Net Neutrality issues

(Originally written as a comment at http://www.avc.com/a_vc/2009/10/net-neutrality.html)

I am interested to see where this goes in the US, as Koreans tend to benchmark the US when it comes to regulation. They demonize the US ("The age of wall-street capitalism is over!") when they don't like it, and praise they like it ("Hey, even the US did it.").

There may be other issues, but it comes down to two questions to me.
1. Should the ISPs be allowed to charge differently based on network usage?
2. Should the ISPs be allowed to block certain dada (or applications)?

I think the answer to #1 is easy. Yes. The freedom to pricing is probably the most important freedom after freedom to entry (that is, to start a businss that you like). When you cannot determine how much you want to charge for your product, you are not much different from a bureaucratic government service. Plus, price regulation will distort the resource allocation. For example, it will benefit heavy loaders, whether their contents are popular or not.

#2 is a bit more tricky. My sense is that when consumers don't have alternatives than the an ISP, the regulation of not allowing blockage may be justified. But when consumers have alternatives, it should be left as a businss decision. Theoretically, there could be different ISP business models purely based on such discrimination. One hypothetical model I can think of is a child-friendly ISP, of which value proposition could be "No more worries. We block porn contents." For parents who are not techy, this could be a very good solution.

If the competitive situation differs by regions, perhaps #2 decisions could be delegated to states or below? Just an opinion.

My assessment of some key freeconomics arguments

(Originally written as a comment on Fred Wilson's blog. http://www.avc.com/a_vc/2009/08/some-serious-freeconomics.html#comment-14635342)

Rather than commenting on 'another' perspective, here are my key points on free, which I have been repeating over and over here and there. I think there are too many fuzzy (and sounding fancy and deep) statements when it comes to discussing freeconomics. So, I stated using 'right' and 'wrong' to make it as clear as possible.

1. Ever decreasing marginal costs naturally lead to free. (Wrong)
First, the marginal cost is never zero. Unless you invented a perpetual motion machine, there will be costs of electricity, network, computers, storages, etc. Small price times many units, which is necessary if you want to make profits, are still a lot. Most importantly, living expenses of people involved, whether you classify it marginal or not, is substantially over zero.

Second, even if we assume the marginal cost was really zero, it does not justify zero price. There is always the economic cost, which is called opportunity cost, cost of capital, etc. Put simply, you don't want to do a business just because you are not making loss. Unless you make certain level of income, you have no reason to do it over a long term.

2. You should give away contents, and make money giving services, consulting, lectures, performances. (OK, if it's your philosophy. Wrong, if it is your logic.)

I think those who argue for this are generally against the idea of 'idea being sold at any price'. Because it's their value and philosophy, we cannot discuss it analytically. You cannot say I am wrong, because I like rock music more than jazz. So, if you don't like paid contents, you don't have to justify it analytically.

But if you are saying 'that's the only way to make money with contents', that's an analytical statement. And a wrong one. When you have two things to sell, you can make one loss leader and the other profit leader. Assuming piracy is reasonably controlled, it makes as much (or often more) sense to give lectures/consulting for free and make money with contents.

3. Free can be a powerful element to have in a business model. (Right)
First, as someone commented quotating Dan Ariely (though I think it is too obvious to quote an economist), free seems to have a powerful psychological appeal. So it will bring more than usual increase in demand.

Second, free actually saves costs other than the price itself, namely transaction costs. By pricing a product as free, you don't need payment process, which costs time and money. So it is possible that free is economically better than a really low price.

4. Freemium is the best business model for many content and web services. (Not much to comment)

I generally agree with this statement, but there is little to argue for or against. Free samples are almost necessary and have existed always. And it is very efficient to give away free samples on the web. I think the statement should be more concrete, like having some quantitative threshold or distinguishing between what's just tradtional free samping and what's new freemium. For example, is HBR freemium or just traditional paid model with some free samples?

5. You should make contents free for occasional reader and charge niche contents consumed by heavy users. (Not sure, yet.)

This is difficult for me, as it appears to conflict with loyalty economics. In my view, loyalty economics is more solid and lasting management theory than RMS-ROS, BCG matrix type of scale-based strategies. Loyalty says loyalty of your customers, not scale per se, makes your business grow and healthy. And many problems of modern companies occur from the fact that they are nicer to new customers and focus too much on sales. You are treated best when you are a new subscriber, and they milk you over time.

I like loyalty economics, not only because it is analytically solid but also because it's morally high-road. Basically, you give back to whom you owe your living.

