But this kind of discussion presumes that we all share the same goal –reviving the economy and triggering new employment. I can tell you why this program will work – it crates stimulus, takes minimal risks, provides some certainty in the short term as can be provided regarding debt, and doesn’t slash demand at a critical moment.
I don’t think the 150 letter-writers can do the same. Their argument, it strikes me, boils down to “cut spending and slash demand,” and while that might not seem smart, it will deliver the economy and the people who inhabit it into a state of grace and ease their furrowed brows. If interest rates were high or rising, they could point to that as evidence. But they’re low and falling, suggesting that the problem is not as they define it.
Or, an alternative is that the letter-writers, from such dignified guys as Mike Boskin or Doug Holtz-Eakin down to the guys who think Obama’s a Marxist, really don’t share that goal. They see the moment as a chance to make government smaller, which is what they want more than a recovery or a growing economy, certainly for the next few years. Dramatic cuts in spending now would give you the former, but reduce the chances of the latter. And, I think they know it. They're prepared to let the economy tank in the short-term if it means that the state will be helped to wither and the President be defeated in 2012.
I’ll bet you a cigar.
The Gang of Four
My friend Steve Rogers, the greatest pitcher in Expos/Nats history (158 wins of which 37 were shutouts and a lifetime 3.17 ERA), once warned me that the most serious arm injuries he ever experienced were the ones he incurred patting himself on the back. But after my post of several weeks ago on the nature of competition in the broadband market, I’m going to have to accept the risk of injury is part of the game and get out there and pitch.
Back on May 12, I said:
We used to think of competition as being like a sprint – Coke and Pepsi, Oreo and Hydrox racing to a finish line. But Microsoft, Google, Apple, Comcast,
Motorola, Facebook, Amazon, Clearwire, Verizon and the like (but, unfortunately, not T-Mobile) are not on a track – they’re in a cage match, in which alliances and partnerships continually form and reform with the goal of being the last contestant standing – the entity that “brings the entire broadband experience together” for the consumer.
Well, as if he wanted to agree with me as emphatically as possible, Eric Schmidt, the CEO of Google and perhaps the toughest guy in the cage – the biggest, meanest father-raper sitting on the bench -- gave this interview last week.
And in it, in response to a question about “a new platform war emerging.” Schmidt says something important:
If you look at the industry as a whole, there are four companies emerging that are exploiting “platform strategies” very well…Google…Apple, Amazon, and Facebook.
Or, as the article reporting the interview calls them, the “Gang of Four.” What defines a platform strategy? A couple of things, to listen to Schmidt describe it. One is a consumer orientation, a second is ubiquity (global presence), and a third is excellence in one aspect of the Internet experience – whether Google search, Apple gadgetry, Amazon retailing, or Facebook social connectivity. And the crowning piece of the definition is that the product becomes a platform for other value services – that Facebook becomes an e-mail service, and Google’s new “+1” feature becomes Facebook, and Apple’s Kindle becomes a stalking horse for an alternative to Apple phones, and Apple phones become a platform for an entire new apps industry in which the others take part, and so on down the line.
In fact, when Schmidt was asked who the “next” member of this Gang was (why shouldn’t the Gang Of Four have five members? Consider the Big Ten) and whether it was Microsoft – remember Microsoft? – Schmidt said, no, Microsoft was an “enterprise” company. Which means what? That they sell to businesses? Well, yes, but my copy of Office, my Xbox (Ok, that’s literary license – I don’t have an Xbox), and perhaps my phone one day speak to the contrary. No, the explanation must be that Microsoft isn’t involved in the competition in which the Gang of Four is involved – the struggle to be the consumer’s gateway to the broadband Internet, to organize and intermediate the consumer’s broadband experience.
In fact, Schmidt specifically casts out Microsoft and says that the next members of the Gang would be PayPal and Twitter.
OK, PayPal, I can see that – if Apple is gadgets and Amazon is the bazaar and Google is search and Facebook is digital Main Street, then PayPal is currency. I did a piece on NPR about thirteen years ago – I’d link to it but many of my greatest radio moments seem to have been erased by NPR, probably because I was too conservative -- to the effect that American Express ought to get on the stick and buy EBay and PayPal before it’s too late. Jeez, I nailed that one on the head! Can you imagine where they’d be if they’d done that, seamlessly migrating people from their cards to PayPal, integrating the two, making EBay a PayPal/AMEX playground?
But I digress. PayPal, sure, they could become the digital currency of the next epoch, although Schmidt is probably being strategic in mentioning them. But Twitter? Something that Aston Kutcher uses to share his pensees, or the medium of choice for meandering Congressmen who post underdressed pictures of themselves? They’re a prospective champion of the cage match? Can you imagine being Microsoft, the Standard Oil of the desktop computer, and being told by Eric Schmidt – a guy from Novell, for Chrissakes – that you’re really not relevant to where the digital world is going, that you can stand aside and let Twitter get past the competitive rope line and onto the Club dance floor while you and your antiquated rear end sit out in the cold? Whatever happened to respect? I’m Microsoft! I used to be somebody! I was the subject of an antitrust investigation before your co-chairmen had their first beer!
Sorry, old timer. Personally, I think Microsoft might yet get somewhere in the phone business. But their company, essentially, makes computers work, and making computers work seems a good deal less important today than getting them connected to the broadband network, and when the “Cloud” arrives, computers will look like the Princess Phone of the new millennium – lovely to look at, but not all that interesting when you get right down to it. Twitter, on the other hand, may today just be a way to find out if the Korean taco truck will be in my neighborhood at lunch time, but it may yet be the platform – Schmidt’s word -- that people use to buy and listen and chat, and mail and search – or more generally, “find out” – and therefore be the winner of the cage match for who gets to intermediate the entire broadband experience.
Intermeditation! In fact, Schmidt all but says that’s what it’s all about, albeit in another context. He remarks at one point in the interview that music is fundamental to Google’s growth and …well, wait, let’s stop right there. Music is fundamental to Google’s growth? What the hell is that? Music has never had anything to do with Google’s growth. In fact, I’ll bet Larry and Sergey are terrible dancers. Ah, but music is important to Apple’s growth, and therefore it’s a must for Google, because that’s the nature of the cage match.
But back to disintermediation. As Schmidt says, You have this disintermediation possibility, of people by-passing studios and going directly to digital rights.
Or, as he meant to say, We’ll make the studios dance to our tune, just as we will the signal providers, and the device manufacturers, and the rest of them. Because we’re here to intermediate every aspect of the broadband experience.
