Strategies for a discontinuous future.

Consulting & advisory, research notes, in the press, about bubblegen,
next wednesdays.

Saturday, September 17, 2005

I Luv U Nintendo

"...Either you want more polygons or you want the Future."

Link, Link.

-- umair // 4:33 PM //


Social Search

Question of the weekend: did Google just qwn social search?

-- umair // 1:47 PM //

Friday, September 16, 2005


Sorry folks, busy day - email/comment responses will happen over the weekend. Hope you have a fun one.

-- umair // 8:10 PM //

Thursday, September 15, 2005

Simulation Economy

Wells Fargo buys a marketingware island in SecondLife. You knew this was coming.

As ad dollars increasingly flow into online games, I think viral redistribution channels will open up to gamers, opening up huge (ly cool) new avenues for the design of game economies, which right now bear a disturbing resemblance to those of emerging markets. Something to bear in mind...

-- umair // 6:30 PM //


Reconstructors - Market Spaces

Fred points out that what's holding back podcasting is the lack of a reconstructor. This is true across micromedia. Why has print micromedia exploded? Because RSS enables reconstruction at almost zero marginal cost.

But that's not true for AV micromedia. So what we really need are lightweight, open AV standards, IMHO.

-- umair // 2:03 PM //

Wednesday, September 14, 2005

Network Scale Economies vs Metrics

God, I love blogging. I give cool sh*&t away for free and yet I still get deliberately pissy comments:

"...If you were to plot average CPC (cost per click) * (number of searches) over time, I suspect you would get a plot like the Google one. Both are growing. Maybe just CPC alone is growing like the Google plot.

Rising CPC is in large part determined by scarcity on search engine response pages. Can you give a more concrete explanation of how that is explained by your mumbo-jumbo?"

Ha ha. That was so funny I forgot to laugh. Let's step back for a minute and try and understand the point of my graphs yesterday (I admitted that post was badly written, dude) in this commenters terms.

Google is realizing demand-side (aka network) scale economies. That means it's going to create (and hopefully) capture more and more value from growth in it's user base. In the commenters terms, this means that either searches/user and/or average CPC rises.

But focusing on those metrics is how we often miss what's really going on strategically. This is something I argue at engagements all the time. In this case, if we make an economic argument we can easily and pretty intuitively understand the real drivers of the metrics above.

There's one simple reason - network markets follow natural monopoly dynamics. To make it concrete for metric driven folks like this commenter, first think about Google in two ways. First, as a someone who makes markets between buyers and sellers of ad space. Second, as someone who makes markets between buyers and sellers of information (ie, search consumers).

Now ask yourself: assuming all competitors' network sizes are exactly equal, if Google is the most efficient market-maker in just one (not both) of these spaces, what happens?

Where is the average media buyer likely to advertise? On Google. But if everyone reaches that conclusion, all producers defect to Google, you get scarcity, and average CPC rises. By the same token, searches/user will rise as all producers defect, because competitors won't be able to invest as much in the quality of search results, and so all consumers will defect to Google. You can follow the logic the other way as well; the result is the same.

Note that Google is not initially the 'best' in this case - but natural monopoly dynamics create feedback effects which let Google 'win' regardless. These show up in my graphs yesterday as network economies of scale. So the point is that economics drives all of this - don't focus so much on the numbers, think about what's really happening.

-- umair // 10:20 AM //


Yahoo vs Flickr

Yahoo catches some flak for Yahooizing Flickr...predictable, lame, value destruction, blah blah:

"...One Yahoo! ID. So much fun!"

D00dz, please. That's about as corporate as you can get.

-- umair // 10:08 AM //


Radio Economics

A number of interesting podcasts on Economics. Features some excellent economists such as Roubini, Becker and Dey.

-- Mahashunyam // 2:06 AM //

Tuesday, September 13, 2005

Web 2.0 Doesn't Does Exist, eBay + Skype, and Network Scale Economies

OK. What is Web 2.0? Is there such a thing? Is it just FUD that non-geeks fall for? All questions that have been asked lately. Good ones, too - I think it's important to define this.

My answer is (you guessed it) about economics, not technology. I mention it below, in my Skype posting. Here it is: Web 2.0 is a shift to from tight, hierarchical architectures which realize exponential network FX, to loosely structured architecture which realize combinatorial network FX.

