Andreas Goeldi's Blog – Page 2 – Just some thoughts…

Scarcity and the world of digital media

The favorite discussion topic of the media and Internet elite is currently how the economics of content will develop in our digital age. Several big media conglomerates recently announced that they would start charging for online content. This was mostly greeted with ridicule from the digerati, who are still high on the radical ideology outlined in Chris Anderson’s book “Free”.

Brad Burnham pointed out in a recent blog post that both sides probably lack a deep understanding of the fundamental economic shift that is going on here. He mentioned the work of pioneers like Herbert Simon and Michael Goldhaber on the economics of attention as a framework for better insights.

I think it’s correct to say that we are currently experiencing the rise of something like a parallel economy, driven not (like our currently suffering traditional economy) by money and scarce physical goods, but by information and scarce attention. However, probably nobody really understands yet what this economy will look like as it matures and how its interaction with the “real world” will work. Obviously, the two will have to coexist, because last time I checked, my local supermarket didn’t accept hyperlinks as payment for groceries.

We are all so deeply rooted in the principles of the traditional physical economy that it is easy to forget the basics. The good old economy as we know it revolves around scarce physical goods and (more recently) around scarce services. The goods are scarce because considerable work has to be invested into their production, starting from the (often scarce) raw materials that we find in nature. Services are scarce because most of them require some kind of skill, and acquiring these qualifications needs time, which is limited and therefore valuable. Humans trade these scarce goods and services amongst each other because of course not everybody can produce every type of good or service. And then there’s of course money, which provides a more efficient way to trade stuff by separating value from a lumpy physical item or perishable service. Money is basically condensed value, which stems from physical scarcity.

So far so good. But how is the digital economy different?

Most importantly, value in the Internet economy is detached from the physical world and its limitations. For instance, a digital text can be valuable without having a physical manifestation. Sure, all these bits have to be stored somewhere, but the storage medium is a reusable commodity, not bound to this particular piece of information. Digital information can of course be copied without loss of quality (this doesn’t exist in the physical world) and distributed over a network, instantly reaching every corner of the world. And all of this is remarkably cheap nowadays.

The result is a huge abundance of information. And this changes what is scarce: Not the actual product (information), but the capacity for consumption — attention. Every day more free information is made available to the world than a human being could consume in a lifetime. Obviously, human attention is finite, and therefore it’s the scarce factor in the digital world.

That’s why many Internet users can’t understand that media companies want to charge for their online content. Aren’t they already getting the most valuable thing that an Internet user has to offer, his or her attention? And obviously, attention can be converted into real money through advertising, so what’s the problem?

At this point the discussion typically breaks down, because media companies, and newspapers in particular, have a very hard time financing their costly content production just from online advertising. There are probably two main reasons for this problem:

First, on the cost side, newspapers still apply the old principles from the physical world to their content production process. In the old media world, news has to be distributed physically (or through scarce airwaves), and therefore it is most efficient to produce local newspapers that cover all the important news in one single information product. This results in probably dozens or even hundreds of editors slightly rewriting the very same news agency report, adding almost no value. In a digital world of ubiquitous information, that’s completely unnecessary.

Furthermore, a key value proposition of newspapers is the context that they create by selecting the most newsworthy content. Again, this process is duplicated for every single newspaper. In the online world, there are far more efficient and sophisticated ways to provide this value, even though most can’t exist without at least some human intervention. But frankly, semi-automated aggregators like Memeorandum often provide a better view of what is going on in the world than most newspaper homepages.

About 50% of the total cost of a newspaper goes into physical production and distribution, the rest into actual content production. But if you subtract the obsolete and redundant editorial work that most newspapers are still doing, what would be left? Maybe 5%, maybe 10% of the cost base? Most probably, it’s even less. The percentage of truly original reporting in most traditional media is surprisingly low. But in the digital world, there’s no mechanism to finance the unneeded redundant production of information, because there’s already so much information out there.

Secondly, on the revenue side, advertising is a very unsophisticated and inefficient way to convert attention into money. Today’s advertising models are still built on the scarcity models of the past — the type where ad space is scarce, not attention. If you wanted to reach people in a certain local market with your commercial message, your only option was to advertise in the local newspaper or on local TV and radio stations. Even in big markets, there were only a handful of channels available, with very limited and therefore expensive ad space. Targeting was only very basic, because reaching many people with a lot of wastage through mass media was still more efficient than other methods.

That’s of course fundamentally different in the online world, but ad agencies and publishers are still stuck in old thinking. Most online publishers complain about the low rates that they’re getting for display ads. But that’s not surprising, since online ad inventory is almost unlimited. The trick is to reach the right audience at the right time. But ad agencies still think in big demographic clusters, not in the situation-specific micro-segmentation that the Internet could provide. It’s therefore not surprising that paid search is by far the most lucrative form of online advertising, since Google and its competitors can convert very specific attention (somebody searching for a certain topic right now) into commercially relevant results.

So what needs to happen to make the attention-driven online media economy viable?

Clearly, media companies have to become leaner and more focused. They need to concentrate on original content that really adds value and therefore is worthy of people’s attention. That’s frankly only a fraction of the current media production. All the other fluff, as well as the fat corporate structures on top of the actual content production, will simply not be viable online.
Also, media companies need to recognize that unique context, filtering and editorial selection are more essential than ever in dealing with people’s limited attention. This will be a great way for media brands to get competitive differentiation. But today’s typical news homepage is still built on an old, generic one-size-fits-all model that is neither cost-effective nor customer-friendly.
Publishers and advertisers have to experiment with new ways of converting attention into commercial value, i.e. building the bridge from the attention economy to the monetary economy. I think we currently stand at the very beginning of this process. Traditional advertising is becoming increasingly ineffective. But new ways to channel people’s attention in order to sell them something are still embryonic. Almost certainly, there will be many ways to do this, but no silver bullets.
Media companies have to recognize and deeply understand that attention is the scarce commodity in the digital economy and therefore is a currency in itself. The current conflicts between Google and newspaper publishers show that old media executives are starting to get this, although most of their actions go into the completely wrong direction.