And I don’t mean that pejoratively – that’s what platform competition – the cage match -- is all about. It’s about becoming the frame in which the consumer/user places the rest of the broadband experience. And that’s the real competition in the broadband market. Signal carriers created these new competitors by virtue of the fast and affordable networks they created, and now they have to keep up with them. Content producers thought they would meet their customer on the network, but now find that a new class of platform megafirms are the entryway to the consumer’s frame of reference.
That’s the real nature of competition in the broadband world today – a cage match among firms that offer connectivity, devices, applications, content, and
more. Each tries to intermediate the others, each tries to capture the lion’s share of the value of the integrated broadband proposition. Schmidt gets it, and the rest of us need to as well.
Video Killed the Radio Star
Remember that song? It was recorded by a band called the Buggles and it was (ironically, in the true sense) the first song aired on MTV when the video channel began killing radio on August 1, 1981. I remember when it was first released, as it challenged for a brief moment my then- (and now-) contention that there was nothing aside from Elvis Costello that I wanted to isten to that was recorded after 1971 or so, except for people who made ecords before 1971 or so. But fortunately, I decided that aside from te cute hook, it didn’t really challenge my prejudices, and I could go on dsmissing the work of an entire generation without concern.
This brief insight into a tortured soul aside, the song came to mind when I read an amazing article in the Washington Post last week. It reported on a study by the broadband analytics firm Sandvine concluding that Netflix accounts for 30 percent of all broadband traffic during peak hours, and that Netflix, together with Google’s YouTube and other on-line video services account for 46 percent – almost half – of peak Internet broadband use, and that they’ll account for 55 to 60 percent of all traffic by the end of this year.
It was an amazing article for two reasons. The first reason is it confirms that video has burgeoned on the broadband Internet, so much so that it already accounts for half of traffic. Now, to some extent, that’s circular, because video is such a bandwidth hog that whenever users are streaming the most probably will turn out to be the peak period of broadband use. But it also makes clear that broadband itself is becoming more ubiquitous and more powerful at rates we didn’t anticipate at the beginning of this decade. I’m sure many of the critics of the pace of broadband adoption – or the folks who advocate that Internet infrastructure providers share their investment with whomever comes along, or that advocated a national fiber network paid for by the federal government -- go home and watch high-def videos or use amazing apps on the 4G devices and never stop to consider the contradiction.
But the second amazing thing about the article is that the Post appears to have no idea about the significance of this milestone. Because the Post’s reporting focused on how cable and telecom companies were going to start billing broadband users according to how much data those users pull down.
Well, duh. Of course the service providers are going to have to charge users according to how much they use, although I can guarantee you that same outraged souls somewhere are going to complain that broadband infrastructure providers have the audacity to charges users by how much they use (abridging their access to information!) instead of turning their systems into some kind of all-you-can-eat free data buffet. But that’s not the point.
The point is that we can’t afford any longer to nurture the dream that everything on the Internet must travel on the same terms and conditions as everything else or, as the dreamers call it, net “neutrality.” Because the spread of video makes clear that we can’t, and that we shouldn’t. Some traffic is incidental to the system’s operation. But other traffic is the equivalent of an eighteen-wheeler on a farm-to-market road, clogging all other traffic and imposing costs on every other vehicle.
And the drivers of these broadband big rigs aren’t the valiant entrepreneurs and the “little guy” that some advocates of “neutrality” claim they’re fighting for. They’re Netflix and Google (YouTube), who are getting a free ride paid for by the rest of us when they congest the network and impose costs on all other users.
And the free riders know it. Netflix, as I mentioned in a post last December, entered into a deal with one of the companies that makes up the Internet backbone called Level 3. Companies such as Level 3, Orange, Comcast, British Telecom and others have arrangements called “peering,” in which traffic jumps from their systems to each other’s on its way to the final user, so long as that two-way flow is roughly in balance. Level 3 is in other businesses, though, such as being a CDN – a content distribution network, an entity that takes a website’s content to the backbone, where it finds its way to the final
user. And they cut a deal with Netflix under which they would take Netflix’s movie streams to the backbone for distribution to users.
But when Level 3 showed up at Comcast’s backbone system (not its “last mile” system, the one that takes signal to your house – Comcast would have to lose its mind to deny its customers access to the Netflix product) with a massive flow of Netflix films, Comcast told them they’d have to buy more ports to the Comcast backbone network – the volume of traffic Netflix represents went way beyond the normal proportions of two-way traffic that “peering” covers.
Level 3, rather than deal with reality, went to the Federal Communications Commission and complained that Comcast’s refusal to carry as much Netflix signal as Level 3 provided was a violation of the FCC’s principle of “net neutrality,” and wanted Comcast to be forced to carry it. So now, it turns out that what they wanted to force Comcast to carry – in the name of “net neutrality” and an “open internet” – is at least a part of what makes up 30 percent of Internet traffic.
The Washington Post may not get it, but that’s the real meaning of the burgeoning use of video on the Internet. It’s a challenge to the doctrine that the content is small and the networks are big, and that the networks can be told the terms on which they can carry signals without any loss to themselves or their users. It shows that there are big Websites that want to ride the “neutrality” slogan into a world in which they offload their costs on to everyone else.
And the most outrageous part of the whole thing is the sophistry of the “neutrality” camp. I think most of the advocates of neutrality aren’t out beating the drum because they think it would be good for the world if Netflix and YouTube can eat up the system’s bandwidth without paying a fair price for it. That thought probably never occurred to them.
But the reality is they’re being played for dupes. An amazing column in USATODAY recently claimed that “neutrality” was about “the big guy versus the little guy.” But the “little guy” they claim to have in mind turns out to Netflix, or YouTube, or the other sources of cholesterol in the Internet’s broadband arteries.
Maybe some of the advocates willing to say this kind of stuff will think twice now that we have a clearer idea of what traffic the Internet carries, and before video kills again.
Demolition Derby
I live in a leafy post-war suburb outside D.C. that was first populated by the G.I. Bill Generation, who gave it an intimate, neighborly feel. But as the G.I. Bill Generation aged, the neighborhood started to experience a schism of sorts, as the original settlers wanted to preserve the place as they knew it, a goal that often conflicted with the reality of change. The defining episode in this conflict occurred when an architect wanted to buy an abandoned sandwich shop on MacArthur Boulevard and turn it into an office and showroom. And since no one had maintained this place for a while, many of us thought he had a great idea. But, as part of the deal, the architect wanted to enlarge the carport behind the shop to accommodate a couple of vans, and the militant neighborhood orginalists raised holy hell about it – they would only approve a plan that kept the property as it is – well, as it was, particularly as they remembered it. The architect cut his losses and walked away. (P.S. A second architect bought it and, now chastened, the local elders allowed him to build the carport. Now the preservationists are giving him grief because he wants to install solar panels. Really.)