On the other hand, it is probably necessary to give away some samples to non-users. And when you have very innovative products, the ones who do the most favor to you are the ones who dared to use your products initially. I think in this situaltion, they are the loyal ones who deserve your special treatment. However, the problem is that, when you distribute your most popula contents for free, most of the users are not the brave early adopter who risked their valuable time and efforts.

My hypothesis is that this is a problem of degree or subtle business model design(free which content to whom and how much). Just like how much focus on sales and how much on caring loyal customers are a subtle degree issue.

I hope Fred Reichheld, Bain partner who started Loyalty Economics, to think about this from loyalty perspective. He seemed to find it interesting, but it would be really nice to listen to his perspective.

Dilemma of free (and freemium)

Defined too loosely, Freemium is pointless. I wonder whether that's not what some people are trying to do, by arguing that News Corp's move is Freemium. Maybe true, but then what's not so Freemium? Free samples existed forever and everywhere.

Freemium was the savior of the original (more radical) Freeconomics, which had too much intellectual flaws. (Near zero marginal cost naturally leading to zero price?) People seemed excited, but some in the free camp seemed to realize its ground was weak. Then came Freemium, which was reasonable, and did not have much controversial arguments. We all know it worked, even before Internet. It just has a more aggressive, modern, and digital feel. However, there is one problem. It is not as controversial as the original radical free. And because free samples were with us forever, Freemium was there to be defined. As a special and new way of using free or as a new terminology for an old practice.

Make the concept sharp and the camp looses Rupert Murdoch, who everyone knows is tough and smart, or make the concept loose (thereby boring) and you still have him as an ally. Dilemma?

Freeconomics or Freeligion?

There are discussions about freeconomics, triggered by the publication of Chris Anderson's book. I have already written quite a few times about why its economic logic is flawed. See them here.

I cannot help asking this question. Do advocates of freeconomics think that free is the most economically effective price, or that free is the most morally right price?

I hope the former is the case. But price being determined by supply and demand, they seem arguing too passionately for for the only ultimate price. If they believe strongly that it is morally (or socially or by any viewpoint) right to price at free, they can say so. But it's different from saying 'free' is inevitable because of economic forces.

Let me step back a bit. You can be excited to find a truth that confirms your philosophical or religious beliefs. In those cases, however, you should be especially careful not to be too confident with insufficient logic and evidence.

Why aren't hedge funds failing as fast as banks? | Chris Dillow - Times Online

Why aren't hedge funds failing as fast as banks? | Chris Dillow - Times Online

Key sentence: "state ownership, for all its obvious faults, can be less dangerous than dispersed private ownership."

I don't know well how the hedge funds are performing recently or whether hedge funds have a better owner-manager structure. But I agree in theory, except for the last part about Shiller. I am not sure how it is consistent with the less dispersed ownership.

Self-interest and altruism (or empathy)

What Is Altruism? - Freakonomics Blog - NYTimes.com

I left a comment:

One thing many economists, or whoever doesn’t believe in voluntary giving (as opposed to forced taxation), seem to assume that one needs to sacrifice one’s self-interest to contribute to others’ wellbeing. Therefore it won’t happen easily. Therefore we need forced contribution.

I don’t agree. Whether you call it self-interest or greed or utility or whatever, people pursue happiness. And very often people feel happy when seeing others happy. Plus, people feel proud and happy when they have helped others.

I don’t know academic distinction between altruism and empathy, but I am certain that contributing to others’ happiness is not inconsistent with pursuit of one’s own happiness.

Which economics to bet on?

Greg Mankiw's Blog: Wanna bet some of that Nobel money?

If Dr.Krugman takes it, it wil be the gamble of the Obama era.

Bastiat: The Broken Window

Bastiat: Selected Essays, Chapter 1, What Is Seen and What Is Not Seen | Library of Economics and Liberty: "What would become of the glaziers if no one ever broke a window?'"

That's the question that Bastiat questions. And he says...

"Society loses the value of objects unnecessarily destroyed," and at this aphorism, which will make the hair of the protectionists stand on end: "To break, to destroy, to dissipate is not to encourage national employment," or more briefly: "Destruction is not profitable."

Breaking and rebuilding, or digging for digging's sake won't produce any good. We will be wasting resources. I hope government leaders of the world to keep this in mind.

If everyone free-rides, free market may free-ride, too

A post at Marginal Revolution covered an interesting issue: http://www.marginalrevolution.com/marginalrevolution/2008/12/a-remarkable-qu.html

Here is a related question I have been thinking about the art market.

If people buy an artwork as a speculation, to sell later at a higher price, then they must be making the assumption that there will be people who ‘like’ the artwork.

But, if everyone thinks that way, that is they buy based on ‘other people’s preference’, how can the price be determined?