But at the end of the day, attention has to be convertible into money somehow, since people still live in the physical world, where scarcity is a reality and money is needed. Companies and their executives will continue to be measured by their financial success, not by the attention they accumulate. Determining the monetary value of intangibles like attention, intellectual property, brand assets and customer loyalty is a thorny problem, and it’s unlikely that there will be a commonly accepted solution anytime soon.

However, people working outside of the traditional corporate framework might be willing to forgo at least some of this conversion. Under some circumstances, people tend to value attention more than money. Let’s be honest: Most people in the Western world already have more material things than they need. Particularly the richest European countries are increasingly turning into post-material societies that don’t necessarily try to optimize their GDP, but instead the general well-being of their population. And getting attention is something of fundamental importance for humans.

So it wouldn’t be surprising if more and more people would add value to the digital economy without getting paid for it in monetary terms. The open source ecosystem is of course a great example of how this can work. And most bloggers blog (and Twitterers tweet) because they like the attention and the good things that can result from it, not because they get paid.

Another example: Craigslist provides fundamentally the same value as the many classified sections in newspapers that it basically killed, but it captures only a fraction of the monetary value. Does that make any sense at all? Yes, because Craigslist created a top 20 website that commands a lot of attention with minimal resources. It provides a valuable service and gets paid with huge amounts of attention and loyalty, as well as with quite a bit of money. It is wildly profitable in monetary terms, but obscenely profitable in attention terms. That’s bad news for the people who used to make a living selling classified ads, but good news for Craig Newmark.

Welcome to creative destruction, attention economy edition.

(Picture: Josh Sommers, CC license)

Software pricing: When does freemium really work?

Freemium — the combination of a free basic version with paid “premium” versions of a software product — is an increasingly popular business model for software. Many Internet startups and even giants like Microsoft and Oracle are using this model for at least some of their products. A lot of iPhone apps for instance are available in a basic “light” version that needs to be upgraded to the paid version for more functionality or content — a typical freemium strategy.
The advantages of freemium seem obvious: It’s a good way to get free marketing. It can reduce sales costs dramatically, because users can self-educate. It lets the product speak for itself, thereby leveling the playing field, which is a particular advantage for smaller companies with small marketing budgets.

But does freemium really work that well in practice? There are early signs of a backlash against this model. Google recently strongly de-emphasized (i.e. practically killed) the previously offered free version of its Google Apps suite, which used to be free for companies up to 25 users. Potential customers are now encouraged to try the product for free for 30 days and then start to pay $50 per user per year. A similar change can be seen at 37signals, once the poster child for freemium, who now hides the permanently free versions of its products pretty well. Startups like photo sharing site Phanfare and the recently demised LucidEra (a vendor of SaaS business intelligence) tried freemium models, but weren’t successful. And many other startups that use freemium are still far away from profitability.

So the question is: Under what conditions does freemium really work for software vendors? Obviously, customers like freemium, but how can software companies use this model to build a really sustainable business?

It think there are probably six conditions:

1. Your marginal costs have to be extremely close to zero.
Freemium only works if the distribution and support of an additional copy of your product (i.e. the marginal costs) costs you almost nothing. Thanks to the Internet, the digital distribution of software is now nearly free, both for downloadable applications and online apps.

That sounds obvious enough, but I think many companies underestimate how close to zero the costs really need to be. Web-based applications for instance need to provide enough server capacity and storage for all these freebie users. This can quickly add up to substantial amounts, even if the capacity for one single user is cheap.

2. The target market has to be big enough.
There doesn’t seem to be any reliable data about how many users of a free product end up buying a paid edition. Obviously, this will strongly differ from product to product. But from anecdotal evidence, it’s probably safe to assume that typically less than 10% of users convert to the paid version.

If freemium is your main sales channel, this obviously means that your target market needs to be large enough so that you still can build a sizable business just from getting paid by a few percent of the total potential user base. Furthermore, the free marketing benefits (and maybe even positive network effects) of freemium can only kick in if there are enough people to spread the word about your product, and for that they first have to be interested in what you have to sell. In other words, niche products that only appeal to relatively few users are probably not ideal for freemium. Some more targeted form of sales might be the way to go there.

3. Your product has to be very simple.
It’s great that users can self-educate about your product while using it for free. Hopefully, they will soon reach the limits of the free version and feel the desire to upgrade to the paid edition.

But for this to work, your product has to be very, very simple. People don’t read manuals and rarely follow online tutorials. The product just has to be easy to use and has to provide obvious value almost instantly, so that users will have enough motivation to dig deeper. Some of the better iPhone games are a good example.

4. If your product is not simple, you need competent customers.
Not all software products can be and should be simple. This has nothing to do with a lack of usability, but with the scope of features that a product offers. Photoshop is not simple. Database systems and application servers are not simple. Content management systems (the decent ones) are not simple. They’re powerful tools for skilled professionals. Products that satisfy the needs of professional users are almost certainly not as easy to use as consumer software, because you need a certain skill set to make sense of what the product does. That’s a problem for freemium.

LucidEra’s founder tells the story of his company’s failed attempts at selling through the freemium model. Many trial customers were simply not able to figure out what the product was good for. They never really used the more advanced features and therefore never really saw a lot of value in the product.

So if you want to sell a complex, powerful product using freemium pricing, make sure that you address a well-defined, skilled audience. Your users need to already understand what they want to do with your product, and they have to be motivated and skilled enough to invest considerable time into working with it. Only then will they discover enough value to upgrade. If you offer a complex product to a user base that has not previously used this type of software (like in LucidEra’s case, selling BI to mid-market customers), freemium will be tough.

5. There has to be a minimum useful feature set, but plenty of additional functionality.
We’ve probably all used freemium software for which we didn’t see a need to upgrade. There are probably two cases where that happens: When the free version of a product doesn’t offer enough functionality, you don’t recognize that this is a useful product that is worth paying for. On the other hand, some free versions offer so much functionality that it will only make sense for relatively few users to upgrade to the paid version.