And I recall a lawyer-neighbor telling me that the preservationists had never heard of the legal doctrine of “constructive demolition,” which means that if a property has been abandoned and falls apart, you can finish what Nature started and tear it down. “And once they get that determination from the County, they’ll be able to put up a row of townhouses that will be a lot more unsightly than a few vans on a carport,” he said grimly.
I’m reminded of this (probably unduly long) story by the opposition to the merger of ATT and T-Mobile. Because much of the opposition has the character of the elderly retirees who wanted to preserve an abandoned building in its original, if untenable, form. They’re very focused on whether the mobile phone market has three players or four, and think that preventing the combination of T-Mobile and AT&T will meaningfully influence the level of “competition.”
There’s a legitimate process of anti-trust review to be applied here by the Justice Department, but let’s reduce the problem to a thought experiment. Some folks argue that the national mobile market isn’t competitive right now – in fact, the FCC recently didn’t quite say it wasn’t competitive, but demurred from saying that it was.
But if it wasn’t competitive, then how did T-Mobile end up with a declining market share and a (relatively) stagnant product offering in the first place? Didn’t it get the memo about how the four major providers were colluding to raise prices and restrict supply? The only explanation for how T-Mobile ended
up by the wayside is that they were outcompeted, meaning that competition has driven prices and product quality past the point where the fourth largest provider can’t survive on its own.
And if that’s the case, then what’s the competitive loss if it’s taken over by AT&T? T-Mobile obviously doesn’t constrain anybody’s behavior – it’s in bad shape, has a smaller footprint than its competitors, doesn’t offer the Fourth Generation products and services that its competitors do, and if you talk to its
customers, the best thing they can say for it is that it offers “great customer service,” meaning its customers appear to require a lot of service.
There are other issues involved in the merger – conspicuously, the chronic shortage of spectrum that makes T-Mobile, which has some, attractive to
AT&T, which wants more. The FCC has big plans to find more spectrum, but “plan” is a word we use for what hasn’t happened yet. But more on that some
other time.
To my thinking, the real risk here is not that an anti-trust review ixnays the merger, although if my thought experiment is the criterion, that would be a mistake. The real, hidden, danger is that the advocates for more intrusive regulation of the Internet will see the merger as an opportunity to saddle up some of their pet hobby horses and take them for a ride.
To wit, here’s a reaction to the merger proposal from Nilay Patel, an editor of Engadget, from which I’ll quote at length:
…the current state of the US wireless market sucks. It sucks hard. AT&T is straight-up lying when it says that there's "fierce" and "intense" competition in the wireless market. …and the FCC and DOJ have the opportunity to blow it up by attaching significant conditions to merger approval.
And man, does the wireless industry ever need some big-time blowing up. AT&T points to the explosion of Android and the iPhone as evidence that the wireless industry is competitive, but I see that only as evidence that Google and Apple are big enough to be competitive regardless of the knee-deep carrier bullshit they're forced to wade through en route to the consumer…Mobile is exploding in spite of the carriers, not because of them. Let's fix it.
So, what am I proposing? Two very simple rules:
• First, that the FCC impose the same open-access requirement on the newly merged AT&T as were imposed on Verizon's 700MHz spectrum purchase. That means AT&T would have to allow any device and any application to use its network, just as Verizon has to with its LTE network. You might recognize this riff -- it's a little something called net neutrality.
• Second, that the FCC require AT&T's 700MHz LTE devices to be interoperable with Verizon's 700MHz LTE devices. This would allow a consumer to take their phone and switch carriers just by swapping a SIM card. There are technological hurdles to making this happen, but it's key -- allowing consumers to easily jump ship will force the carriers to actually compete for their dollars.
Hey, buddy -- you kiss your Mom with that mouth? Regardless, let’s start with the claim that Google and Apple (and RIM, and Motorola, and Amazon, and whomever else) are so big they had to wade through…let’s call it the obstacles posed by Verizon, AT&T, Sprint, T-Mobile, and the other carriers. As I see it, Google, Apple, and whoever else have the carriers dancing to a tune played on a handheld device. In fact, AT&T, which won the first round of the iPhone sweepstakes, ended up substantially upgrading its network and accelerating its progress to 4G to keep its iCustomers iHappy.
So the result was what you’d expect from competition – more investment, better service, a better customer experience. The wave of new devices certainly
contributed to the – dare I say it? – intense competition among AT&T, Sprint, and Verizon to roll out more capable, better 4G phones. Rather than wading through a cow pasture, the device and applications providers are forcing the carriers to improve, which in turn is forcing the device guys to innovate as the networks’ capabilities grow. Witness, iPad, Xoom, and the rest of the devices that did not exist until the carriers invested in the speed and signal strength to support them.
But Patel’s most frightening statement is not his Through the Looking Glass view of how the wireless eco-system works. It’s his willingness to overlook the imaginary merger danger in exchange for two policy prescriptions – his radical quids for a nonsensical quo.
The first is “a little something called net neutrality,” which is a “little something” the way the Beatles were “four clever moptops” and the Von Hindenburg Disaster was “a delay at the airport.” Under Patel’s doctrine, network providers would have to accept all applications and devices, whether they were not engineered for the network, or lacked security features and invited spamming, or were band-width chewing videos that didn’t pay for the congestion they caused, or whatever else. The network, contrary to Patel’s implication, is not a series of “dumb slurries” that can take crushed coal powder one day and a fine claret with good nose and body the next. They’re complex and nuanced networks that require management, and some of the choices Patel derides – like what goes on them – are management issues, not editorializing or discrimination. Do you want the phone in your pocket to bring you a few dozen marketing calls a day, like the phone on your wall does?
But, paradoxically, remember that the neutrality camp came to their view because they thought – or at least asserted – the wireless market was not sufficiently competitive and that consumers wanted all this “openness” but were being denied it. After all, the advocates knew better than the market. Well,
Verizon agreed to some stipulations when it bought the 700 MHz of spectrum in for reasons known to them -- they call it the "Open Development Initiative." So if Patel and the neutrality guys are right, then AT&T ought to be emulating the Verizon deal just to maintain their competitive position. Advocating that AT&T sign on to the same regulatory dictates is a tacit admission that consumers don’t care about what the neutrality types wanted at all, that the VZ stipulations were just a hoop the neutrality guys wanted the company to jump through just like the old-timers in my neighborhood wanted the architect to skip the carport, even if nobody really cared and the carport ended up getting built anyway.