This seems similar to Keynesian beauty contest, in which entrants are asked to choose a set of six faces from photographs of women that were the "most beautiful" and those who picked the most popular face are then eligible for a prize. (source: http://en.wikipedia.org/wiki/Keynesian_beauty_contest)

My hypothesis is that the market will be unstable, prices swinging widly together. Because everyone is waiting for a signal that shows other people’s perception, a tiny fraction of people that moves before other people can influence the great majority. These early movers are buying based on their own aesthetic preference, unlike others. How few these independent buyers are, they are the total sample of the market and their influence can be huge.

Let’s say there is only 1 buyer who really likes a painting, and she is willing to pay $1000. Then the price that a speculative buyer would pay should not be higher than $1000. These are people who would not pay even $100 to buy the painting, without the speculative opportunity.

However, when there are a lot of speculative buyers, it does not seem to work like that. Speculative buyers guess what the price would be, based on their knowledge about people’s preference. Furthermore, it is also possible for some to try to ‘move’ the market.

Then, the voice of ‘real’ demand is mixed up with the voice of these ‘experts’. And the majority of free-riding speculators will put more weight on the experts’ opinion, because the experts represent the market, not just one buyer.

So, when things are good, they overshoot. And there is no ceiling in rising price. B hears from A that the price will go up, and tell C the same thing. C tells A that people are saying the price will go up. And it goes on. When there is few buyers buying for their own enjoying, this bubble grows itself.

When market turns pessimistic, things look opposite. When there is a real buyer, he could stop the decline of the price. He will buy when price has dropped sufficiently. But if there is no real, as opposed to speculative, buyer, there is no natural stopping of the fall. Only until the experts get bullish again.

The key difference between speculative buyers and real buyers is whether the price one is willing to pay is reasonably fixed or vary widly according to external influences. Not to make this post too long, my conclusion is that unless there are enough real buyers deciding independently the market will be very unstable.

There is another topic related to this, which I would like to write about later. That’s about ownership premium (or call it distributed ownership discount). I think distributed ownership of an asset or a business lowers the value of the asset. A company owned by many small % shareholders will be manages worse than one owned by a few large % shareholders, other things being equal.

Insuring high-risk customers.How?

Fred Wilson's 'Making My Personal Health Record Public' is inspirational, though I am not completely agreeing (or disagreeing). Privacy matters aside, I think the insurance issue is a very interesting one. The biggest project I did as a strategy consultant was about insurance, making the first online insurance in Korea (and one of the first globally, as we could not give the clients any success case when they strongly demanded one) and strengthening the existing agent-based insurance business. The project involved auto and life insurances.

This is same in the auto insurance. No one wants to insure a truck or a motorcycle in Korea. So a lot of them go uninsured, or get alloted to insurance companies by some rules (part government, part self regulation).

I have discussed with an exec that there may be a business opportunity to create an insurer who specializes in high-risk vehicles. Fundamentally, insurance exists because there are risks. Unless the risk is systematic (meaning accidents tend to happen together), they are insurable. The problem is, then the price may be quite high.

The other solution is to make an insurance company that says 'we have one price for everyone regardless of the risk profile'. The key will be to pool risks widely and to forego the costly underwriting process (which means they don't investigate your track records). The goal is hassle-free, simple, reasonably-priced insurance. The problem here is there might be adverse-selection. Because they give lower price for high-risk cars, you may attract only high-risk cars. The problem will be especially real when the competing insurer says "you are paying for high-risk motorcycles at that insurance company. Come to us and we will offer lower price." So the key is whether the saved underwriting-process costs of the 'one-price insurer' can be as large as saved claims of the 'discriminating insurer'.

The last solution is the government regulation. The government could create one big monopoly insurance company, or ban private insurance companies to discriminate the insured. I don't think this is a great idea. It will became politics, not business.

My example was about auto insurance, but the same is true for health insurance. And my personal opinion? The first one. The second one is attractive, but I am not very positive the cost saving can justify the claims difference.

Internet is not free

An AT&T excecutive said that due to surge in online content, expecially video, the Internet will hit full capacity by 2010. According to him, $130 billion is needed to improve the global Internet infrastructure.

http://www.news.com/2100-1034_3-6237715.html

Certainly, the Internet is not free. The marginal cost argument ("as the marginal cost approaches zero, the product will naturally become free") misses a basic truth in business and economics.

Let's assume the marginal cost of operation is zero, as pro-free people seem to argue (which can never be true by the way). Even at the zero marginal cost, you cannot price the product zero, because then you cannot recover your investment.