Google Apps prior to the recent strategy change was an example of the latter case: Small companies got almost all the functionality for free. If you had less than 25 users (and most small companies are way smaller than that), there was simply no good reason to upgrade.

Most successful freemium vendors now use a carefully designed combination of feature restrictions and a limit on the amount of data you can store or the number of users you can sign up. It’s clearly not easy to strike the right balance. Setting the right restrictions is probably the single most difficult thing in the freemium model.

6. You need to really understand the demand curve.

A demand curve in economics describes how many people are willing to buy a product at a certain price. If you can have only one price for your product, you lose a lot of potential customers (who don’t want to pay that price) and you lose a lot of potential profit (by undercharging the customers that would have been willing to pay more).

The solution for this dilemma is price differentiation. Why does Microsoft offer eight different versions of Windows Vista at different price points? Because it wants to ride the demand curve and extract as much money as possible from different customer groups. If Microsoft would offer only one version at a low price, it would leave a lot of money on the table (but maybe have happier customers).

Freemium is of course a form of price differentiation. The assumption is that there are many people who have a very low willingness to pay, but still find a certain product useful enough to spend some time with it and maybe tell their friends about it, some of whom will be willing to pay something. Most freemium products offer several different paid product levels with different feature sets — price differentiation at work.

The problem is that it’s really difficult to find out the shape of the demand curve and match it with your cost curve. One question is what the price point for your cheapest paid edition should be. Will many people pay $9.99 a month? Or is it better to start at $99/month and hope that you get so much free marketing out of your free version that many people will sign up who are willing to pay that price?

A key consideration is your cost curve and the usage pattern that users at different levels have. In some businesses, the most active users who use the most resources are also the most profitable ones, because they have a high willingness to pay. In that case, it makes sense to have a relatively high minimum price. But there are also cases where the low-intensity users are the most profitable. Then it makes sense to extract money from as many people as possible, even if it’s a far lower amount per user.

Conclusion: More an art than a science. And watch out for pitfalls.
There are obviously many variables that go into effective software pricing. Freemium can be a great model, particularly for smaller companies. But it is hard to get it right, and it can also be dangerous on several levels. If you get the demand structure wrong, you might leave a lot of money on the table. If you underestimate the costs caused by your free users, it will reduce your profits dramatically (and it’s not easy to get rid of these users without risking a hit to your reputation). Oh, and how about liability? If you lose a freebie user’s data, can he sue you? Better make sure that your terms of service are watertight.

Freemium is not a panacea for the software industry, it’s just another tool for the hard task of getting software pricing right. It’s great for certain market segments, but software companies should avoid to go freemium just because it’s convenient and reduces sales costs. Sure, a freemium model can get you more users relatively quickly, but in the long term, it might hurt your bottom line and growth prospects dramatically.

Finally, what would Google do? There’s probably a good reason why Google basically got rid of the free edition of Apps and now does pretty conventional software marketing with billboards and the like. They now even do competitive upgrades, as well as channel sales through resellers. Sounds more like traditional software industry tactics than the wonderful world of free Internet-based software.

(Picture: Timothy Lloyd, CC license)

Can Apple crack the code in tablet computing?

Not the real Apple tablet The plot thickens: Even renowned publications like the Financial Times are now saying that Apple will soon launch a tablet computing device, sort of a large-scale iPod Touch.

If true, that would be a pretty bold move. The history of tablet computing — flat devices that use a touch screen or pen for interaction — is a long sequence of failures and disappointments. Microsoft had at least three shots at this market, starting in 1993. Windows XP Tablet PC edition in 2002 was a flop, and the entertainment-focused Ultra-mobile PC, released in 2006, didn’t fare much better. Now tablet-oriented features can be found in every copy of Windows Vista, but very few PC models use them. Many other vendors tried their luck with tablet form factors, but the only moderate success were probably the PDA devices of the late 90s.

So what does Apple need to do differently in order to be successful in this market?

I’m actually a fan of the tablet form factor. I experimented with the first “Windows for Pen Computing PCs” back in 1993 (which were really, really bad) and still own four different Tablet-PC and UMPC devices plus various PDAs and smartphones. From my experience, Apple needs to avoid the usual pitfalls and do the following:

1. Make sure it’s really mobile.
Tablet devices are supposed to be extremely mobile. But that’s pretty pointless if their battery life makes you carry around a power brick and various accessories anyway. My worst device in that respect was a UMPC built by the now defunct OQO. Its battery lasted less than two hours, and the power brick was bigger than the computer itself. So Apple needs to make sure that battery life is adequate and that the product doesn’t need any accessories (such as easily lost digital pens or external keyboards) to work — as in: Really work for the things people want to do with it, not just for a quick demo.

2. Do one or a few things really well.
The most successful tablet device in history, the Palm PDA, had a very clear focus: It was a digital replacement for your appointment book, not more and not less. Microsoft’s tablet PC on the other hand suffered from ambition overload. It tried to be a full-blown PC, but also a digital notepad, a highly portable information capture device for professionals, and oh yeah, also a great entertainment gadget. Unfortunately, it did none of these things particularly well. So Apple needs to decide what its tablet device should be for and provide a great user experience for that purpose. It looks like it will have a clear entertainment focus, which is probably a good idea.

3. Have a truly simple UI, don’t try to solve the hard problems.
Most tablet devices contained some kind of handwriting recognition. This seems to make sense for a tablet form form factor, but the sad truth is that computers are still pretty bad at reading handwritten text. A success rate of 95% (which is what most vendors claim) sounds good, but is almost unusable in practice. Most tablet devices have relatively slow CPUs and are therefore not able to get much better results. That’s why Apple should concentrate on an extremely simple touch UI without fancy input methods. But judging from the iPhone, Apple already knows that.