And the second demand Patel makes takes us further into hyperspace. There are certainly some “technical hurdles” to making all networks interoperable for devices – asking that is like trading a player from the Red Wings to the Pistons and asking him to play for his new team without taking his skates off. Besides, it goes back to the first point – having different devices on different networks has forced both the networks and the devices to get much better, very quickly. Only the oldest among us will remember what life was like back in, say, 2005, before “smartphones” and apps were a multi-billion industry, before
mobile download speeds of 5-12 megabits, before the Chevy Volt and Lady Gaga and Michael Jackson and Liz Taylor walked among us, before the Expos left
Montreal.
All that stuff happened – well, except the Nats and Lady Gaga and so on – because there was no mandated interoperability. If everything was “plug and play” (ignoring the inconvenient “technological hurdles”), then we could have had Apple, with its interoperable iPhone and iPad, monopolizing the device market, and running a toll booth for every new application trying to reach the market. Why would AT&T, Sprint, or Verizon bust their chops upgrading their networks just so Apple could cream skim the entire mobile broadband eco-system? Universal interoperability would have been a competitive debacle, even if it sounds like a no-brainer at a distance.
So if we’re going to review ATT/T-Mobile, let’s review it. Will it lead to predatory pricing? Do AT&T’s claims that it will be better able to expand its roadband network have merit? Will T-Mobile be missed? Those are all questions worth answering
But confusing the merger question with the need for “neutrality” is wrong – and disingenuous. Schumpeter called the ongoing process of innovation “creative destruction.” That’s a better fate for T-Mobile than using it as a pretext for an unwarranted regulatory regime, or letting the company descend into
“constructive demolition.”
The Cage Match
I keep wanting to write about the merger of AT&T and T-Mobile, I really do – not because it’s so important, but because it’s really so unimportant. Sure, there are a few critics who think that T-Mobile’s disappearance will make a significant difference in a market from which competition has already made them (T-Mobile, but also the critics, I guess) irrelevant. But every time I get it together to draft something, something more interesting happens.
Back on March 24, I was about to hold forth on the merger when something far more important indetermining the future of communications happened – the release of the iPad 2. But as I planned to update and post the T&T-Mobile piece this week, time and tide decided to stop waiting for me and an even more important event overwhelmed me once again – the acquisition of Skype by Microsoft. Because long after T-Mobile’s cellular network is gone and forgotten, the Microsoft/Skype combination will influence what happens in broadband.
Why is Microsoft willing to pay so much -- $8.5 billion -- for Skype, a product that’s yet to turn a profit? For a start, because it fits in so many places. Mcrosoft has a very nice teleconferencing product, but a growing number of businesses are using Skype for teleconferencing, and it’s better to compete against yourself than let others compete against you and win. Integrating Skype into Office and Outlook not only meets this objective, but keeps Office and
Outlook alive in a world in which you can get Open Office or other substitutes or the price of asking, and in which the “cloud” will soon bring you computing
on demand, which could make products such as Office expensive and pointless.
Skype would also fit in with Microsoft’s Xbox game products, which have never seen and don’t intend to soon, but I know that talking to someone while you’re blowing their avatar’s head off has to be more fun than simply blowing their avatar’s head off without the trash talk. $8.5 billion dollars so
some pimply kid can say “Gotcha, Dude!” Heaven help us all.
Then there’s the mobile market. The dramatic improvement in the major wireless networks means that mbile phones can increasingly handle Chester Gould’s pioneering vision of two-way, real-time video calls. And despite its advantages of money, name brand, money, money, engineering talent, and money, Microsoft continues to be a second-tier player in the mobile market. The Wall Street Journal says today that Google's Android operating
system has 35 percent of the U.S. market, with Blackberry at 27 percent and Apple, at just over a quarter. Microsoft is at 7.5 percent and dropping. Small wonder that Microsoft has recently thrown its lot in with Finnish handset manufacturer Nokia, which once dominated the device market, back when devices were simpler. To me, it’s a great match – Microsoft has some good ideas about what handheld devices could do, but it can’t make the product cheaply or attractively enough to crack the market, while Nokia can make things just fine, but needs a better operating system to teach its old dogs new tricks. And if you throw Skype into this mix, then Microsoft suddenly looks like a threat in the mobile market, instead of a something between a sad commentary and a joke.
Then there are the other markets to which Skype bridges. Skype is a video service – it just happens that the videos it sends are pictures of people talking to
you. Netflix is a video service – it just happens that the videos it sends to your devices - -the same devices as pick up Skype – don’t talk back when you talk to them. Skype is a social network – it just happens that instead of poking people or posting stuff on their pages that will embarrass you even more than that tattoo for the rest of your life, it calls them. Facebook is a social network, too – Skype could do whatever Facebook does if they wanted to write the code, but its strategy is to focus on one part of your relationship with your ‘friends,” contacts,” or whatever you want to call other people – talking to them. Facebook could have bought Skype just as easily and built it into its pages. Ebay’s a social network, too – heck, to their credit, they realized they were in the
same people-to-people business as Skype back in 2005, when they bought Skype for $2.6 billion. (And then sold it a few years later, leaving behind only fond memories and a $1.4 billion accounting charge – unlike love, accounting means you have to say you’re sorry.)
Is a pattern starting to emerge? First, Microsoft wants Skype because of its wireline business – making its Office, Outlook, and other old school computing
products more attractive. Then it wants to enhance its presence in the mobile market and revive its operating system in wireless. Then it wants to prepare to do battle with the social networks and peer-to-peer applications. Then it wants to be able to move videos and other content across a range of platforms and devices. Then it wants to enhance its gaming. What does it all add up to?
It’s all the same market! Do you get it yet? Back to ATT/T-Mobile – you’ve got some people out there wringing their hands over whether the ghost of T-Mobile makes a difference in the mobile market when, in fact, the market for wireless signal is just one facet of a meta-competition among wireline providers (telco, cable), wireless providers (whether it’s cellular or WiMax or satellite), device producers (from the iPhone to the Xoom to the Kindle to the Xbox), applications producers (like Skype), content producers (be they Facebook or Ebay or Google or Warner Brothers or NBC). They’re all in the same business and they’re all competing against each other! Because they’re all trying to be the same thing – the “systems integrator” for the consumer.
We used to think of the mobile signal providers – the Verizons and AT&Ts and Sprints and perhaps the Clearwire and some others – as Christmas trees on which the ornaments of a handset and maybe some primitive service – GPS or some such – were hung. But now, the consumer doesn’t pick the tree and
then go get the tinsel. The iPhone changed that – suddenly, the consumer picked a device and then went and got the signal that best fit it.
When I was an executive at Unisys, we had a similar moment. It was when we realized that our relationship to our customers – and it was a business client base, no one ever brought a Unisys home to run Visicalc or play Pong -- was being intermediated by the Arthur Andersens and the other technology consultants who were doing the systems integration, matching the gear and the operating systems and the software and the surrounding environment. Our
customers were suddenly telling us, “Call my agent,” which is one thing you never want to hear.
