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Podcast: Exponent Episode 021 – Gamergate of Thrones

On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this week’s episode Ben and James discuss why Ben thinks the Internet is totally overreacting to HBO’s announcement that they will sell subscriptions directly to customers, and then delve into what might be the underlying motivations behind Gamergate.

Links

  • Ben Thompson: The Cord-Cutting Fantasy – Stratechery
  • Ben Thompson: Why TV Has Resisted Disruption – Stratechery
  • Ben Thompson: The Jobs TV Does – Stratechery
  • Kyle Wagner: The Future of the Culture Wars is Here, and It’s Gamergate – Deadspin
  • Paul Graham: Before the Startup – PaulGraham.com

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

The Diminished iPad

Something very strange is happening this week: there is an Apple event, and very few people – including myself – are particularly jazzed up about it. Oh sure, I’ll watch it, and I hope I’m surprised, but there is very little in the rumor mill – a retina iMac, OS X Yosemite, and the iPad Air 2 – that is particularly noteworthy. If anything, it is that lack of noteworthiness that is the most noteworthy thing of all.

Earlier this week, one of my absolute favorite Twitter followees – SammyWalrusIV – posted a brilliant piece about the iPad:

The iPad is at a crossroads. Introduced by Steve Jobs four years ago, the iPad has gone on to become a phenomenal success (225 million units sold bringing in $112 billion of revenue and approximately $30 billion of profit), but I suspect Apple management will alter the iPad line-up in response to wearable devices and larger-screen phones and in the process iPad’s ultimate trajectory will be more modest and niche than many expect.

This is certainly a big comedown from the sky-high expectations that followed the iPad’s explosive growth in 2010 and especially in 2011, when many conjectured that the iPad business would ultimately be bigger than the iPhone. The question, though, is if the decline in the iPad’s fortunes is simply the natural order of things, Apple cannibalizing itself before others have the chance, or a missed opportunity.

I think that it’s all three.

The Disappearing Middle

At the first iPad presentation, Steve Jobs was at pains to explain that the iPad would only work as a product if it found a spot between the iPhone and Mac where it did some number of things much better than either.

Jobs iPad Placement Slide

There’s no question, at least in my mind, that the iPad delivered. From day one it was a great reading and video device especially, and games – particularly the complex Euro-style board games that I like – were a revelation. New apps soon arrived, too; I particularly remember how blown away I was by Flipboard. The iPad, though, truly came into its own with the iPad 2; it was significantly lighter, making it a lot easier to hold, and much faster. And by that time the App Store was in full swing, with compelling new apps being released constantly, all on top of an interface that was far more approachable and usable for simple everyday tasks. In addition, the iPad had seemingly impossibly long battery life, making it well worth the carry anytime you were away from the house for an extended period of time.

Over time, though, that middle has shrunk. Macs have gotten much smaller and, more importantly, achieved much better battery life, removing one of the iPad’s biggest advantages. Suddenly convenience pushed in the direction of carrying only one device. And, while the iPad may have been simple, its limitations meant that if there were only one device, it would usually be the more powerful but complex Mac.1

Apple’s Self-Cannibilization

And now the iPhone is making a major play for the original iPad standbys: reading and video. One can absolutely argue that the iPhone Plus is superior to the iPad or iPad mini for reading; it’s lighter, thinner, yet plenty big enough to get lost in a good book or essay (for me, the iPhone 6 is enough; then again, I used to read RSS feeds over WAP). The battery life is just as good, if not better; more importantly, it’s always with you: on the bus, in line, and on the couch. Reaching three feet for an iPad may not seem like much, but the additional friction of physical movement, finding your app, waiting to sync, etc. just doesn’t seem worth it anymore. As Sammy put it:

Why buy an iPad when you could have an iPhone with a screen that doesn’t seem that much smaller than an iPad mini? Why buy an iPad when you can have a more powerful and just as easily transportable Macbook Air? The space between a phone and PC is smaller now than in 2010 primarily as the phone has become more powerful and larger. Tablets are getting squeezed.

Obvious though larger iPhones may have seemed to many of us, Apple still deserves praise for pushing ahead with the iPhone Plus in particular. Anyone who thinks this won’t have an impact on iPad sales is surely kidding themselves. And make no mistake: that’s bad for Apple in the short term. Sure, the iPhone Plus has much better margins – both in percentage and absolute terms – than the iPad mini especially, but one iPhone Plus per customer is still much less money for Apple than that same customer buying both an iPhone and an iPad.2 Apple though, just as they did with the iPod and Mac previously, has proved itself willing to cannibalize itself.

