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  • The Jobs TV Does

    This is Part 3 of a three-part series on what changes, if any, may be coming to TV

    TV, as I have recounted in the last two articles, is as firmly entrenched as an incumbent can be.

    • The idea that you can cut the cord and simply watch the shows you currently want to watch (unbundling) is a fantasy; the economics that make those shows possible depend on the current pay-TV model (See Part 1: The Cord-Cutting Fantasy)
    • Great content has few substitutes, high barriers of entry, and depends on networks as de facto venture capitalists willing to take risks on new shows (See Part 2: Why TV Has Resisted Disruption)

    Competing with this model has, and will continue to, fail. There is no go-to-market strategy that is feasible.

    In fact, the only way things will change is through true disruption.

    Disruption is a funny word; in most of the tech press, it has come to mean little more than “competitive,” and functionally superior products are often labeled as “disruptive.”

    This is precisely backwards; a disruptive product is inferior to the incumbent, and usually relies on a completely different business model (usually a lower margin one). A disruptive product is almost always cheaper, and in fact usually doesn’t seem competitive at all, at least in the beginning.1

    Competitive (or “sustaining”) products simply try to provide the same function but better. TIVO is a classic example in this space; TIVO’s competitive proposition is that it is a better set top box than the one you get from your cable company:

    • Both the set top box from your cable company (STBFYCC) and the TIVO change channels
    • Both the STBFYCC and the TIVO display a channel guide
    • Both the STBFYCC and the TIVO pause live TV
    • Both the STBFYCC and the TIVO record shows to watch later
    • Both the STBFYCC and the TIVO can be programmed to record a specific show

    The TIVO does a lot more, and does it better, but the differentiation is at the margins. It is a sustaining product, and has serious limitations: getting cable cards is a pain, and the upfront cost is significant relative to STBFYCC. I have no doubt Apple, say, could create a set top box even better than a TIVO; I also have no doubt that it would suffer the same fate.

    So, if a better set-top box is doomed, what might disrupt TV?

    The theory of disruption rests on the idea of “jobs to be done.”2 TIVO does the same job as a set top box; but – and this is the crucial point – the set top box is only a means to an end. What is the job we hire TV to do?

    It turns out there are quite a few. Some of the jobs TV has traditionally done include:

    • Keep us informed
    • Educate
    • Give a live view of sporting events
    • Enlighten and story-tell
    • Provide escapism

    For decades TV was better at each of these jobs than anything else in consumers’ lives. It was in this period of superiority that the present economic system of pay-TV was developed, and, in a world where so many jobs were done by one device, any price was a great deal.

    It’s in jobs-to-be-done, however, where the unbundling that matters is happening. “Keep us informed” is the obvious one: the idea of relying on TV news is so archaic to most of you that I know I raised your hackles by even putting it in that list. Same thing with “educate” – one can learn far more from the web than even the best TV.

    In other words, two of the jobs TV has traditionally done are now done far better, and far more cheaply, by personal devices like computers, tablets, and phones. That is disruption.

    Yet, we pay more than ever for TV; the vast majority of the population gives enough of their attention to some combination of sports, story-telling and escapism to sustain the current model.

    It’s attention that is key; our attention is a zero sum resource – every minute I spend playing a game, for example, is a minute I don’t spend watching TV. And, if any company “cracks” TV, it’s not that they’ve figured out how to do TV better, but that they’ve figured out how to win a greater and greater share of consumer’s attention by doing the same jobs that TV does, but better.

    TV is so entrenched because it’s actually cheap for what you get, it benefits from tremendous network effects, and it’s a default choice for most people. In fact, its entrenchment is not unlike the entrenchment of the PC, which ruled the roost for 25 years: cheap for what you get, tremendous network effects, and Windows was the default choice.

    Ultimately, what disrupted the PC was not a competitive product; even today Windows still has >90% share of PCs. However, Windows commands an ever dwindling share of the time spent on all devices; phones and tablets have taken away attention because they do many of the jobs we previously hired PCs to do – read, draw, music, video, games – better.