Customers are telling everyone in what the FCC calls the broadband “eco-system” to call their agent, but their agent is themselves. They’ll decide which signal, which devices, which applications, and which content they’ll bring together. And, as a result, each of these segments is linked in a meta-competition for the consumer’s allegiance. Sometimes they respond by offering the customer something new, or something their competitors do – Apple Face Time the
latter, Amazon Kindle the former-- and sometimes they fail – Google Wave, even Microsoft Bing, when you come down to it. Sometimes they try to get it through acquisition – Comcast and NBC (and therefore Hulu), Google and YouTube, now perhaps Microsoft and Skype. Hell, Google’s just announced that they’re going to build and market their own laptops. Huh? Why are they bothering? To be the point of entry into the digital, broadband world.
This is the real competition that drives the broadband space. Better devices force better signals and allow better applications; better signals permit better devices, applications, and content; better applications and content lead consumers to demand better signal and devices. And they all compete with each other to be the point of entry into this amazing “eco-system” of connectivity, devices, applications, and content. We used to think of competition as being like a sprint – Coke and Pepsi, Oreo and Hydrox racing to a finish line. But Microsoft, Google, Apple, Comcast, Motorola, Facebook, Amazon, Clearwire, Verizon and the like (but, unfortunately, not T-Mobile) are not on a track – they’re in a cage match, in which alliances and partnerships continually form and reform with the goal of being the last contestant standing – the entity that “brings the entire broadband experience together” for the consumer.
You’d think an economist would have figured this out. Some have, others are still trying to figure out what to wear to T-Mobile’s funeral. The best single statement of this new kind of competition is a great paper by Jonathan Sallet, who knows his economics from what his economist friends told him over cocktails, but has been around technology long enough to write this piece, a great place to start.
One of these days, I’m going to write about AT&T and T-Mobile. It’ll be on a slow week. But can you blame me? After all, why go to a poorly-attended funeral when you watch an exciting cage match?
Big Ben
The details do not yet exist, but we know this about the deficit reduction package that will emerge from the Administration’s negotiations with the Congress: it will be too much, too soon, and too unbalanced as to be fair, at least by my standards. That much seems likely. But what strikes me as even more certain is that it will put the nation’s hopes for a sustained recovery squarely on the shoulders of Ben Bernanke, and when you wear the economy on your shoulders, you can be sure that there’s a target on your back.
There are two stories here –the fiscal one and the monetary one. The fiscal negotiations are in one sense going the way they should, with both sides developing what would ordinarily be construed as caricatures of their positions, in anticipation of doing the dance that leads to splitting the difference.
The President is not yet ready to discuss major reforms of Medicare and Social Security, but he’s happy to cut back our military presence and to raise
takes on the rich.
And so am I. Sitting above the $250,000 line that makes you rich, I intend to suck it up with a smile worthy of Warren Buffett or Bill Gates, Sr., who have argued that they can’t take it with them, so why not let their money go to Mammon when their souls go to God?
The Republican side’s proposal, authored by House Budget Committee Chair Paul Ryan, is similarly skewed. It’s major component – the one leg on which it stands – is to turn Medicare into a voucher program and set the elderly loose on the tender mercies of insurance market, creating a great opportunity for Robert Wagner, Wilford Brimley, and – were that he was alive to savor this hour! – Ed McMahon – the traditional television spokespeople for the Inadequate Insurance Company For The Very Old. These coots – and a few cootesses – will be haunting the ad time on the evening news and the Judge Judy/Judge Joe programs, pushing Metamucil, dental crème, and robot insurance into a guerilla viral marketing mode. Imagine Wilford looking up from
his fishing rod, sighing, and letting fly with the pitch: So you’ve lost your Medicare! Well, nobody wants government insurance anyway! Just take that check they sent you and take it over to The Here Today Health Insurance for the Elderly, which they will, of course, even if the lucky customers figure out later they’ve just made a down payment on a pine box. Oh, that’s going to be wild.
How’d you like to be 80 and looking for coverage?
Tell me what I’m missing.
Like Obama’s approach, Ryan’s hope is to avoid a discussion of Social Security, but then to parry any sentiment for tax increases with a call for corporate and personal tax reform that lowers the rate, broaden the base, and is pitched as being “revenue neutral,” although a tax reform that lowers rates to 25 percent would have to be offset by all of the Big Daddy tax preferences now found in the code, like IRAs or the deductibility of home mortgages, neither of which is in the cards. (He actually hasn’t said which tax expenditures he’d use to offset the revenue loss, but the loss is so great that the answer must be “all of them.”) Obama’s tax plan, again, is to line up everybody in the country in order of income and then have everyone starting with me raise their hands, and no frontsie-backsies.
The problem with this negotiation is that Obama and his side are playing chess, and Ryan, as the representative of his, is on a buffalo hunt. The interface between the two is going to be a bitch.
I say that because Obama is trying to chivy his adversary into the obvious equilibrium in the middle, the real solution to the deficit problem. It involves aggressive cost controls and some means testing on Medicare, cutting and deferring Social Security, weed out nasty or peripheral domestic spending (farm programs, NPR, and don’t forget the National Institute of Peace), and run Obama’s (and my) soak-the-rich view of progressivity, although I’d rather scrap the current system and go to a VAT. The president’s objective is to balance the budget, to wage what the Committee on Economic Development called, in its
landmark 2003 study on how to bring the budget into balance, a “war on all fronts,” – meaning entitlements, defense, taxes, and discretionary spending.
But is Ryan doing the same? I doubt it. He’s not that interested in reducing the deficit, never has been. He’s voted for a series of tax cuts that brought the nation out of the miraculous fiscal balance it inherited from Clinton, has gone unperturbed about fighting prolonged military adventures without sacrifice, and his plan does what’s hard to do – shut down Medicare – while not picking up the relatively easier jobs (the incremental fixes that would keep Social Security whole).
So I read into this that Ryan’s objective is not Obama’s, but the objective of the Conservative Jesuits, as personified by Grover Norquist, who are straightforwardly not as interested in reducing the budget as they are in rendering the state useless to the average citizen.