To be sure, Apple is certainly not too worried: the downside of a bigger phone is reduced convenience and portability, opening up room for a device that is even more portable and always with you – the Apple Watch. And, just as the iPhone was much more profitable than the iPod it replaced, the Watch will almost certainly be much more profitable than an iPad.

The iPad’s Missed Opportunity

However, I think that Apple has missed a significant opportunity to make the iPad into an essential fourth device (in addition to the iPhone, Mac and eventual Watch). Sammy gets at the problem:

I can’t remember the last time I downloaded an iPad app. Curious to see how others were doing, I posed a question on Twitter, “How many iPad apps have you downloaded in the past month?” On any given question I get a decent number of responses, but this time I received a very muted reaction with a few “0” responses. Why am I not downloading iPad apps? I consider iPad app innovation to have slowed with iPhone continuing to take a disproportionately high amount of attention in the app ecosystem. Most of my daily mobile usage now occurs on an iPhone.

This echoes my own personal experience. While I still use Paper on the iPad (primarily for this blog), much of my reading has moved to the iPhone simply because the iPad apps are inferior (TweetBot) or non-existent (Nuzzel).3 More broadly, there simply aren’t that many apps like Paper that make an iPad essential. I personally will always own an iPad simply because Paper on the iPad does something for me that no other Apple device does; this simply isn’t the case for nearly enough people.

This is Apple’s fault.

While I wrote a few months ago that too many developers blame Apple for their own business mistakes, the fact remains that Apple has incentivized developers to build shallow apps with customer-unfriendly business models. Specifically, by not enabling trials, which would allow truly superior apps to charge more for paid downloads,4 and most damagingly, not providing built-in paid upgrades, which would incentivize developers to build and iterate complex apps with the confidence they could capture additional revenue from their existing customers over time,5 Apple has made it a fool’s errand to build something like the aforementioned Paper.

I wrote about Paper specifically in a series last year about Apple’s App Store failures:

  • Papering Over App-Store Problems link
  • Casual Gaming is a Sustainable Business but not a Platform Differentiator link
  • Why Doesn’t Apple Enable Sustainable Businesses on the App Store? link

In that final piece, I chalked up Apple’s refusal to allow developers to build sustainable businesses to their 1997 paranoia:

The trouble for Apple – or any platform provider – is apps that cross that line from nice-to-have to completely irreplaceable. It’s at that point a user’s loyalty shifts from platform to app, and there are no greater examples than the aforementioned Photoshop and Microsoft Office [which Jobs had to beg to continue supporting the Mac, most famously at the 1997 Boston Macworld Expo]…

But there have been downsides to this paranoia. Apple’s inefficient use of its cash is the most famous, but I think developer hostility is an aftereffect as well. I would go so far as to argue that that Boston keynote was at the root of Jobs’ opposition to any 3rd-party apps on the iPhone, much less app store policies that enable sustainable businesses. Never again would Apple be held hostage to an app that was bigger than Apple.

The problem is that must-have apps are exactly what the iPad needs to become indispensable. And sadly, while Apple seemed to shrug off much of that 1997 paranoia at this year’s WWDC, they didn’t make any real changes to the App Store policies around trials and upgrades that would truly make a difference. Truth be told, though, this year’s WWDC was likely already too late. By then iPad sales had already started to decline on an annual basis, giving developers even less incentive to focus on the iPad.

The iPad Going Forward

To be clear, I’m by no means declaring the iPad doomed. It remains far more accessible for many people than a Mac will ever be, and rumors about split-screen apps and larger sizes suggest that Apple sees its role as slowly but surely replacing the Mac over time, particularly for the younger and older generations. It remains a killer device for video, although that’s a job that is fulfilled just as well by cheap Android tablets. There are also niches that are thriving on the iPad, particularly in music, and here the iPad is highly differentiated from Android. In addition, Apple is clearly positioning the iPad as a tool for the enterprise; Tim Cook’s default answer for questions about the iPad has been to point to Apple’s partnership with IBM.

Still, I can’t help but reminisce about what might have been had Apple harnessed the incredible developer enthusiasm for the iPad in 2010-2012. More than any other iOS device the iPad needed help to make it indispensable to everyone, but Apple famously doesn’t like depending on anyone. And now no one cares.

