I wish we didn’t have to have this discussion over at TechCrunch, but it really is happening.  Internet radio and its cousins are facing asymmetric pricing compared to terrestrial radio.  Many call it stupid of labels to cripple internet radio.  After all, doesn’t internet do a much better job of promoting music purchases?  Listeners can actually identify the song and artist playing, and the interface even provides convenient links to purchase channels via iTunes or Amazon.   Surely that must be a great sales driver that can not be replicated by the non-interactive interfaces of terrestrial radio!  Well it probably is, but internet radio is also deeply disruptive to the fame-creation process, an important source of value to record labels.

Funny signals

Many Web 2.0ers look forward an era where fans can easily signal their tastes, generating preference data which could then be used to form robust recommendations.  More data is a good thing right?  However this signaling has no place under the current business model.  Today, labels invest money in production and promotion to make signed artists famous, and any outside signaling pathways would be more of an interference than an asset to the fame-creation process.   Part of this promotion engine is terrestrial radio, where the playlist is influenced by the content industry.  Internet radio is a radical departure from this because its playlists are generated algorithmically.

In internet radio, the audience signals preferences to the industry, while in terrestrial radio, the industry signals preferences to the audience.  Both are promotional channels to create fame, but its “tell us what you like” vs “tell you what to like”

This is critical to labels because much value is derived from the fame-creation process.  In the old paradigm, before the internet made preference signaling easy, it was difficult to gather early-stage information on which artists are likely to grow famous.  To deal with this uncertainty, the industry developed a model where talent scouts selected artists, and then fed these artist through a powerful production/promotion engine which virtually guarantees fame.  That way, labels don’t have to worry about betting on the wrong horse: just juice them up to secure the win.  Because the artists are signed pre-fame, the initial contract is far more favorable to the label than to the artist.

The degree to which the initial contract favors the label is directly proportional to the uncertainty around the budding artist’s potential fame, an uncertainty that is asymmetric given the label’s ability to influence the outcome

Essentially, the fame-creation process then was actually a form of arbitrage.  But the introduction of early-stage signaling changes all that:

If an artists arrives at a label having already been made famous by audience-to-industry signaling pathways, the label loses bargaining power when signing the deal.  Additionally, the introduction of externally-generated fame competes against the internally-generated fame in which labels are already deeply vested.

The three pillars

You could certainly build an internet radio/listening service that fits within the old promotion paradigm.  It is neither the internet nor the radio that embodies the threat, it is the user-generated content (preference data) and its democratizing effect.  Specifically, democratization knocks out one of the three pillars of value in the recording industry: marketing.  To learn more about the three pillars, I suggest you read the classic Ian Rogers letter to Guy Hands.  It is pretty much required-reading for anyone looking to transform the music industry.

Check out this phishing url:  http://www.facebook.com.profile.php.id.371233.cn.  Part of the reason why it’s so deceptive is because the true domain, “371233.cn” is at the very end of the URL.  But it didn’t have to be, in fact, it was probably a boneheaded design choice.

Domain naming conventions got the “left-to-right = hierarchy” metaphor backwards, with the root level at the end of the string

And we end up with these awkward URL strings where you traverse up the hiearchy at first, but once past the domain name, the URL starts to resemble a file path, where you’re traversing down down the hierarchy.   Just have a look at the latest Firefox location bar and you can see that the correct design choice is to put the root identity at the beginning of the string.

And meanwhile, we can get rid of that damn ‘www’ sub.

The iPhone is loved for its simple & gorgeous interface, its powerful desktop-like browser experience, and hated for its touchscreen typing experience.  Why then, did the supposed “iPhone killers” from Samsung and LG copy the touchscreen part, but not the interface and browser?

Hopefully the Blackberry Thunder with RIM’s no-nonsense design will be a home run!

Mike Speiser reminded me of a point which I feel very strongly about: the right of content/service providers to advertise on their pages.  Congress recently stipulated that major advertising networks such as Yahoo and Google provide the means for users to opt-out of behavioral advertising schemes.  While having good intentions to protect consumer privacy, this is essentially a form of price intervention, a perspective perhaps overlooked by policy makers.