And the center of this effort right now is Medicare. In a sense, it will be one day be more important to the average American than is Social Security today, as a generation more affluent than their predecessor lives longer, has more income, but faces a wide array of treatments that can extend life and preserve its quality, but at great cost. Social Security will give tomorrow’s retirees a supplement to their income. Medicare will give them what they won’t be able to get otherwise – insurance against the last volley of shocks the flesh is heir to. And, to the Republican Jesuits, raising taxes – even on Midas and Croesus – only brings in revenue, and revenue doesn’t help, since it balances the budget and makes it less important to cut whatever the state is doing with the exception of going to war and producing ethanol. The objective is not to create fiscal balance – it’s to strip the ability of the state to improve the lot of its citizens. It’s dressed up as “freedom” or “liberty” or “tough love” or any number of semantic finesses, but it comes down to that – if people can’t get medical care from the government, and then, after we’ve settled that, retirement payments from Social Security, then what good is the state to them? Building
infrastructure, regulating the environment, extending the broadband Internet, or overseeing financial markets would be next in the firestorm against state
competence.
Which takes us to Standard & Poors rating agency, which this week put out a notification that the U.S. readiness to repay its debts was still AAA, but had its view of that rating had gone from “stable” to ‘negative,” which mean, technically, that it might fall in the next two years or, more thematically, like the old joke says, “Mom’s on the roof.”
S&P is the first among the agencies to take this view. Whether they truly believe it, or want to play a productive, patriotic role by highlighting what’s at stake, or want to protect themselves from looking as blind to the risks of sovereign debt as they did to those of mortgage backed securities, I don’t know. Fitch, a smaller and often more heads-up counterpart, puts it this way: “Ultimately, the recognition of the dire consequences of failing to raise the debt ceiling in a timely manner will prevail over differences on the more fundamental issue of how best to place U.S. public finances on a sustainable path 0ver the medium- to long-term”
They might be right. But the dire consequences are also the anti-state right’s most formidable weapon; their argument is that if we don’t negotiate a shutdown of the beast, we’ll blow it up.
Which means that the best we can hope for in a compromise is a round of deep cuts and an agreement to take the matter to the voter in the 2012 election. In fact, that’s probably been Obama’s strategy from the start; he made last year’s deal extending the Bush tax cuts for two years so that they would appear on the agenda during the 2012 campaign. If Obama can’t win re-election on a program of taxing incomes higher than mine, he might as well go back to
wherever he was born.
Well, that’s the fiscal story, and I said earlier there were two stories, a fiscal one and a monetary one. The fiscal one, just told, ended with two sides at a table negotiating two very different agendas. Whatever the outcome is, it’s going to be bad for growth. If it leads to a government shutdown, the specter of a default on federal debt will loom over markets. If there is a deal, the federal government will join state and local governments in taking spending out of the system just as the recovery is leaving its chrysalis.
Which leads to the monetary story. The Fed’s program of buying financial assets in order to keep interest rates down, called Quantitative Easing, or QE2, is now the major stimulative program at work right now, and it is sorely needed. And there are plenty of…well, plenty of people with incredibly bad judgment who oppose it, because they regard it as a harbinger of imaginary inflation.
A leading such voice is Richard Fisher, President of the Dallas Fed. In an interview here, he calls for curtailing the program because “my gut tells
me” firms may soon start passing through rising input prices, and “this will result in some unpleasant general price inflation numbers in the next few
reporting periods.”
Well, those are some finely-tuned guts. Because there are no such signs today, unemployment is still high and wages stagnant - I mean, his guts are downright clairvoyant. Maybe they speak in tongues. The only inflation we’re seeing is in food and fuel, both of which are being driven by exogenous events. Should we make a point of deflating – the nice word for shrinking – the rest of the economy because of that? Do Fisher’s guts see wage settlements rising in response? Has anyone told his guts that a lower percentage of the workforce is at a job than anytime in almost 30 years?
Obviously not, but with fiscal policy set to contract, it will be up Bernanke to manage this kind of dumb talk and to champion ongoing expansionary monetary policy. In fact, to get the Congress to the sensible middle on deficit reduction, Bernanke should be speaking now, loudly and visibly, about his commitment to keep QE2 and a new round of QE3 in place to substitute for the effects of any budget agreement. All he needs to say is "If marekts believe the deficit reduction is real, and react accordingly, I'm not going to stand in their way."
And I think he should get started on that now, because the guns will soon be trained on him. An orchestrated chorus of conservative voices has gone after Bernanke for his aggressive pursuit of a growing economy using novel means – the widespread asset purchases of the QE2 . It’s worth considering whether some of these critics, for partisan reasons, may yet want the economy to fail. Bernanke should talk about using monetary policy to offset the budget reduction deal underway, in order to assure markets and keep growth expectations in place.
If we ever do get a budget compromise, we will, more than ever, need Chairman Bernanke to be Big Ben.
Chicken and Dumplings
Between the budgetary Perils of Pauline, Japan’s evolution into a radioactive theme park, and Whatever It Is in Libya – War? Mission? Police Action? – there’s plenty of news flying under the radar (ironic Libya references notwithstanding). But here’s one story that flew by the other day that is absolutely
mind-boggling – the Federal Communications Commission, last Thursday, voted to let other mobile data service providers have the right to let their users roam the AT&T and Verizon mobile data networks at a government-specified price in order to reduce their customers’ roaming charges.
That is, Sprint, or T-Mobile, or any of the smaller rural carriers, or any other carriers (like Cricket), can have access to national wireless data networks without ever having to invest in them.
From the moment they entered the front door, the current leadership at the FCC has had two mantras – the first was the need for competition, the second the need to expand the broadband network to create ubiquitous, high-speed Internet access. But, like Jeff Goldblum’s sublime moment in Annie Hall, the FCC forgot its mantra.
Skip for a second the realities that first, the market was pretty competitive and that broadband was racing ahead – in fact, the two went hand in glove. When the current FCC crew walked in the door, carriers were investing tens of billions annually in infrastructure and high-speed broadband was quickly being adopted – a recent Nielsen study found that U.S. consumers are now second only to the Swiss in having a “super-fast” connection.
And look past the FCC’s confusions over how these goals related. In the name of “neutrality,” the FCC tried to impose a regulatory regime on service providers that disallowed them from offering premium services to those who needed an uniterruptable signal to offer new services, and that let Big Video – YouTube and the other Internet-choking video providers – hog up the system’s bandwidth without having to face the true cost of doing so. Somehow, the reality that you can’t force mandates on the networks and expect them to continue to expand nonetheless got lost on the FCC.
But now we’re moving onto the next level. Earlier this year, a Coalition of the Unwilling, comprised of just about every mobile service provider except those
that have actually built a national network, approached the FCC and asked that it provide them with the right to force roaming agreements on the two national networks for data services.
Here’s what Charles McKee, federal affairs vice president for Sprint, had to say when explaining why the FCC should force Verizon and AT&T to give his system the right to roam their networks at a government-specified price:
“The expectation of consumers is their smart hone is going to work wherever they go. Data is not just an abstraction for onsumers now. They use it every day and rely on it more and more instead of voice.”