  1. I’m using Mac as a stand-in for all PCs; the point holds regardless
  2. I keep hearing people say that Apple is actually coming out ahead not only because an iPhone Plus is more expensive than an iPad but also because people will update the iPhone Plus more frequently; that’s true, but ignores the fact that said customers were already buying iPhones regularly. Two devices is worth more than one, no matter which way you cut it
  3. It should be noted that TweetBot’s lack of updates are likely due to Twitter’s token restrictions, while a Nuzzel app is coming. The more important point, though, is about Paper and similar iPad-only apps
  4. There is no way for customers to know with confidence that a paid app is worth the money; trials would separate the wheat from the chaff
  5. It’s not an apples-to-apples comparison, but Aldus PageMaker, the application that made the Macintosh a success, charged around $500 for an upgrade every couple of years

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PayPal’s Incentive Problem

Last week eBay announced that PayPal would be spun out into a separate company, fixing two big problems for PayPal:

  • While PayPal grew big by being the payment method of choice for eBay transactions,1 off-eBay transactions have since become the majority of PayPal’s revenue, meaning management’s need to prioritize eBay’s needs was misaligned with PayPal’s growth opportunities
  • PayPal also had an individual-level incentive problem because they didn’t have their own stock. Stock options and/or grants are the incentive tool of choice for everyone from the CEO down to new hires in the tech industry, which meant any new PayPal hire was necessarily hitching their wagon to eBay

Still, I understood eBay’s previous argument that there were tremendous synergies between the businesses, and there’s no question that the loss of PayPal and the insight gained from being party to every transaction on the eBay marketplace is going to hurt the core business. Moreover, I think it’s highly likely that much of PayPal’s recent (impressive) growth was paid for with cash thrown off by eBay’s marketplace. There is a lot of logic to staying together.

That’s the thing with most big company endeavors, though: they almost always look good on paper. After all, the big company has all the cash, all the experience, all the developers that they can throw at any problem that arises. And yet, Silicon Valley is in many way premised on the idea that big companies can be beaten by, as the myth has it, a founder in a garage with little more than an idea. On paper it doesn’t make sense, and yet the examples are legion.

I’m not surprised though. Something I’ve learned over time – and believe today more strongly than I ever have – is that nothing matters more than incentives. It doesn’t matter how much money or experience or developers you have if your incentives are not aligned to solve the right problem. This is the big advantage that startups have vis a vis corporations: a startup starts with the problem and then creates the incentive structure under which their company operates. To put it another way, for a startup the incentives are defined by the problem. Small wonder, then, that startups are so focused on a solution.

A start-ups incentives are defined by the problem they are seeking to solve

A start-ups incentives are defined by the problem they are seeking to solve

A big company, on the other hand, has already solved a different problem – the problem that defined them back when they were as a startup. Now that the big company is facing a new problem, they have the wrong set of incentives – incentives that are defined by the old problem, not the new one.

When a successful company seeks to address a new problem, they are often handicapped by their old incentive structure, leaving them susceptible to a startup able to fashion problem-specific incentives

When a successful company seeks to address a new problem, they are often handicapped by their old incentive structure, leaving them susceptible to a startup able to fashion problem-specific incentives

This means that all of the advantages a big company has – their money, their experience, their developers – are all pointed in the wrong direction, leaving an opening for the new startup who has defined themselves by the new problem.

Unfortunately for PayPal and their future shareholders, PayPal is the old startup in this example. Their success in solving the “square” (peer-to-peer payments) problem has left them handicapped when it comes to the next “pentagon” opportunity: merchant-based payments, both online and off. eBay may be selling on top.


The central issue with peer-to-peer payments is that there is no merchant account involved. That means the entire infrastructure that has grown up around payments – particularly around credit cards – is not applicable. This infrastructure included fraud protection, authentication, dispute settling, and fees, lots of fees. PayPal built up something completely different: their primary connection was with your bank account, not your credit card, and instead of charging credit card-type fees, they simply kept your money a few days extras and profited off the float.

More broadly, the PayPal network – and the advantages that accrue to anyone who owns a network – was based on accounts with usernames and passwords. You couldn’t send money to someone – or more importantly, accept money – unless you had a PayPal account. In fact, many of PayPal’s legendary growth hacks, including literally paying people for signing up their friends, were predicated on increasing the number of user accounts on PayPal and thereby increasing the value of the network.