For content/service providers who give away a free, ad-monetized product, advertising is akin to a pricing agreement.

So this is really about the right to set your own prices.  It’s not the same as forcing anybody to view ads or have behavior data collected about them: it simply means that business should have to right to refuse service to anyone who doesn’t agree with the advertising or “pricing” scheme.

After all, if you don’t agree on the price, the transaction shouldn’t happen.

But now there are two problems that circumvent the right to advertise: ad-block software, which is essentially stealing, and the recent out-put legislation, which behaves exactly like price control.  If behavioral targetting technology can boost you ad revenues from a $1 CPM to $10 CPM, then letting users opt-out while retaining the same service is essentially a government-mandated price decrease from $10 to $1.  This seems quite misguided, considering the number of startups offering great free products but have yet to achieve attractive CPMs.

Ad-blocking is tricker because the provider doesn’t know it’s happening.  So to be fair, ad-block should be updated so that it report its presence in the user-agent string.  It’s a fair compromise between letting users block ads, while informing providers and letting them decide on whether to block service, or at least show a nag message.

Everybody was talking about it in 2006…

When did it become clear to you that the browser will be more important than the operating system?  Beneath the AJAX and pretty colors, this was seemingly the underpinning of Web 2.0.  But when did people really start talking about the internet as a platform?  As far as I could remember, the idea was popularized right around when Google acquired Writely and turned it into Google Documents in 2006, and fully solidified when Facebook launched its platform in 2007.

The visionary in hindsight

…but did anyone see this earlier? I mean…way earlier?  Like 1995 early?

What do you suppose was going on in Bill Gates’ head when he said that Java “scares the hell out of me”?  Looking at Microsoft’s aggressive Internet Explorer and Java strategy in the following years, I believe his vision of the internet must have been frightening accurate: that “write once, run anywhere” will erode the relevance of host operating systems, leaving them dumb interfaces good only for controlling hardware.  No wonder he fought Java so hard, and mobilized Microsoft’s A-team to rework IE from the ground up for the big 4.0.  (IE 4.0 was the money shot to to Netscape)

It’s not surprising that he would have this insight.  After all, Gate’s is widely praised for the vision that it is software, not hardware which will command the most profits as soon as hardware makers commoditize themselves by adopting the IBM-PC standard.  He knew this while the big boys were still drinking the hardware koolaid.

Wait…but that was software killing hardware.  What does that have to do with web services killing software?

The fear of openness

Lets dig deeper into Gates’ first insight.  Hardware wasn’t always divided between Mac-vs-PC.  The PC standard is actually what was originally the IBM hardware platform, amongst many other hardware makers with their own incompatible specs.  As IBM PCs grew to dominance in the early 80s, they also had the best range of software, many of which developed by IBM.  To piggyback on this advantage, other manufacturers soon adopted the “IBM-PC Compatible” spec (remember those stickers?).

This is the event which commoditized hardware, and made software the differentiating factor.  The moment hardware opened up, it handed its pricing power to software—a vertical shift which I believe was the fundamental force behind the Windows and Office cash cows.

But now the same thing is happening to software.  The rise of cross-platform browsers and web standards didn’t just make the lives of web developers easier; it commoditized software, and made web services the differentiating factor.

We are sliding along a gradient.  As downstream products demand openness from the upstream platforms on which they sit, they also commoditize the platform and thereby yank profits from upstream.

What do you think happens when Facebook-MySpace-Bebo become inter-compatible, and embrace unfettered data potability?  People stop caring which social network they’re on, and the platform applications become the killer apps, in other words, the differentiating factor.

I think this is the fundamental reason why strategists are weary of openness, and explains Facebook and Apple’s “evil walled garden” behavior.  Openness and interoperability has dethroned the last two kings of technology: IBM then Microsoft.  If I were them I’d say openness “scares the hell out of me” too.