Or here’s the president of the Rural Cellular Association explaining without pretense why he should be able to glom on to somebody else’s investment and keep his job, country club membership, and standard of living: “This really is getting to be a matter of survival for many of our companies out there .”
As Arlo Guthrie said at the draft board, you got a lot of damned gall, Sergeant.
Here are companies that are unwilling or unable to compete by building infrastructure – note the words “compete” and “build,” the avowed dual goals of the FCC – and instead, they figure that the mood over there is pretty hostile to the big carriers and why not take a pass at being given access to the data networks?
I suppose you can’t fault a lad for trying – if I was Sprint (or a small, rural carrier) and I could force my way onto somebody else’s network, essentially giving my customers mobile data access without ever providing it myself, I’m not sure that my moral compass would point True North.
But the FCC surely knows better. Imagine being either of the two biggest networks and having spent a king’s ransom getting 4G technology – download speeds of as much as 12 mbps, wireline speed on a device in your pocket -- out in the field, only to be told that you now had to cut deals with the companies that said “not me” back when it was time to put up real money. Why would you continue to invest in infrastructure under those terms? In fact, we had precisely this kind of regime in the telephone world in the late 1990s and early 2000s and companies refrained from investing because of it – companies that built Internet infrastructure had to resell it at government-determined prices. That’s how all the DSL carriers appeared back then – they could free ride on the companies who created the infrastructure and live off their competitors’ investments by government edict. And it’s how those companies disappeared as well, because they made no investments, produced no innovation, did nothing but hitch a suckerfish ride on the whales who did the real work. Unsurprisingly, companies wouldn’t build more hostage infrastructure under those circumstances. But when the courts reversed the policy, high-speed infrastructure burgeoned.
And now, we’re heading back to an explicit policy of allowing – encouraging -- free riders on the high-speed wireless networks. What stops Sprint, or Comcast, or Cox, or Green Acres Mobile Data Services from offering 4G services without ever spending a dime on their provision? Sure, the “expectation of consumers” is that they can get data services wherever they go, but Sprint, to use the self-selected example, has made little effort to give their consumers what they want.
At some point, the infrastructure builders have to look up and think, why are we bothering? That’s particularly true for rural areas, where mobile access is going to be the dominant path to high-speed connectivity (despite some pretty silly statements to the contrary). These areas aren’t built out yet because
they’re not very profitable – duh. There’s little incentive to sink costs into low-density areas. The Administration at one point offered a National Broadband Plan that created incentives to get this activity going, but now they’re acting in ways that will bring that build-out to a halt – or expand
dramatically the budgetary cost of further subsidies to get the job done.
Moreover, these “data roaming” agreements are commonplace in the market. Voice roaming is already mandated by the FCC, because the law specifies that “telephone service” have this kind of “common carrier” approach. But the law very explicitly distinguishes between “voice service” and “data service,” and for good reasons, since “telephones” were regulated going back to the original communications acts, and the (old) telephone infrastructure was built by franchised monopolies in exchange for guaranteed returns. So the telephone system has a public legacy. But high-speed data networks like the ones the FCC seems intent on communalizing were built by private entities with risk capital in a competitive market. And if you build these networks, and Green Acres Mobile Data Services wants to use them, there’s certainly a price at which you’ll make a deal -- that’s why the deals are commonplace. In fact, the big
networks like these deals, because the carriers they’re dealing with help the big guys expand their own access to consumers.
So the other carriers aren’t after access – they can get access – they just want the government to muscle the networks and get them a better price. And ultimately, this doesn’t help consumers and doesn’t get infrastructure built, it just transfers profits from the companies who built the network to the suits who run the free riding companies.
Like its forays into “net neutrality,” the legal basis for the FCC’s decision strikes me – a practicing non-attorney (hell, my biggest legal career aspiration is to avoid being a defendant) – as tenuous at best. Do they really think a court is going to look up and say that “data” services ought to be regulated as are
“telephone” services because some “consumers expect it?” It’s like Pepsi asking for access to the formula for Coke because folks like Coke! If you didn’t know better, you’d think the FCC has decided that its best tactic is to promulgate regulations and let the court throw them out – it’s the regulatory equivalent of the lipstick scrawl on the motel mirror saying “stop me before I kill gain.” This makes the chorus of groups” (and, much to my regret, Senator Al Franken, who’s got this all fabulously wrong) that linger outside the FCC’s doors happy, while protecting us from the real repercussions of what the groups want. That can’t be what they’re thinking, but that’s the pattern.
The FCC has decided to rewrite the old story about the Lttle Red Hen. In the original, of ourse, the Hen’s idler cohorts sit on their duffs while she mills the wheat and bakes the bread. And when they all want to eat, she tells them to stick it – no work, no eat . The FCC’s petitioners smell what’s in the oven and are licking their chops. But in the FCC’s version of the story, the Pig, the Cat, and the rest of the menagerie not only take the Hen’s wheat, but take the Hen as well, and have a tasty dnner of chicken and dumplings.
The Tempest And The Teapot
Two things happened this month that have bearing on the course of the evolution of the broadband network. One was seen as momentous but, to me, is ultimately a non-event, a tempest in a teapot. The other was regarded as a manic sideshow, but is an important landmark in the profoundly competitive and innovative broadband market’s ongoing transformation.
The inconsequential event was the proposed merger of ATT and T-Mobile.
The manic landmark was the release of the iPad 2.
Maybe I’ll get to the merger today, maybe I’ll let it go a few days. Why not? For one, the issue isn’t going away, but more importantly, when we look back at March, 2011 years from now, the fact that ATT and T-Mobile merged (presuming they will) will be regarded as an afterthought, much the way we now regard the merger of Price Waterhouse and Cooper & Lybrand, or perhaps Sprint an Nextel, or perhaps, more autobiographically, Burroughs and Sperry. I’d spend time explaining my nonchalance, but there are more important things to do.
Like talk about the iPad. Of course, I don’t have one. Younger people do. People wonder why older people don’t get this stuff, and I can tell you why. It’s not technology aversion. It’s that if you have an iPad you can do cool stuff and older people don’t do cool stuff. And it’s a shame, because now, for the first time, the full functionality of (personal) computing and information processing look to be mobile – it’s one of the two great Rubicons that everyone ever involved in information technology has always anticipated – computing on the fly (check), and voice activation and recognition (not yet, but Jack Donaghe’s working on it with remote controls). And if that’s where we are – if we now have a device that makes computing mobile, bridging the wired and wireless worlds, then we need to consider a new model of competition in a new, multi-dimensional, integrated market for broadband services and applications.