The problem for PayPal is that, as noted, peer-to-peer payments is a “square”-shaped problem; all of PayPal’s internal incentives are designed to solve this problem first-and-foremost. That’s why when it comes to a new problem, like easily enabling an individual or small business to be a merchant, PayPal is markedly inferior to what is on offer from startups like Stripe (for e-commerce) and Square (for offline purchases). For example, consider the purchase process on Stratechery:

  • Stripe (my choice):
    • Customer enters credit card right on the site
    • Done!
  • PayPal
    • Customer is kicked out to a PayPal payment page
    • Customer is asked to sign-in to PayPal, create an account, or proceed anonymously
    • Should a customer sign in or create an account, they will be pushed to use a bank account to pay (the credit card option will be available but it’s purposely buried)
    • Customer enters or selects a credit card on file
    • Done!

The entire PayPal process is much more convoluted for users – I haven’t even gotten to how much more painful PayPal compared to Stripe is for merchants, but take my word that it’s even worse – and the reason has nothing to do with the transaction at hand; rather, pushing users to make accounts and to use their bank were keys to the old PayPal problem of enabling widespread peer-to-peer payments, and PayPal – like nearly all incumbents – can’t help but apply the old solution to the new problem even though it makes the new solution worse than it otherwise can be. And so Stripe is eating their lunch in the “pentagon”-shaped problem that is enabling someone like me to be a merchant.2

PayPal’s offline challenges are much more basic: while PayPal was the first to allow individuals or small businesses to accept credit cards at all without a merchant account, physical retailers almost certainly already have a merchant account set up. This means that PayPal has to convert merchants from what most feel is a “good-enough” solution to one that, frankly, is only better because PayPal says it is. Sure, merchants like lower fees, but not necessarily the hassle of obtaining and training workers on new point-of-sale systems, and, even if they were to go through the trouble of supporting PayPal, what customer wants to unlock their phone, open an app, and enter a password when they can simply swipe a credit card?3

And now, into the offline space comes Apple Pay, offering a payment experience that is far more secure and simple than anything that has come before. From an excellent write-up on the The Unofficial Apple Weblog about how Apple Pay security works:

With Apple Pay, no credit card data — even in encrypted form — is ever stored on the iPhone or on Apple’s servers. Similarly, no credit card data is ever transmitted to or stored on a merchant’s servers…the fundamental aspects of Apple Pay weren’t concocted in Cupertino. Rather, Apple Pay was designed in accordance with an emerging token-based mobile payments standard which aims to increase security and reduce the incidence of fraud. To that end, Apple is getting into the mobile payments space at just the right time.4 So while Apple isn’t necessarily inventing the wheel here, Apple Pay again represents the first real implementation, on a massive scale no less, of the relatively fresh tokenization specification.

This is the tough part about being a tech company: PayPal spent years perfecting the perfect solution to that square-shaped hole that addressed thorny problems like identity, security, and fraud, and they were successful because we had nothing better. But time and technology move on, things like tokenization and NFC and Touch ID are invented, and new market opportunities predicated on the ease and ubiquity of credit cards but without the hassle and insecurity come along. And over there on the sideline is PayPal fixing a problem in a much smaller and ultimately less attractive market.

The analogy I would draw to PayPal today is Microsoft and mobile. I wrote in Microsoft’s Mobile Muddle:

Saying “Microsoft missed mobile” is a bit unfair; Windows Mobile came out way back in 2000, and the whole reason Google bought Android was the fear that Microsoft would dominate mobile the way they dominated the PC era. It turned out, though, that mobile devices, with their focus on touch, simplified interfaces, and ARM foundation, were nothing like PCs. Everyone had to start from scratch, and if starting from scratch, by definition Microsoft didn’t have any sort of built-in advantage. They were simply out-executed.

It’s actually more nefarious than that; it’s not only that Microsoft didn’t have any advantage in mobile relative to Apple or Google or anyone else, it’s that their previous success in a closely connected but ultimately different field put them at a significant disadvantage. Microsoft was (and in my opinion, continues to be) heavily incentivized to approach the world with a PC mindset, but that’s the exact mindset they needed to let go of to build an effective mobile platform.