4. Make really, really good hardware.
Tablets need to be light, and that’s why many vendors compromise on hardware stability. Most of my tablet devices have one or several mechanical defects, since highly mobile use tends to be strenuous for hardware and the flimsy build quality of many of these devices is simply not good enough. An Apple tablet device at the rumored price of around $800 needs to be much more robust than the iPhone. People will expect these things to last for several years, not just until the next model comes out.

Apple already has the other necessary ingredients for a success: It knows how to generate that “wow” factor that is necessary to make people consider a new product category. It has retail shops that will provide a hands-on experience for consumers — something that the Windows-based Tablet PC market always lacked. And it has the developer ecosystem and licensing agreements to provide interesting content for the new device.

Now the only question is if and when Apple will come out with such a new device. If somebody can crack the code in tablet computing, it’s clearly Apple.

Facebook’s and Twitter’s business model problem: The very long tail of user activity levels

Facebook and Twitter seem to be the big winners of the current social media wave. Both services are growing like crazy, adding hundreds of thousands per users per week. But both companies are still struggling to find a profitable business model, currently prioritizing growth over revenue. Once you dominate the world you can always figure out how to make money from it, right?

Maybe. But the seemingly huge user numbers of these services could turn out to be far less impressive (and commercially relevant) in practice. Sure, both platforms have tons of registered users, but are these users really active? That’s probably something advertisers would like to know before they spend money on these channels.

Several new reports (e.g. here and here) indicate that Twitter’s user activity patterns follow a typical “long tail” distribution.

Longtail

There are a few heavy users that are extremely active, tweet a lot, have thousands of followers etc. But beyond this small group, usage drops rapidly. 50% of Twitter’s registered users are basically inactive. Since Facebook is far less transparent than Twitter, there are no similarly precise studies about usage of the leading social network. But a quick survey of the activity level of my 358 Facebook friends showed similar patterns. Only 71 (=19.8%) of my friends showed any activity in the past 72 hours, with only a handful clearly dominating. Admittedly, that’s anecdotal, but I’ve not seen any studies that show a different pattern.

Now, it’s not surprising that this kind of service has a long tail usage pattern. You can find very similar patterns in other types of communication networks like the phone system, e-mail, instant messaging, etc. The problem lies in how to best monetize these services. Both Facebook and Twitter don’t charge users. They want to monetize their services indirectly. Facebook mainly sells ads and virtual goods, Twitter still has not come up with a business model, but probably will go a similar route.

The problem is: these monetization approaches depend heavily on actual usage. Nobody pays much for ads that not many people see or click on. Virtual goods are profitable, but you can only reach a decent revenue size if many people buy them. So if it’s true that only 20% of users on both Facebook and Twitter are really active, that’s a big problem for both services, since their opportunity to sell ads and premium services is much smaller than their raw user numbers suggest. Granted, both platforms are very big even then, but maybe it’s not quite enough for total world domination…

So what would be a better way? Think about it: How does your phone company charge you? Your cable company? They charge flat fees because they want to extract a lot of money from low-volume users. Sure, they have different price levels for different user types, and they offer premium services, but the lowest levels are not cheap at all.

For instance, I’m a very low volume user of phone services. AT&T charges me for a 550 minutes per month package for my iPhone plan, of which I typically use 100 minutes or less. There’s no smaller package — tough luck for me. Do you want high-speed Internet at home, but use it only a couple of hours per week? You’ll still pay the full price. You need Microsoft Office for your business (because people send you fancy PPTX and DOCX files), but only use it every couple of weeks? That’ll be $399 for the “Standard Edition”…

These flat-price plans are simply a very profitable way to make money from services that have strong network effects plus a long-tail usage pattern. Charging based on usage (and online advertising is economically speaking an indirect way to do that) is fine as long as you sell to a heavy user, early adopter customer base, but as soon as you reach the mainstream, flat-fee models are way more profitable.

So the problem for Facebook (and, supposedly, Twitter at some point) is that the current business model will not really scale well with further growth in the mainstream, low-usage market. Online ads are measurable, and advertisers will only pay for audiences that are really active, i.e. generate page views or click on ads. I think Facebook and Twitter can only scale financially if they find a way to charge people even if they don’t use the service frequently.

By the way: Google recently killed strongly de-emphasized the free version of their “Google Apps” suite of messaging and productivity apps. Their model until recently was that small companies with less than 50 users could get the product for free, financed through advertising. Looks like that didn’t work out so well. The costs for accommodating a lot of mainstream users probably grew more quickly than the revenue from heavy users and ads.

And I’m convinced that Facebook and Twitter will face similar challenges in the near future.

The End of Substance, or: Is Blogging Dead?

A worrying trend is becoming increasingly obvious: Many of the very best and most interesting bloggers are writing less and less.

Some examples: Nick Carr is down to maybe a couple of posts per month, and there’s a similar pattern on the blogs of Dharmesh Shah and the always controversial Andrew Keen. Jason Calacanis recently decided to send out his more substantial pieces through his e-mail list only, and his former blog is now just a photo stream. Marc Andreessen and John Hagel seem to have disappeared entirely. And online PR guru Steve Rubel just officially gave up blogging and instead wants us to read his “lifestream” on Posterous — which is nice, but hardly a replacement for his deeper analytical posts.

It’s a striking pattern that particularly well-known tech bloggers (i.e. real thought leaders) who specialize in longer analytical pieces (i.e. real substance) are pulling back. It feels like well thought-out content is increasingly replaced by noisy, relatively random short bursts of information on Twitter, FriendFeed, Tumblr and similar platforms.

What’s going on here? Based on my own experience as a much less important blogger, I think there are three main reasons for this trend:

1. Blogging is hard work. Twittering is not.
Let’s be honest: I can easily reach about three times as many people on Twitter (and, through a feed, on Facebook) as with this blog post. And the ratio is probably even more dramatic for A list bloggers. Writing a smart Tweet that will grab people’s attention takes seconds, writing a good blog post takes hours. And the difference in the level of attention and positive feedback you’re getting might not be large. Twittering and lifestreaming are simply a more efficient way to get attention. And yes, people do blog to get attention.

