Saturday, January 28, 2012

From VCRs to SOPA, Big Media's Troubled History with Technology

There’s a mantra of the digital age that’s as old as the internet itself: information yearns to be free. But when that information is copyrighted intellectual property, another mantra comes to mind: there’s no such thing as a free lunch.

For years, the media companies behind SOPA have watched sites like MegaUpload enjoy a “free lunch” at their expense - with a bill totaling $16 billion per year. Yet inexplicably, SOPA was not aimed at pirated content sites like MegaUpload as much as it targeted Google and Facebook – sites that drive tons of potential paying customers. In fact, the U.S. took down MegaUpload just days after SOPA was killed, suggesting that SOPA is in fact unnecessary in the war against pirated content.

$16 billion in lost revenue indicates piracy is a major problem, but that’s not to say that media companies haven’t figured how to cash in on their content online. Whether it’s paid downloads from iTunes, advertising revenue from Hulu or licensing fees from Netflix, companies like Disney, News Corp. and Time Warner have done a fantastic job of monetizing content in ever changing ways. This transition to digital has been lucrative for media companies and it has vastly improved the experience for their customers. In the history books, the digital era will be remembered fondly by content consumers and producers alike.

Whether or not the media companies deserve credit for cashing in on the digital era is another question. In fact, the companies behind SOPA have a history of opposing technology that ultimately turned out to be a major boon to their business.

The Opposition to VHS
In Congressional hearings in the 1980s, Motion Picture Association of America head Jack Valenti likened
the effect of the VCR on the film industry to the Boston Strangler. His prediction couldn't have been more off - box office revenue remained strong and VHS paved the way for the video rental companies like Blockbuster which turned out to be an enormous incremental revenue stream for the film business.

Viacom's lawsuit against YouTube
During the course of the lawsuit, YouTube created its Content ID technology which enables YouTube to
identify copyrighted content and give the owner a chance to sell ads against it. This is a sizable business for
both parties. YouTube makes a third of its revenue on such ads, which it shares with the content producers.

The Shunning of Netflix
In an amusing bit of hypocrisy, media companies aimed to protect the video rental business they once tried
to kill. After initial reluctance to strike a deal with Netflix, media companies realized that on-demand
streaming allows them to monetize back-catalog TV content like never before. Rather than gather dust, they
can make money on the Wonder Years and Frazier all over again. Netflix is paying more and more for new content too. In 2008, Netflix entered into a four-year streaming deal with Starz estimated to be worth as much as $30 million a year. That same deal, which gives Netflix rights to Disney and Sony movies, is up for renewal at a figure rumored to be closing in on $300 million a year. That would be 1,000% growth, not too shabby.

It’s pretty clear that when it comes to new technology, media companies tend to do everything in their power to screw themselves over. SOPA it seems, was just the latest stumble in the media companies legacy of biting the hand that feeds them.

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Sunday, January 8, 2012

A Knicks Fan's Lament

Knicks fans could use a hero

As the Knicks blackout approaches its second week, it’s anybody’s guess who will win the high stakes standoff between Time Warner Cable and James Dolan’s MSG Network. The only thing that’s certain is the fans lose.

Subscribers to Time Warner Cable have been denied the pleasure of watching the last three Knicks games. To the dismay of fans, during this stretch neither TWC nor MSG has felt compelled to return to the negotiating table, although talks are set to resume next week. Instead, the two rivals have busied themselves with marketing campaigns that cast the other as the villain. This bid to win the hearts’ of the fans is ultimately a red herring. No matter which side is “wrong”, the fan still gets screwed. This theme of the exploited consumer is conspicuously absent from the mainstream media’s coverage of this story. The exception is Bob Raissman’s fiery article that appeared in Saturday’s New York Daily News.  

What makes things even worse for Knicks fans is that they have no recourse. Other than Satellite TV, TWC is the only cable provider in the neighborhood - a point that is underscored by Verizon FIOS’ decision to curtail expansion of its service. Even if consumers were motivated to ditch TWC in favor of Dish or DirecTV, they’d have to abandon their “triple play” with TWC and ultimately have a much higher monthly bill.  This phenomenon is not unique to New York. Cable companies across the US enjoy deep entrenchment thanks to the triple play which dampens the threat of what little competition there is. 

If you were lacking any evidence that the cable subscription business needs to be disrupted, look no further. 