So it is with PayPal. Moving money between people who lack merchant accounts is an interesting problem that PayPal has mostly solved, but it turns out that this is a different problem than merchant account payment problems. Worse, it’s PayPal’s old solution – user accounts – that made them the least likely to come up with the new solution based on anonymous tokens, something that would have been true whether PayPal were a part of eBay or not.5

In the long run PayPal will have a nice business with peer-to-peer transactions and, at least for the short term, moving money internationally (although this is clearly Bitcoin’s most obvious killer use case). However, the massive growth that awaits companies playing in the merchant space, including Apple, will always be just out of reach of a company willingly – and understandably – tying its own hands behind its back.6

  1. I was on eBay from the beginning, which meant I was very familiar with getting money orders and sending them through the mail with faith the seller would come through. PayPal was a game-changer, their desperate efforts to diversify away from eBay notwithstanding
  2. Thus the acquisition of Braintree
  3. This is why PayPal was so slow to challenge Square; the sort of merchant who uses Square has no time for PayPal-style payments. They want to just deal with credit cards, which made the entire market less of a priority for PayPal
  4. Merchants also have an October 2015 deadline to update their terminals to support chip-and-pin; since new terminal will certainly include NFC, nearly all merchants will support NFC by next year
  5. I am aware that Apple Pay – and Stripe for that matter – are largely U.S. only affairs. I expect this situation will be fleeting, but even so, the U.S. is by far the largest payment opportunity in the world
  6. Yes, I have basically described disruption

American Girl, Minecraft, and the Next Generation of Builders (Daily Update Sample)

While full-length articles on Stratechery are free, I also offer the Daily Update for $10/month and $100/year. Each day I write at varying lengths about 2~3 topics of the day, delivered to your inbox, private RSS feed, or via direct link on the right side of this page. The following is a sample of a Daily Update from September 16, 2014

I wrote on Stratechery about the Microsoft angle of the Minecraft acquisition, but I wanted to spend some time on why I’m so bullish on Minecraft in particular, and why I think it’s an excellent fit for Microsoft.

First, though, I want to talk about dolls: American Girl dolls, to be exact.

In graduate school for a design research class we had a semester-long project that was focused on American Girl: specifically, through design research methods (which are largely ethnographic in nature, including observation, shadowing, and in-context interviews), we were to understand what made American Girl such an unbelievably successful (and wildly profitable) business, and then use that insight to create a similar product for boys.

For those who aren’t familiar, American Girl is a line of dolls and associated paraphernalia, including books, clothes, and stores at places like 5th Avenue or Michigan Avenue with hair salons, hospitals, cafeterias, etc. The average purchase in said stores is in the multi-hundred dollar range, and the average American Girl family spends thousands of dollars by the time all is said and done.

The core of American Girl, and the original product line, is time-period specific dolls, such as Molly McIntire, who lived during World War II, or Kirsten Larson, who lived on the American frontier. American Girl didn’t just sell dolls, though: the key was the books. As Wikipedia notes:

The Historical Characters line of 18-inch dolls were initially the main focus of Pleasant Company. This product line aims to teach aspects of American history through a six-book series from the perspective of a 9- to 11-year-old girl living in that time period. Although the books are written for an eight to twelve year-old target audience, they endeavor to cover significant topics such as child labor, child abuse, poverty, racism, slavery, animal abuse, and war in manners appropriate for the understanding and sensibilities of their young audience.

What we realized through our research is that it was these books that were the key to American Girl’s success: while kids loved the dolls because dolls are fun, it was the books that made the parents feel like they were doing good by their kids by buying American Girl. They weren’t buying a frivolous toy; rather, they were buying something that would instill values, impart knowledge, and enable a shared experience. That created a powerful alignment where kids loved the dolls because they were fun, and parents loved buying the dolls because they were educational.

I’m sad to say the second part of our project – how to translate this insight into a new product for boys – wasn’t as successful. Our idea was pretty much a poorly thought-out ripoff of American Girl. It turns out, though, that the answer showed up in what should have been an obvious place: video games. Specifically, Minecraft.

(An important aside: the project I just told you about was by definition delineated by gender, but I do believe that’s a false distinction, and I won’t use it from this point on. Boys certainly play with dolls, and girls absolutely play with video games. And, I’m proud to say, my daughter has built some pretty mean Minecraft houses on the iPad)

Minecraft is a video game, and like most video games, it’s very fun and engrossing to play. Kids are interested. Minecraft, though, is also about building things, and design, and even community. You learn a lot, and that makes parents interested as well. Minecraft is the same powerful alignment of parent-and-children incentives as American Girl, and I think that’s a big part of its success. Satya Nadella certainly agrees. According to Geekwire Nadella told the Seattle Chamber of Commerce:

To me what Minecraft represents is more than a hit game franchise. It’s this open-world platform. If you think about it, it’s the one game parents want their kids to play.