2. The quality of feedback on blogs decreases with audience size.
One of the most motivating things about blogging are the comments and resulting discussions with the really smart people who read your blog. When you have a couple of hundred readers, the quality of this interaction tends to be very high. Unfortunately, it always seems to decrease as you get more readers. Suddenly “trolls” show up, you get more and more spam, and in many cases people simply seem to comment because they want to get some attention for their own blog, not because they have something to contribute. This kills one of the most important reasons for blogging.

3. You don’t necessarily get rewarded for quality.
I still remember what a thrill it was to get my first blog comments or get linked on other blogs. On Rivva.de, the German equivalent to Techmeme, I was for a while in the Top 15 most influential blogs and news sources, with a higher ranking than some well-known mainstream news outlets. How cool is that? Blogging can be very rewarding. I guess most people feel the same, even if they’re well-known authors. Traditional media doesn’t offer the same kind of instant gratification feedback loop that blogging provides.

But, you know, it gets old. And what’s even worse, the positive feedback doesn’t necessarily increase with the quality of your output. Commercial blog publishers (one of which I’m a co-founder of) know that the pure posting frequency is often more important for success than the quality of your posts. And most bloggers probably have experienced that a really strong post that they put a lot of work in hardly got any feedback, while sometimes the more fluffy pieces get picked up like crazy.

So it’s not surprising that quality-oriented bloggers in particular are looking for the next mountain to climb, the next reward curve, the next shiny new toy. And that’s not necessarily just in social media. Several popular bloggers have published books recently, are working on their speaking careers or are focusing on their startup projects.

For a while, blogs were probably the best source for breakthrough thinking about technology and entrepreneurship issues. I think this short era is coming to an end, at least for some time.

Social media, and maybe online media in general, is currently in the cambrian explosion phase. We see new concepts and channels almost every day, and the market is changing very rapidly. It probably will need a few years to settle down, for the winners to emerge, for more constant structures to evolve.

People who contribute substantial content to any medium don’t just do that because it’s fun, but because they can expect certain rewards, either in money or status. The reward equation in social media is currently changing too rapidly. That’s fine for some experimentation, but in order to create long-term incentives for deep thinkers, the ecosystem has to cool down quite a bit. In the meantime, read a good book.

What will the news media of the future cost?

(This post is a translated version of an article that I wrote for netzwertig.com, the leading German tech blog)

The media industry is in the middle of a deep transformation, and nobody knows what the successful business models of the future will look like. Sometimes it’s useful to look at this kind of situation from the perspective of good old-fashioned economic laws, because they apply even in the digital age.

The current discussion about the future of media is shaped to a large part by ideology and wishful thinking instead of rational analysis. There seems to be little common ground between Internet prophets (“Information wants to be free”) and traditionalists (“Good journalism deserves good money”). Some online pundits seem to think that media companies should never, ever charge for their products again, while many managers of traditional media businesses would love to see the Internet shut down altogether.

Unfortunately, this whole discussion typically doesn’t address the heart of the matter. The future of media business models will not be decided by ideology and idealistic visions, but by simple market laws. And to understand these, a bit of economic analysis typically works much better than idealism.

Obviously, most traditional media companies, newspapers in particular, currently have a revenue problem. Print circulations (and ad sales) are falling rapidly, and users seem to be unwilling to pay for online media.

Broadly speaking, this trend reflects a change in the supply situation. To use a bit of Economics 101: The price that can be achieved for a certain product is a result of the relationship between supply and demand. Economists like to illustrate this with supply and demand curves:

The supply curve S shows that suppliers will produce more units of a product (x) if prices (p) are higher. On the opposite site, customers will buy more of a product if prices are lower. The demand curve D therefore is sloped in the opposite direction. Since we’re talking about media here, the demand curve is pretty steep. This reflects the fact that people can’t consume much more media even if prices fall. There are only so many hours in a day, and attention is limited. The point where the supply and demand curve intersect is the market equilibrium that determines the market price and the volume of product sold.

The increasing popularity of the Internet as a news medium has pretty severe consequences for this equilibrium. Since Internet-based media have a much lower cost of distribution, suppliers can provide much more of their product at the same price. The supply curve shifts down (from S to S2). As a result, the volume of media products sold increases a bit, but prices fall pretty dramatically. That’s exactly what we’re currently experiencing in reality, although reality is of course more complex than this very simple model.

Now for the important question: Is this new position of the supply curve (and therefore the much lower price level) sustainable, i.e. can it remain at this point in the long run? That’s not obvious, because supply behavior often overshoots a sustainable point in technological revolutions — just think back to the dot com era. Business models need some time to find a stable new point.

But the way to a new long-term equilibrium is not linear and depends on a lot of factors, not least of all the interaction with traditional market segment. In news media, it is currently rational behavior for newspaper companies to offer their content on the web for free. But that’s only true as long as the traditional print business is healthy. Let’s play a bit with some numbers to show the idea behind this claim.

Each supplier obviously has to consider at which price he wants to offer a certain amount of his product. Without going into theoretical details: roughly speaking, the supplier has to consider his marginal costs, i.e. the costs that are caused by producing another unit of a product, and the average costs that in the end have to be covered by revenue.

And now we see the fundamental difference between traditional media that are bound to physical distribution, and the digital world: Each information product initially creates costs for the production of the actual content (for instance, salaries for journalists). But when it comes to the costs per unit — the marginal costs — analog and digital media are fundamentally different. The costs for the production and distribution of a printed newspaper are substantial. But serving an additional reader on a newspaper website costs almost nothing.
Now let’s look at a simplified model case for a hypothetical newspaper company. Let’s assume that the production of content costs $250,000 every day (not unrealistic for a major newspaper). Let’s further assume that the printing and distribution of a newspaper costs 50 cents per copy, but serving another reader on the newspaper’s website costs only 5 cents (caused by the need for additional bandwidth and server capacity).