Hopefully, you can pretty simply see from the graphs what I'm talking about - that combinatorial gains (seriously) dominate exponential gains (seriously) dominate linear gains. If I can get a bit geeky for a sec, from a world of x^n, to a world of n^x, where n is network size, and x is utility/value/etc. This is Metcalfe vs Reed, if you like, although I think several economists were first to these ideas.

More simply, Web 2.0 is about the shift from network search economies, which realize mild exponential gains - your utility is bounded by the number of things (people, etc) you can find on the network - to network coordination economies, which realize combinatorial gains: your utility is bounded by the number of things (transactions, etc) you can do on the network.

The point is that this shift is combinatorial - each person can do X activities in a combinatorial network, and it's combinations of these activities that make value explode. Contrast with a exponential network, where it's the number of people on a network that create value. That is, a relationship between any two people is 1:1 in an exponential network, but many to many in a combinatorial network. It should be intuitive to you that the former kind of network has more potential for value creation.

The graphs make this pretty clear. They're meant to show what the sources of value for these three players are. Pretty clearly, eBay's main value driver is it's user base - the regression between revenues and users is almost perfect. It's not a combinatorial network; eBay is not creating value by letting activities scale faster than users. That means eBay is realizing almost no network scale economies.

Check out what Reed notes as a constraint to network FX:

"...each user typically has a fixed, small set of friends and family that they call all of the time. Since the value of these services to a particular user does not depend on the number of other users of the network, the total value of these services grows more slowly�proportional to N, not N�."

Does this sound familiar? It should - it's the eBay problem, in a nutshell.

Now, for Yahoo, and especially for Google, things get more interesting. They're deriving more and more revenue relative to users; there's not a simple linear relationship between users and value like there is for eBay. They are realizing network scale economies.

Clearly, users are not the primary value driver here - it's the transactions they engage in; that is, Google is creating (and capturing) more and more value from users as the user base grows, and Yahoo is trying, but only marginally succeeding.

The implication is that Google and Yahoo are mediating many to many relationships between users - transactions, if you like. Yahoo's deriving mild exponential gains from weak network economies, and Google is (almost) deriving combinatorial gains from strong network economies.

Why is Google realizing stronger economies? Well, pretty intuitively, it's done a much better job at both search and coordination. At least as far as online advertising goes, it's made it easy to find buyers and sellers, and to then close the deal relatively costlessly. Yahoo's still trying to find it's feet as a real maker of network markets, versus a simple aggregator/distributor, which is pretty clearly demonstrated by the graph (and should be intuitive).

This is an old theme of mine - from search to coordination. I hope this makes things a bit more concrete for those of you who I haven't chatted with.

I also hope it helps you see why so many people are getting excited about the value creation potential of Web 2.0. If the theory's right, it's going to be a very valuable market. And since the theory for Web 1.0 was pretty much on the money (despite the crash, evil ibankers, silly analysts, etc), I'd say fasten your seatbelts - note that I've used revenues in the graphs; in fact, I should've used a cap-based measure, which would have exaggerated scale effects (but didn't have time). In short, this is very real value creation we're talking about.

Technical notes: I should've used a cap-based measure; didn't have time. My user numbers are probably off, since they're based on Googled public data, but hopefully close to get the idea across. I'm also comparing global Yahoo to US Google. The scale effects should stay similar regardless. Oh yeah, and this post is really badly written, but again, no time to edit...sorry.

-- umair // 11:05 AM //


More eBay + Skype (Strategy Edition)

OK. Why did eBay buy Skype? The 2.6 billion dollar question.

Let's step back for a sec. What's eBay's biggest threat/problem? Simple - Google. That's another way of saying that eBay's business is predicated on slashing search (eBay reputation system) and transaction (PayPal) costs between buyer and seller.

Now, the problem is twofold. First, eBay hasn't really innovated on either of these dimensions for quite a while (Sorry guys). At the same time, second, Google has (do I even have to say it!) been vaporizing search costs in every domain it can find.

So what's been happening on the ground is that Google's been grabbing eBay's high-value power sellers, who find setting up their own shops largely using AdSense actually often drastically lowers their customer acquisition and retention costs compared with eBay. It's not hard to understand why - eBay's market structures simply aren't scaling, while the sheer number of Google queries has exploded.

This is really about Reed vs Metcalfe, or about what kind of network externalities dominate your platform, if you wanna get geeky with me for a sec. If a power seller shifts to AdSense, all of a sudden he realizes combinatorial gains from network externalities, because AdSense is many to many. eBay, on the other hand, offers exponential gains from network externalities - the auction mechanism is still essentially one to one.