A roller coster in a theme park requires a large investment to build, but once it is built the marginal cost of running it another round is almost zero. So, the theme park should take customers for free? Of course not. (If you can make money elsewhere, you might do this. This is another area where pro-freers are misleading, which I want to talk about some time.)

The Internet economics cannot be understood correctly if you only look at the marginal cost during the operation stage. Whether you are an ISP, a web service, or a content provider, your cost is concentrated in the investment and fixed costs as opposed to the marginal costs. And when you were deciding to invest in it or not, you certainly assumed some revenue. Don't forget that.

Division of labor is alive and well in web 2.0

I found an article, which questioned the democracy of web 2.0.

Digg, Wikipedia, and the myth of Web 2.0 democracy. - By Chris Wilson - Slate Magazine

I agree with the content of the article, but not with the definition of democracy. It seems that some people think that democracy is a system in which people share the same responsibilities. They say it is not democratic when some people do most of the content contribution at Youtube of Wikipedia.

However, I think 'that' is really democratic. What they call 'democracy' sounds like mechanical equality.

In democracy, people are not required to do the same things. People do what they choose to. And this freedom tends to lead to division of labor, because people differ in what they like to do as well as what they do well.

I think the Digg and Wikipedia are great examples of why the free market economy is a very natural system for a human society. Many web 2.0 sites give equal property for everyone. Everyone is given a free asset. For example, everyone is given the same free blog account. Even so, the outcome is not equal. Someone becomes a celebrity blogger, while many others remain a blog without a reader.

However, a celebrity blogger, who belong to the top 1% of the pyramid, can be one of 99% who are mere consumers at a restaurant. No one can be the 1% in all aspects of our life. Sometimes you lead, and other times you follow.

This is not complicated. It is a simple truth arising from the fact that people differ in their passion and capability. Then we should be doing different, not same, things.

What is this called? It is called division of labor.

Communist manifesto at paragraphr.com

We (Innomove Lab) just posted "Communist Manifesto" by Karl Marx and Friedrich Engels at paragraphr.com, which is a web app being developed by Innomove Lab.

I am not a communist. To be honest, I have never read Marx properly. First of all, I did not want to ruin my family by becoming another socialist when I was in college during the time of military government. Another reason, which is more important, has to do with my reading habbit. When I read anything, I try to understand the key messages and decide to continue or stop. I tend to continue when I see something counterintuitive and non-linear. Innovator's Dilemma, one of my favorite business books, was such a kind. "Good management is exactly the reason why good companies fail." How can I resist?

When I tried reading Marx or Marxist literature, I have not seen any such thing. I felt it would be very linear. It would be "What you see is what you get" analysis of capitalist society.

By the way, I think "capitalism" is a misleading term. I think the core of free market economy (my preferred term) is freedom to innovate. To tell you what I mean, assume you are an employee at a supermarket in 1992. Having seen the Internet, you really get excited. You have a lot of happy thoughts, imaginations. Then you tell your boss, the supermarket manager, that they should make an online shop. He does not agree and declines your proposal. He says "this is good enough". What do you do?

Well, here is the critical difference. If you were in a communist society, you should just give up. It is a "community" decision that you should follow, whether it is democratic or (more likely) dictated by the elites. What if you were in a free market economy? You can leave and start up! I believe that this freedom of pursuing your own venture is the critical difference of the two systems. Everything else must be details.

You may say that I did not compare apple to apple. You are right. We need to additionally explain what the core assets of a free market economy. I think it is the idea, which you as a supermarket employee had. So, ultimately a free market economy is an economy which compensates for (successful) creativity. Unlike any other assets, including the capital, idea does not have a limit. An innovation gives a good environment for another innovation. And as long as we give indiciduals the freedom to do something at your own risk, there will be people who disagree with status quo and start a revolution. And some will always succeed. So, wait forever for the market economy to reach an end. I bet it won't come, though the society will be more equal than now (I will write more about this in Mass Niche). That's my view of the free market economy.

Back to the Communist Manifesto. Anyway, I did not have a chance to read a Marx book completely. And here we have Paragraphr, a platform to discuss a writing and a project in need of usage and feedback. So, why not put a Marx writing on it and read it there. Hopefully we get some feedback on rankrz.com, which I am realizing is quite difficult as a company outside the US, and I get to read and test commenting myself (slowly). Lastly, though I want to avoid any political or ideological discussions, my feeling is that the recent "Free" issues and so on have non-business, non-economic implications. If that is really the case, why not have two tracks: current and trendy Free and digital goods on one hand, and classical and fundamental thoughts on the other.

Would you join me reading the mind of Marx?