If we look at average costs for different audience sizes, we’ll see the following picture:

The first unit of a newspaper is incredibly expensive, but the more copies you produce, the better initial content production costs are distributed over all readers. The more circulation grows, the more the average costs per print copy (red curve) approaches marginal costs.

But what happens if the company publishes the same content both in print and on the web? Since the additional costs for the web channel are low, the total average costs for both media taken together (green curve) rise only slightly. If we assume that revenue from the print business already covers the costs of the newspaper, the Internet can potentially be very profitable for the media company. Even if online ad sales are relatively low, they can easily cover the small additional costs, and the rest is pure profit.

But: If the print business starts to fail — because readers migrate to the online edition — and the web channel has to carry initial costs alone (blue curve), we get a different picture:

Of course, costs for a pure web offering are much lower, but they are way higher than zero, particularly if the number of readers is relatively small. As soon as the cross-subsidy from the print side falls, the Internet channel has to provide much higher revenue to finance the initial costs of content production. And in many cases, it could be difficult to achieve this from ad sales alone.

Some Internet prophets seem to think that media companies should never again charge for content. That’s a pretty naive view. This approach only works as long as there is a healthy traditional (print) business. And obviously, this traditional business is eroding.

So what can be expected if the print business fails altogether? The harsh reality is that many media companies will not survive it. That’s why overall supply of news will start to decrease, and prices for news will rise.

More specifically: The phase in the development of the news business that we are currently experiencing is not sustainable. I’m convinced that the era of a huge oversupply of free news will come to an end sooner or later.

Media companies with a well differentiated product will start to charge for their content again, and users will pay if they can’t get the same quality content elsewhere — and that will increasingly be the case with shrinking supply. Online news subscriptions will be much cheaper than their paper equivalent, but they will cost something, probably around 10-40% of a newspaper subscription.

The economic characteristics of online media have another important consequence: The big players will have a huge advantage, since it’s economically crucial to distribute initial costs over as many readers as possible. Print media experience scalability problems at some point due to their physical production. But the Internet is largely free of these concerns.

The world of digital news will almost certainly be bi-polar. On one side there will be a few giant media conglomerates that will produce news for global markets. Almost certainly, they will offer their products in different versions for different price points. The freemium model, which is already popular in the software market, could very well be the model of the future in media. And these media conglomerates will make sure that the oversupply of news will be kept in check.

Next to this, there will be plenty of space for small, often semi-professional providers that can publish their content for free, thanks to low production costs. Advertising will be the typical business model, driven by an increased selectiveness of advertisers who want to reach certain interesting target groups in focused way. There will be a few segments where small media companies can established paid content franchises, but this will be a niche phenomenon.

The situation will be tough for the group in between: The medium-sized publishers that have to carry a substantial cost base from the print era, but don’t have the scale to reach a huge audience. Realistically, the model of the medium sized regional publishing house will very likely vanish. The economic structure of digital media doesn’t leave much room for this type of company.

Again: The current situation of the media industry is an anomaly that is not sustainable in the long run. This conclusion is not about ideology, but about market forces. We all will have to get used to paying for high quality news, probably pretty soon. It will be cheaper than the good old newspaper, but not free forever.

Wave could be Google’s Microsoft Office

The blogosphere is buzzing about Google’s major announcement yesterday: Google Wave will be a new communications platform that integrates elements of e-mail, instant messaging, wikis, photo sharing, collaborative document editing and more.

Aside from all the technical niceties of this new platform (Open APIs! Instant content updates! Smart spell checking!), Wave could turn out to be one of Google’s smartest strategic moves in a long time.

Many critics say that Google is still a one-trick pony: The company makes huge amounts of money in its search advertising business, but all the many other Google products barely generate any revenue at all.

But if you apply the same standards, even Microsoft is just a two-trick pony: The Redmond empire generates most of its profits from Windows and Microsoft Office. Windows of course was the basis for the success of Office, but Microsoft leveraged this platform dominance in a particularly smart way: By bundling several formerly disparate productivity apps into an attractive suite that provided, thanks to Windows, a much nicer user interface than the competition (remember WordPerfect? Exactly my point).

In some ways, Google Wave is doing the same. It leverages many of Google’s particular platform advantages from its search business that no competitor can match: its huge server farms that guarantee instant responsiveness, the rich data from its billions of spidered web pages (how do you think they do their spell checking?), its rich cloud-oriented programming frameworks, its experience in browser-based GUIs (finally something to do for that fast JavaScript engine in Chrome) and so on.

And more than that, Wave pulls together elements of previously separated web-based applications. Even though some people already fear that the result could be bloatware, I think that this is a particularly smart move. The current ecosystem of web-based collaboration tools is way too complicated for the average user. Sure, theoretically all these independent applications could be pulled together with open APIs and some RSS magic, but in practice, that’s too complex for normal people. Most users would probably prefer a single, consistently structured place where they could do all this stuff.

Wave could be to web-based collaboration what Microsoft Office was to PC-based productivity apps: The product that unifies all this emerging functionality for the average user, under a trusted brand and leveraging an established platform. And in the process, Google could potentially find a second cash cow.

What Media Companies Could Learn From Microsoft: Smart Bundling

The media industry is desperately trying to find new business models for the online age. A lot of the current discussion revolves around micro payments: Is it possible to get users to pay small amounts for each newspaper article? The metaphor “iTunes for news” seems to become a favorite model of many media people, and major players such as News Corp. are already planning to roll out micro payments.

I think they couldn’t be more wrong about this. It’s actually amazing that traditional media companies seem to be largely blind to the factors that made their traditional business models successful.

One factor is the control of distribution channels (I blogged about this earlier). This is difficult to replicate in the digital world, because digital content is so easy to replicate and distribute.

But the second element is actually much easier to implement for digital content: Bundling.

When you buy a CD (if you are still old-fashioned enough to do that), you pay $15 or so for a collection of around 10 songs. Chances are that you are only interested in one or two of these songs. So why don’t you just buy the single? Mainly because the music industry since the 50s consciously pushed the album format, suggesting more value. Look, you only pay $1.50 per song on the album, but singles often cost $5 or more for just one song.