And this is really eBay's problem: Web 2.0 is a shift to from tight, hierarchical architectures which realize exponential network FX, to loosely structured architecture which realize combinatorial network FX. eBay's being left behind in an exponential Web 1.0 world. See the graph above for pretty vivid evidence of how eBay realizing almost no network scale economies.

So, back to eBay's 2.6 billion dollar question. The question is: how do we create a discontinuous reduction in search/transaction costs, especially for our power sellers?

Well, in short, that's what they're hoping to do with Skype IMHO. One way is to leverage Skype into Paypal. Another way is to give power sellers an almost costless but hugely beneficial marketing channel. Etc, etc...the possibilities are huge and manifold.

To be honest, I think the best answer is probably that eBay doesn't know exactly precisely where Skype fits in, but given the curve above, they've got to make the transaction from zero network economies to Web 2.0 combinatorial network economies (viz, Google's value as f(user). And Skype is a pretty cool way to do it, because it instantly explodes the outdated mechanism that mediates transactions on eBay, and isn't letting them scale faster than users.

-- umair // 10:45 AM //



NYT moving op-ed etc to sub only next week.

Bets on how long this will last? My guess is about 6 weeks - 2 weeks for the results to be pretty definitive, 4 weeks for confusion about what to do about it.

Note to NYT - check my media economics ppt in about 2 weeks.

-- umair // 10:34 AM //


More eBay + Skype (VC Edition)

Gen points out that Rob Stavis @ BVP snagged a 150x return. Back of the envelope, that means roughly that his A round bought 35ish% of Skype for $6m. That's an A round valuation on the order of $20m (!)

Given those numbers, this was a bet I'm surprised folks didn't take. You'd grab a 10x even if Skype only cashed out at $200m, which at the low end of current valuations is only on the order of 10 million users. Nice one to BVP for spotting this huge arbitrage.

-- umair // 10:29 AM //

Monday, September 12, 2005

Humor of the Day

Greatest text ad ever?

"...Forget blog
When you could be having fun on the greatest site on earth.

Check it while you still can at Technorati.

-- umair // 5:44 PM //


eBay + Skype

Acquired at 2.6 billion/4.1bn with earnouts.

Some deal math: according to my numbers, at total funding of roughly $25 million, that's a 20-25x+ return. That works out to a minimum value/user of $50+ depending on how you wanna slice users (EG, if we discount the current base by 50%, which is probably somewhat fair, since registered users do not equal actives, and you can register multiple names, value/user hits $100ish). But even that minimum is a significant jump from current values in the Web/Media 2.0 space (much higher than MySpace).

The peer production component of my Media/Web 2.0 model spits out numbers very close to the price eBay put on Skype - my valuation stands almost exactly 2 billion, which means a (minimum) 30% strategic/control premium is being paid by eBay.

That's not surprising, because I use numbers close to the above range to value peer production plays. Those numbers are revealed by several market valuations I won't get into here. The strategic rationale, of course, is that peer production has a far stickier and more durable revenue model than other Web 2.0 competitors.

This is cool, because it's almost textbook validation of my model, which tells us a lot of breathless articles right now talking about inflated valuations and big premiums are contradicted by numbers which can be backed up with pretty solid strategic arguments.

More to the point, this is great news for those in the Media/Web 2.0 space - valuations just got seriously amplified (and validated again) by the market.

Why the acquisition? At $72m of revenues, that's a multiple of 36. For comparison, Google's IPO EV/rev multiple was 15. Could Skype get more than *double* Google's revenue growth expectations from the market? I think Skype has gotten a very nice premium from eBay - and I haven't even counted the earnouts.

Not bad for a year or two's work.

Let's hope this makes VC's across the board much less risk-averse, and willing to play with even more cool Web/Media 2.0 stuff.

Will try and talk about some strategy behind this tomo, too busy today... :)

-- umair // 12:30 PM //


Plasticity, aka The Countdown to Hypercivilization

John Naughton's nice piece about the relative lameness of the ROKR can be summed up in one word: plasticity. Let me explain why plasticity is so important.

Let's think about what's really happening in media. It's not about the digital home (Sorry Economist), etc. All of this stuff is FUD - it will make you totally miss the point.

What's really about to kick off is a huge battle for the next media dominant design. How will Media 2.0 products/services be produced, marketed, distributed, delivered?