Ben Popper explores why this is in a really great piece on The Verge:

Minecraft gives Microsoft an intergenerational success story that few other games or services can replicate. The Verge spoke with dozens of parents who see Minecraft not only as an incredible tool for bonding with their children, but a gateway to education in computer science that could restore some appeal to the Microsoft brand for the next generation…

A lot of parents are especially happy to spend time and money on Minecraft for their kids because they see it as a teaching tool. Minecraft teaches kids about architecture, and players can use something called redstone circuits to create simple mechanical devices, even entire computers, out of Minecraft blocks. And while Mojang offers a number of different versions and upgrades of Minecraft to download, the incredible variety of worlds to explore and items you can build comes from “mods”, modified software created by the community that can be installed on a server to reshape that world or the rules that govern it. For many young players, mods become a gateway to the world of computer programming, something parents, and perhaps Microsoft as well, are keen to encourage.

John Lilly, the former CEO of Mozilla – and certainly no Microsoft fan! – had a similar reaction to the purchase and what he thought it might mean to Microsoft:

So here’s the thing: the next generation of makers — 5 or 10 years down the road — they’re all building worlds in Minecraft today. Just look around. Watch what the most interesting kids around are getting obsessed about. Take a look at what they’re building, and the levels of complexity they’re grappling with before they even really can grok what they’re making.

They’re next.

And Microsoft buying Minecraft — and, hopefully, investing in Minecraft in a way that also lets it stay independent and vibrant — says, very clearly, that Microsoft wants to stand, again, with the makers.

That’s exactly why Minecraft fits so neatly with Microsoft’s productivity focus, why I’m such a fan of the purchase (read the Verge article and you’ll see lots of places Microsoft can improve the experience and make it more accessible), and why I so desperately hope it doesn’t succumb to the Xbox’s need to exist.

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Podcast: Exponent Episode 020 – I Want You to Be Wrong

On the newest episode of Exponent, the podcast I co-host with James Allworth:

In this week’s episode Ben and James discuss the problems with Ello’s business model, James’ discomfort with Facebook, and why Social Networks always have ads. We also talk about incentives and something surprising Ben learned from the notorious Episode 18.

Links

  • Ben Thompson: Ello and Consumer Friendly Business Models – Stratechery
  • Ben Thompson: Facebook Launches Atlas – Stratechery (members-only)
  • Ben Thompson: Friction – Stratechery

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

Ello and Consumer Friendly Business Models

Vox introduced Ello this way:

A brand-new social networking startup — Ello — has gone viral. At one point on Thursday, the site was acquiring 31,000 new users an hour — many of whom flocked to there because of a disagreement with Facebook over its policy requiring real names, which some say is unfair to LGBTQ and transgender users.

Ello might be the new Facebook or the new Twitter or the new social media flop. It’s too early to tell.

Actually, no, it’s not too early. Ello will fail, deservedly so. It has a consumer hostile business model.


Discussion of how a company makes money – its business model – is often completely divorced from discussion about the product at hand, but I think that’s a mistake; business models fundamentally impact product, if not now, then assuredly in the future. To their credit, Ello is quite up-front about the fact that many of their decisions are driven by business models, specifically, their opposition to ads. From their WTF document:

Many other social networks (like Twitter, Facebook, Tumblr, Google+, Instagram, etc. etc.) started out ad-free, then suddenly switched gears. They modified their privacy policies, started selling information about their users to data brokers, and bombarded us with ads. Many users of those networks feel betrayed.

Ello’s entire structure is based around a no-ad and no data-mining policy. Quite frankly, were we to break this commitment, we would lose most of the Ello community. Including ourselves, because we dislike ads more than almost anyone else out there. Which is why we built Ello in the first place.

OK, so how exactly will Ello make money?

Very soon we will begin offering special features to our users. If we create a special feature that you like, you can choose to pay a very small amount of money to add it to your Ello account forever. We believe that everyone is unique and that we all want and need different things from a social network. So, we are going to offer all sorts of ways for users to customize their Ello experience.

I have no idea what these features might be – a mobile app and an API would be good places to start – but the gist is clear: to get the optimal Ello experience you had better pay up, but only once, and you’ll have it forever.

This is a terrible idea.