How about your newspaper (if you still read one)? How much would you be willing to pay for today’s front page story in the New York Times? How much for the top article in the business section or sports section? A dollar? A few cents? Nothing at all? This probably depends strongly on your interests. On any given day, there are probably a handful of articles in a newspaper that you would be willing to pay for specifically. Most of the rest are worth almost nothing to you. But you are willing to pay a couple of dollars for the whole thing.

This is bundling at work. It’s extremely difficult to set the right price for a piece of content, since different people will see very different value in it. Therefore, it’s often the most profitable solution to sell bundles of content items at a relatively low total price to extract the maximum value from customers.

A great example for this from another industry is Microsoft Office. This suite of productivity programs today completely dominates the market. Most people would probably agree that that’s not because Microsoft had the best programs –some people still have nostalgic feelings for WordPerfect and Lotus 1-2-3. It’s because Microsoft sold the most attractive bundle of adequate programs at a very nice total price.

Here’s a simplified example that explains why this is smart: Let’s assume that User A wants to do a lot of word processing. He’s willing to pay $250 for a good word processor. He also wants a spreadsheet program, but is only willing to pay $50 for it.

User B is a finance guy and needs a good spreadsheet, for which he is willing to pay $350. He has no use for a word processor, but will pay $50 for a presentation program. And User C, a consultant, is willing to pay $200 for a presentation program, $100 for a word processor and $50 for a spreadsheet.

So, if you’re a spreadsheet vendor, what’s your ideal price? You could charge $350 and only sell to User B. You could charge $50 and sell to all three users, but that would leave money on the table. It’s really difficult to set the right price.

The best solution for this is to sell a bundle of a word processor, spreadsheet and presentation program and charge $300 for it. At this price point, all our fictional users will buy the whole package and will be very happy, because they get a solution at a price they are willing to pay, but with much more overall functionality. The vendor could only make more money if he were able to charge each user an individual price (what economists call perfect price discrimination), but in most markets, that’s impossible.

Microsoft is great at coming up with bundled editions of its software. There are five different versions of Microsoft Office, all with different elements and at different price points, but of course all based on the same code base. Of course, it’s dangerous to overdo this. The seven different versions of Windows Vista were just confusing.

Obviously, bundling works for software. It also works for most forms of content, and it can work particularly well for digital content, because it’s so easy to build bundles of digital content at almost no additional cost.

Unfortunately, the music business largely missed the boat on this. By allowing Apple to sell individual songs through iTunes, the music industry broke the album model, and there’s probably no way to get it back. The new subscription models that some record labels are experimenting with are of course nothing but another form of bundling, although at a much lower average price point.

Newspaper publishers don’t seem to get bundling at all. That’s probably because in the world of the physical paper, they can only sell a very limited number of different bundles (maybe a local and a national edition). Even the only two newspapers that successfully charge for online editions, the Wall Street Journal and the Financial Times, only sell one or two different online bundles. That’s simply stupid. Why isn’t there an expensive Pro version of the FT with full access to all market data, maybe even bundled with additional data sources? A cheap student version? A standard version just with the news and opinion columns? A version for people who want to read the FT primarily on their mobile device and just want the most important headlines? This kind of creative price differentiation would certainly extend the number of subscribers dramatically.

And the same applies to other parts of the media industry: Why doesn’t Hulu (or iTunes) sell an attractively priced subscription for its most popular shows, for instance a bundle that gives you The Office, Family Guy and Saturday Night Live, but also throws in a number of less well-known shows? If that’s the easiest way to get these shows, many people will sign up. The TV industry seems to believe that many people are going to pay $2 or more per episode on iTunes, they are almost certainly wrong. Nobody does that in traditional media. People pay for a satellite or cable subscription, which is a classic bundle. Deciding for each show individually if it is worth $2 is simply too much work. Pay-per-view only works for big-ticket items, and there’s no reason why this should be different in online media.

It’s really remarkable how little media companies seem to get the basic rules of bundling: Sell a bundle of products that have different value to different people at a price that seems really, really attractive when compared to the prices of the individual items. Make sure that you offer different editions that appeal to different target markets. That’s all. Just ask Bill Gates.

(Picture: My aim is true, CC license)

Is the Party Over? The Flattening S-Curve of IT Innovation

OK, maybe it’s just the recession. But many people who have worked in IT for some time seem to feel a sense of disappointment these days. Somehow, the IT industry — including the Internet sector — doesn’t feel as interesting as it used to. Not as dynamic. Not as fascinating. Is this just a negative perception shaped by the current crisis, or is it possible that there’s more behind it?

Like most waves of innovation, the adoption of IT seems to follow an S-curve. The early computers had only very few users, mainly big corporations. IT adoption really exploded with the PC, gained speed with user-friendly GUIs and hit its maximum velocity when the World Wide Web was invented. Now it might be slowing down.

A very simplified graphical representation of long-term IT innovation could maybe look like this:

There are many signs that the IT sector is losing steam. A few examples:

1. PCs haven’t changed much in a decade. Sure, my current machine is much faster than the high-end Compaq workstation I was using in 1999, but I don’t do anything fundamentally different with it. Most of the innovation happened in the decade before that. In 1989, very few people edited photos, accessed global data networks or were even using a mouse.

What’s more, the innovation in operating systems and basic PC applications has stalled. Users don’t see a good reason to upgrade from Windows XP to Vista, for example. Innovation in PCs is now merely incremental. The market has found its “dominant design” and doesn’t seem to be willing to change much about it — except prices, which are falling dramatically. My new $300 Asus netbook basically has the same capabilities as my $3000 subnotebook five years ago.

2. The enterprise software market is consolidating. Enterprise software companies are increasingly living off their maintenance fees and service revenues from their installed base. There’s less and less new license revenue because big-ticket IT projects are largely a thing of the past. Corporations are very reluctant to repeat the costly mistakes of the late 90s, when huge ERP and CRM projects were all the rage. The prototypical software company of this new era is Oracle, which is following a strategy of aggressive consolidation of smaller rivals.