But fear not Knicks fans, recent history is on our side. Even as TWC and Dolan hold us for ransom, they ignore a truth that brought down the record label business: In the digital era, industries that prioritize corporate earnings over user experience are destined to be disrupted. The music industry’s dogged insistence to sell $20 CDs instead of a la carte tracks was undermined by pier to pier services like Napster and ultimately replaced by iTunes. Although Knicks fans can’t depend on P2P to save the day, technology behemoths Google, Apple and Microsoft are ready to check into the game. Move over Chandler, Melo and Amare, here comes another Big Three.

Sunday, January 1, 2012

What Went Wrong for Investors of Zynga, Demand and Pandora

One defining question of 2011’s Tech IPO market was whether Wall Street had the appetite to invest in companies whose financial success is wholly contingent on the collaboration of another, existing business. This question applied to Demand Media whose eHow website depends on Google for survival, Zynga whose games are literally built on top of Facebook’s API and Pandora who is at the mercy of the record label business. 

corporate piggy-backing
It wasn’t the first time investors had to ponder this issue. For instance, back when Netflix was getting started investors had to consider its dependency on the US Postal Service. It paid off well for early investors in Netflix; the DVD by the mail business crushed the brick and mortar model of Blockbuster and Hollywood Video. Still, when one company piggy-backs on top of another, there is inherent risk. Netflix’s dependency on the US Postal Service meant it had to contend with rising rates of postage, cutbacks in service, even theft that’s attributed to the old “lost in the mail” excuse. 

Despite Netflix’s recent woes, investors largely shrugged off its early reliance on the postal service. Yet, when it comes to Demand, Zynga and Pandora who are similarly dependant on another business, investors have not been so forgiving. 

Demand lost 60% of its value in 2011, Pandora was down 37.5% and Zynga was off by 5%. 

So what gives? Demand, Pandora and Zynga are all enjoying considerable growth, why do investors have a double standard?

Consider the three defining characteristics of how the USPS views its relationship with Netflix:
  • Shared Interest:  The more subscribers Netflix gets, the more it benefits the USPS.  The 12 million subscribers who use Netflix’s DVD by mail service translate into an estimated $600 million in postage every year. 
  • Non-Competitive:  USPS has zero interest in launching its own DVD by the mail business.  
  • Incremental Revenue: The revenue USPS sees from Netflix is all incremental. 

In summary, it’s clearly in the U.S. Postal Service’s interest to do business with Netflix.  Now apply those three rules to Zynga, Pandora and Demand’s relationship with its partner and you’ll see why investors have cause for concern.
Zynga - Facebook is one acquisition away from becoming a competitor, instead of a partner, in the social gaming arena.  Zynga already forks over 30% of revenue to Facebook who could further squeeze them if Zuckerberg decides to launch games. Investor’s Best Bet: Mobile.  Zynga can lessen its exposure to Facebook by building games for Android and iOS, like its popular “Words with Friends” app.
Pandora – In the wake of Sean Parker’s digital music revolution, the recording industry went from a $45B per year business into a $12B business. No surprise then, the music business is feeling less than generous - as evidenced by the hefty fees it charges Pandora on a per stream basis.  Those rates are set to rise by 37% in 2015.

For Pandora to even survive that steep increase, it needs to improve the efficacy of its mobile advertising capabilities so it can charge much higher rates. Investor’s Best Bet:  Lobbyists. Pandora can negotiate a better cost per stream rate by proving that the revenue the recording industry makes from streaming is not cannibalizing existing revenue streams like iTunes and terrestrial radio.  As was the case with Netflix, content providers warmed to the idea of streaming once they saw consumers did not “cut the cord” en masse.  However, Pandora seems to be taking aim at radio’s share of the pie.  The music streaming service is coming pre-loaded into cars made by GM, Ford, even some BMW models.   

Demand – Unlike most websites that depend on advertising, eHow is not a “destination site” that consumers check daily.  The only way you land on eHow is through search. eHow has smartly partnered with Google on its new YouTube channel, so that the search behemoth has a vested interest in the success of the eHow brand.  Yet, Google still has no vested interest in driving traffic to the eHow site, which is critical to Demand’s business. Investors’ Best Bet: eHow’s Relaunch.  eHow, which became synonymous with the term content farm, is attempting to become more of a destination site. If it can lessen its dependency on Google by giving viewers a reason to visit the site more regularly, investors will reward. 

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