Let's start with Naughton's point that plasticity threatens most incumbents' existing models. For example, does Apple wanna sell phones or iPods? Do the MNOs wanna sell music or ringtones? Etc, etc...

Now, let me be honest with you. I've found it almost impossible convince media players about the importance of plasticity, despite almost five solid years of evidence. Everyone's still thinking in terms of locking stuff up with Total DRM, which is just around the corner, thanks mostly to Intel.

Did these guys, like, never hear about i-mode? The point is coordinate the growth of all the players in an ecosystem. The problem with the coming Wintel lockdown world is that it replicates exactly the same industry economics we've got today.

Why is that replication a bad thing? Because those economics lead always and everywhere to things like evil record labels, cheesy movie studios - publishers. It's inevitable that these models emerge in a world of distribution/retail scarcity.

Think about what's happening in the games space. It's blowing itself apart, because publishers are naturally risk-averse: their profit function is optimized by publishing Madden 5,000,000,000 times in a row.

Why? There's basically one reason: Wal-Mart shelf space is too valuable to take any kind of a risk on. No kidding. It's the same across almost all media markets - we've all seen the fallout. Pretty amazing, huh?

So the point is that round 2 of the good ole replication wars are about to begin - except that this time, the prize won't be the music industry - it will be control of the next media ecosystem.

On one side, we'll have a handful of disruptive innovators pushing lightweight, flexible, (and hopefully open) standards like RSS, bittorrent, etc; and a bunch of hungry, relatively resource poor Asian outfits eager to leverage openness to push their hardware standards to global dominance. Their goal will be all the good stuff we've been talking about - plasticity, openness, transparency, peer production, etc.

On the other, we'll have Apple, Wintel, Hollywood, record labels, publishers, Yahoo, Ask/IAC, etc. Their goal is, well, you know - to grab a little bit of the new stuff, the bits that are mildly profitable - but mostly, to not get disrupted. The important thing to note is that the strategic intents of these players used to be in conflict, but now they've converged: to have media industry economics change as little as possible.

Here's a canonical example for you: CNN's Katrina page, full with a brand new 'Citizen Journalist' section. Is CNN seriously enabling peer production here? Of course not - in fact, this entire section is just a glorified email link!!

I emphasized 'as little as possible' that because I think it bears some thinking about. If industry economics don't change, it means that despite a major technological shift, old structures stay the same. Now, assuming these technological shifts make production, distribution, etc, more efficient, like they usually do, what this really means is that huge amounts of value get destroyed.

Of course, this is what consumers know intuitively. It's why [email protected] gets so upset about having to use branded printer ink every other day lately. Cory understands that in the very near future, big media producers will be able to leverage their scale to do very nasty things. Like making sure your hardware goes kaput if you do things they think are suspicious.

So round 2 of the replication wars are gonna be pretty nasty - much nastier than round 1, where the most that ever happened was a few people got sued by the RI/MPAA. That's seriously small beans compared to your monitors locking up for a week everytime you try to play a ripped avi - the average cost of this kind of tactic is staggering.

There are two unknown variables in this equation: Google/Amazon/www incumbents who haven't revealed their hands, and from that angle, the only really game-changing moves I can see happening is the GoogleNet.

The other unknown is device makers, like handset guys. We know Motorola's angle, but what Nokia (etc)? I think they have a golden opportunity here, but the evidence that they can handle strategy decay is thin. Think about the N-Gage: Nokia had a (once in a lifetime) chance to totally disrupt game industry economics: to blow them apart. Instead, they chose the same old tired model, and we know what happened to the N-Gage.

Beyond that, it's almost astoundingly predictable how this is all gonna unfold.

If you wanna get a bit theoretical with me, this is really a battle between two worldviews. One is the old techno hippe vision of decentralized communities and markets doing cool stuff; the other is a centralized, corporatized world where (as Baudrillard said):

"...Advertising has taken over "the moral responsibility for all of society and replace[d] a puritan morality with a hedonistic morality of pure satisfaction, like a new state of nature at the heart of hypercivilization.

...the system of needs is the product of the system of production.... Needs are produced as a force of consumption."

-- umair // 11:18 AM //



Recent & upcoming sessions:

Supernova 2007 (video)




due diligence
a vc
tj's weblog
venture chronicles
the big picture
bill burnham
babak nivi
n-c thoughts
london gsb

chicago fed
dallas fed
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world bank
nouriel roubini


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