When I was at Unisys, our Chairman, a very solid, self-possessed guy from South Dakota named Jim Unruh, once told me, as if sharing a grim joke, “Every time we sell a computer, two companies make money – unfortunately, they’re Intel and Microsoft.” Let’s see, how have Unisys, Microsoft, and Intel done in those intervening 20 years? – OK, write one down for Jim.
His remark, back then, was an eye-opener, because for most of the commercial computer’s life to that point, computational power was the miracle, let alone the product. But the paradox was that as compute power burgeoned, compute power became less important to its user, much like aluminum was once regarded as a precious metal until they found a whole bunch of it. Value migrated “up the stack” from compute power to actual “solutions” that made that power do stuff.
Signal is going the same way. The central paradox of broadband is that the more signal innovates and the better it gets, the more it encourages other innovations that compete with it to create value. The more there is of it, and the better it is, the more that rests on top of it and intermediates its relationship with the consumer. And the iPad lies at the heart of that.
Long ago in the Dark Ages – say, the beginning of this decade – the selling point of wireless was signal quality – “Can you hear me now?”, the sound of a pin dropping, that was the pitch. Well, signal today is by-and-large incredible – quality, coverage, reliability, all continue to improve. A decade ago, we were thrilled by 144 kbs. But 4G now delivers 5 to 12 mps or better – faster than a wire to the home a few years ago. So the companies that invested tens of billions to make that happen must be raking in the chips, right?
No, wrong – because the better these signals became, the greater the rush to create value using them, starting with the handset. The handset is now competing with the network as the prime value-generating part of the total signal-device-application-service package. And it was the iPhone that changed all that, that allowed the device to exist on par with the signal ; there’s no greater proof of this proposition that people willingly signed up with ATT to have it. It was like the old joke about the Klopman Diamond – a woman is on an airplane and she’s wearing a magnificent diamond pendant, and her seatmate admires it; “Oh, that’s a remarkable diamond,” says the seatmate. “Well, yes, it’s the Klopman Diamond,” the woman answers, and then adds, soto voce, “But it has a curse!” “Really!” says the seatmate – what is the Klopman Diamond curse?” And the woman answers confidentially, “Mr. Klopman.” ATT was Mr. Klopman to the iPhone Klopman Diamond – the curse that came with it. It was such an obvious issue that Jon Stewart went nuts about it when Verizon cut its deal to bring the iPhone to its network.
But two points ought to be made about ATT’s network problems. The first is that they demonstrate that while signal quality and coverage still count, but they’re not the sole concern. The second is that the surge of traffic ATT realized once the iPhone and its bit-eating applications forced ATT to improve itself, and ended up making it a better competitor, and forced ATT’s competitors to keep innovating as well. The iPhone did to ATT – and to all signal providers – what a textbook competitor does – forced them to invest, innovate, and create more customer value.
And if the iPhone set in motion a virtuous circle in which innovation in devices led to innovation in applications and improvement in networks, which then allowed applications to burgeon (a $4 billion industry that didn’t exist five years ago) and led the cycle to start all over again, the iPad takes us into hyperspace. With its longer battery life, ability to handle video, the power to do what laptops and desktops (remember them?) can do – the iPad offers a way for consumers not only to stay connected with today's high speed wireless networks but to “compute” in a way not really possible even with bulky and more battery-constrained laptops, netbooks, or whatever else. But the iPad, Xoom and other tablets, along with the introduction of 4G networks that make video better and easier, now offer a real alternative to fixed wire broadband networks, and they will transform competition even more dramatically than the iPhone did. It will make video and gaming apps even more important, will make the “cloud” even more important, and force signal providers to stay on the treadmill of investment, innovation, and improvement. And the consumer is again in charge -- the apps, the devices, the operating systems and the networks can be mixed and matched in countless ways. And as consumers sort this out, the circle keeps spinning – better devices lead to better networks, which lead to better applications (I’m still trying to figure out who’s watching a movie on their phone, but the point is you can), which lead to networks expanding, which permits more applications and better devices on which to run them.
The iPad, therefore, is a major step forward in the ongoing transformation of the broadband market, and the best way to state that transformation is this -- where once the consumer decided how to approach the wireless world by deciding who had the best signal at the best price, there are now many different players at many different levels vying for the right to be the consumers’ gateway to this integrated package of signal, devices, and applications and services. Do you pick a signal carrier and then a device? Or do you pick a device and then a signal carrier? Or will you end up picking an application – Facebook? Google? – and then picking the device and, therefore, signal that best hosts it?
This changes the terms of competition – signal, devices, and applications all compete to capture the lion’s share of the value they create in combination. And when each improves, the others must race to fill the gap, lest their competitors do – whether it’s apps that sit on improved devices or devices that use up faster and more reliable signal, or signal that improves to entice more sophisticated devices. We used to think about competition as being like a track and field event, with the race going to the swift. But that image doesn’t fit what’s going on today in a multidimensional market for signal, devices, and applications. If there’s a metaphor for it, it’s one of those theatrical (to use a nice word) wrestling cage matches in which a dozen guys go into a cage and wail on each other until someone’s left standing. The wrestlers immediately go about forming and reforming alliances, alternatively co-operating and beating on each other -- and while they form these transient alliances, they ultimately all compete, because that’s how they win. The only difference is that in the broadband competition world, the match continues forever as the wrestlers, like Sisyphus, never reach the end of their labor, and new wrestlers – be they Facebook or Clearwire, or new wrestling moves – be they Xoom or Pandora – keep entering the cage.
That’s what’s going on in the broadband world today. There’s still vigorous competition among signal carriers – heck, the U.S. market is singular in that it has competition among signal platforms – telcos, cable, and wireless – but there’s then the device manufacturers, the competing operating systems behind them, and the giant applications, starting with Facebook and Google (and Google’s stepchild, YouTube), all of whom compete for a larger share of the value generated by the integration of all the parts. Like wrestlers in a cage match, they form and reforms alliances, but ultimately have interests that put them at odds with everyone in the group.
The iPad takes that to the next level. It only exists because of the ongoing innovation in signal yet it competes with that signal for the consumer’s attention. It is both is a symbol and trigger of this profound transformation. It has forced imitators to match its new functionality while catalyzing more investment and innovation at every stage of the integrated broadband value proposition and giving consumers a new tool to manage their involvement with both wired and wireless broadband.
While the debate begins over whether ATT/T-Mobile is good or bad for competition (a debate, I’d point out, in which every one of T-Mobile’s and ATT’s customers are on one side – can you imagine having T-Mobile service and being unhappy about it?), the real action is happening not only elsewhere, but all around us. That’s what we’ll remember about this moment years from now. It’s time for the people in the teapot to look up and witness the Schumpeterian tempest.
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