3. SaaS is not taking off as expected. The new generation of web-based “Software as a Service” (SaaS) products like Salesforce.com is great and potentially disruptive, but most of these companies are still far away from real profitability (let alone huge margins like those achieved by the leading enterprise software players). Even though subscription-based SaaS has been around for well over a decade, the business model doesn’t seem to hold up very well. What a contrast to the early days of Microsoft or Oracle, both of which were profitable almost from day one.

4. Web 2.0 has all the hype of a real bubble with none of the money. OK, so Facebook now has more than 200 million users. That’s great, but unfortunately, revenues are not growing at the same speed, and profits are still elusive. Youtube is apparently losing hundreds of millions of dollars a year, and Twitter has not even started to look for a business model.

Web 2.0 is a huge success in terms of user adoption (although it’s really only a shift of existing web users to newer sites — actually a small step), but commercially, it’s a huge disappointment so far. Maybe it’s all a question of time, maybe things will look better after the recession. But perhaps the bleak reality is that these sites simply don’t add enough value for users (and advertisers) to justify the commercial success of Web 1.0 giants like Google or Amazon.

Of course, there are some bright spots: The mobile web is finally taking off, thanks to Apple’s iPhone, the BlackBerry and other new smartphones. Media consumption — newspapers, video, now even books — is shifting into the digital realm, hopefully pulling advertising spending with it eventually. And on the horizon, there’s the promise of the Semantic Web (although it has been on the horizon for a long time without getting much closer…).

But overall, the wild days of IT innovation seem to be largely over for now. Things have been slowing down considerably for several years, and that’s not just because the economy is in trouble. It’s a typical pattern for fundamental innovations (like railroads, the telephone, the automobile) that there’s a phase of rapid evolution and dramatic changes that can last several decades. But once the technology has reached a certain level of maturity and most of the infrastructure is in place, growth and the speed of innovation slow down a lot. All the signs suggest that this is currently happening to the IT industry.

Obviously, it would be a huge mistake to think that there will be no further major innovation in IT. Just remember all the quotes by famous people that were wrong about the magnitude of future technological change (although many of these quotes are actually incorrect). However, unless a technology enters a second major wave of innovation — like digital and mobile telephony — the big changes are few and far between.

Assuming that this theory is right and IT is now really becoming a mature market: What are the best entrepreneurial opportunities under these new circumstances? This will be the topic of my next blog post. Watch this space.

“Attention Economy” is the Wrong Metaphor. It’s All About Persuasion.

The concept of the “attention economy” has been around for a few decades now. And many people think that Web 2.0 is the first real-world manifestation of this economic theory.

Briefly explained, the concept assumes that in our modern world — with its constant information overflow — human attention has become a scarce good. Since scarcity creates economic value, attention becomes valuable. Some even think that attention can be traded like commodities.

The conventional way to monetize attention is to sell advertising against it. Media companies publish content that grabs people’s attention, and they resell a part of that attention to advertisers. (Here’s a great article by Dharmesh Shah that explains the difference to what he calls the “wallet economy” where people pay you directly for a product).

Sounds simple enough. But the problem is that the theory doesn’t really explain the commercial nature of attention.

From the point of view of somebody who receives attention, there are two possible value components to it:

1) The intrinsic reputation value of attention, i.e. social status. Example: A programmer who contributes to an open source package doesn’t do this because he expects to make money, but in order to get a higher reputation with his peers.

2) The value of possible persuasion that needs attention as a starting point. An advertiser is not interested in your pure attention as such, he’s interested in selling you something. That’s only possible if he gets your attention first. But the real value is only created if the subsequent persuasion process is successful.

While the first component (reputation) might become more important in advanced societies where people already own most material goods that they could possibly want, the second component (persuasion) is the only one that can really be monetized.

The problem with the oversimplified view of attention is that attention is not uniform, particularly not if it’s supposed to be used for persuasion. You know this from real life: When you go to the mall on a Saturday, you are easily persuaded to buy more stuff. You are already in a buying mood, your attention is tuned to consumption. Not so if a telemarketing firm calls you in the evening during your favorite TV show. They will get your attention, but they won’t persuade you. You’ll probably hang up on them.

The same difference exists in the online world, and it is the reason why Google makes a ton of money, but social networks don’t.

Google probably makes most of its money from searches where people are actively looking for certain products or solutions to problems. The users are in a buying mood — think of the mall on a Saturday afternoon. A relevant ad delivered at this moment is highly effective, and a click is worth a lot of money, because it’s a great starting point for successful persuasion.

Just check a few AdWord prices, and you’ll see this immediately. A click on “Britney Spears” (high attention, consistently in the top 10 search terms every year) costs $0.30. A click on “life insurance” costs $15.80. The Britney-related ads actually receive twice as many clicks per day as the insurance ads, but they’re worth a fraction.

Why do smart advertisers who want to sell to a teen/tween audience not simply buy Britney Spears-related clicks (=attention) and then use the traffic to sell something else that appeals to this target demographic? Because it doesn’t work. If somebody clicks on a specific keyword, they are not in the mood to be persuaded to buy something completely different. Attention doesn’t equal persuasion potential.

Unfortunately, this is the fundamental challenge for advertising on social networks and many other Web 2.0 sites. You go to Facebook to catch up with friends or share stuff, not to be persuaded to buy something. Metaphorically speaking, you’re not in a mall, you’re at a dinner party. And somebody who’s trying to sell you something at a dinner party will likely not be invited next time.

Obviously, there’s an opportunity here. The trick is to catch users when they are in a buying mood or at least in an online environment that is tuned towards consumption. The ad industry is however very far away from really understanding this, because in traditional media, an eyeball is an eyeball.

But at some point, advertisers will start to understand that smart micro-targeting delivers far more relevant forms of attention than having a generic product page on Facebook or slapping an ad on MySpace’s homepage. The rule is clear: Follow the money. And the money is where people can be persuaded.

(Picture: hansol, CC license)