Here’s how this policy will play out in practice:

  • The initial experience of using Ello will be a poor one because you won’t have access to all of the features
  • A poor initial experience will lead to high rates of abandonment among the few friends you manage to convince to try the service
  • You will complain to Ello and they will have exactly zero incentive to make things better

It’s this final point that is critical for me whenever I evaluate a new product or service: does the product’s business model incentivise the developer to be responsive to my needs as a user?

The way this drives my decision-making in hardware is the easiest to understand:

  • Businesses predicated on selling high margin products are highly incentivized to differentiate their products to attract my purchase, and also highly incentivized to ensure quality to guarantee that I stay loyal
  • Businesses predicated on achieving the lowest prices are highly incentivized to drive down costs, and are much more likely to sacrifice quality

Thus, I almost always buy high margin products, especially for products I use regularly. The incentives are better for me as a customer, according to the criteria that I consider important.

Things are a little more complex when it comes to software, but the same guiding principle is still in place: I like companies that are incentivized to make and keep me happy:

  • My favorite business model is a subscription: I pay every month for a piece of software or a service, which means the software or service provider is always under pressure to earn my money

  • Advertising is actually not far off from a subscription-style service: while in a very narrow view the adage “you’re the product that’s being bought and sold” is certainly true, the reality is that the Google and Facebooks of the world are arguably even more incentivized to make sure the user experience is great. After all, the value they offer has to be sufficient to overcome the negative effects of advertising (and in some case, particularly Google search, there are times when advertising is actually additive to the user experience)

  • Up-front payments can go either way:

    • I’m a fan of up-front payments if the developer has plans to release new versions of the software that require me to pay to upgrade. This sort of business is similar to high-margin hardware: not only must this developer offer something very compelling to earn my up-front payment, they must also deliver something of quality to ensure I’m willing to pay for versions two, three, and four
    • On the other hand, if the developer will never charge for upgrades, then I think this business model isn’t consumer friendly at all. A developer of such an app is incentivized to garner as many up-front payments as possible with no regard for existing customers
  • “Unlock”-type schemes are the worse. These can be products where you need to pay for features or assistance to accomplish some given task (free-to-play definitely falls in this category). Developers who use these schemes are incentivized to make the experience of their product frustrating so that I might be willing to pay to avoid the frustration. But, once I pay, there is no incentive to keep me happy

That said, my business model preference is impacted by the type of product that is being offered. For example, while I particularly like subscriptions for productivity-focused products that I use on a regular basis, games are more singular experiences that I take in at a particular moment in time; in that case I like paid downloads that let me experience the game on my own schedule. When it comes to social networks, on the other hand, advertising is clearly the best option: after all, a social network is only as good as the number of friends that are on it, and the best way to get my friends on board is to offer a kick-ass product for free. In other words, the exact opposite of the feature-limited product that Ello is proposing.

Make no mistake: I am very much aware that Facebook is tracking everything I do – and that it’s getting worse. As I wrote on Monday in my Daily Update (members-only), the killer feature of the just-relaunched Atlas is not buying ads outside of Facebook. Rather:

What Facebook is proposing with Atlas is that advertisers can connect the dots between online advertising – on Facebook or off – to actual purchases made by customers no matter where those purchases are made. This means that ads served through Atlas will, in the long run, be much more effective for marketers, even as Facebook improves their targeting which will allow them to command ever higher rates across all of their ad offerings.

Not only is that a marketer’s dream, it’s also profoundly creepy.

Here’s the thing though: the reason Facebook can pull that off is because companies like Datalogix, Epsilon, Acxiom, and Bluekai – all Facebook partners since 2013 – have been tracking what I do and buy for years. Privacy died a long time ago; pretending like Facebook killed it is naive (just ask Richard Stallman). If you truly care about privacy then don’t use the Internet, credit cards, a mobile phone, the list goes on-and-on.

If, on the other hand, you care about making a successful social network that users will find useful over the long run, then actually build something that is as good as you can possibly make it and incentivize yourself to earn and keep as many users as possible.

As for Ello, well, co-founder Paul Budnitz told Mashable:

“The advertisers are the customer and the user is the product that’s being bought and sold,” he told Mashable. “We don’t see ourselves competing with [Facebook], because what we’re doing feels so different.”

I completely agree; it feels like a political statement not a product that I – and more importantly, none of my friends – would want to use, and I’m pretty certain that Mark Zuckerberg doesn’t see them as competition either.