    The disruption of TV will follow a similar path: a different category will provide better live sports, better story-telling, or better escapism. Said category will steal attention, and when TV no longer commands enough attention of enough people, the entire edifice will collapse. Suddenly.

    I’d bet on escapism being the next job we give to something else, for a few reasons:

    • The economics of live sports are completely intertwined with the pay-TV model; this will be the last pillar to crumble
    • Networks still play a crucial role in providing “venture-funding” for great story-telling. Netflix is the great hope here
    • Escapism is in some sense indiscriminate; it doesn’t matter how our mind escapes, as long as it does. Yet it’s also highly personal; the more tailored the escape, the more fulfilling. This is why there are hundreds of TV channels. However, there will never be as many TV channels as there are apps.

    Imagine a $993 “console” with an optional $49 controller and an App Store.4 That’s a lot of potential escapism, and a lot of user attention. It’s a lot of margin too, at least at high volumes. I think it’s a space where a company that thinks different could have a “a significant contribution” and “crack” TV by not, in fact, being a TV at all.

    This is a three-part series.

    • Part 1: The Cord-Cutting Fantasy. Getting only the content you want without paying for everything is a fantasy. Pay TV is socialism that works.
    • Part 2: Why TV has resisted disruption. Great content is differentiated, has high barriers to entry, and depends on networks.
    • Part 3: The Jobs TV Does. The key question is attention, not set top boxes. What jobs do we hire TV to do?

    Also see Steve Jobs on TV, my Apple TV prediction, and my Additional Notes on TV

    1. You could get far with the assumption that anything the blogosphere calls disruptive, isn’t. It’s simply competitive ↩

    2. For more on jobs-to-done, check out this article on the Facebook Phone ↩

    3. Or maybe $129? I think Apple would shoot for their traditional 30% margin ↩

    4. Probably the most potent form of escapism is gaming, and within gaming, I would segregate hard-core gaming from casual gaming. The former is mentally strenuous, the latter decidedly less so. Moreover, the hardware costs required to support hard core gaming are prohibitive for many consumers ↩

  • Why TV Has Resisted Disruption

    This is Part 2 of an exploration of what changes, if any, may be coming to TV. Yesterday I examined why cutting the cord yet keeping the shows you watch (i.e. unbundling) was a fantasy. Also, I should note that yesterday and today’s post are very US-centric; more on the international potential in Part 3

    Pay-TV is a good deal for networks, cable companies, and users. It’s socialism that works.

    But what about the content? Isn’t that the point? Free the content from the networks, and at last we can pay a nominal fee to watch what we want on any Internet-connected device.

    Well, yes, it is about the content; in fact, it’s the content that, in my mind, protects the current system from being significantly disrupted.

    Great content has low elasticity of substitution

    Not all Pay-TV is created equal; while filler content is everywhere, it’s truly great content that drives affiliate fees. Look at the most expensive networks on a per-subscriber basis:

    Affiliate fees and CPMs
    Affiliate fees and CPMs
    • Sports is obviously huge here. There is no substitute, and the affiliate fees reflect that
    • Disney Channel and Nickelodeon have fantastic brands; Dora, Mickey Mouse Clubhouse, and Phineas and Ferb1 are the Lakers, Yankees and Cowboys of kids programming
    • TNT, USA, TBS and FX all have original programming with sizable fan bases, and TNT has the NBA
    • FOX News has highly differentiated itself. I’ll leave it at that.

    None of this content is easily substituted, which allows networks to increase affiliate fees, which serves to preserve the current system.

    Great content production has a high barrier to entry

    Sports is, once again, the obvious story here. There is a finite supply of programming, it is rarely time-shifted (which drives advertising dollars – see the right-side of the chart above), and it’s incredibly expensive. At the national level:

    • $4.4 billion a year for NFL rights (beginning in 2014) link
    • $930 million a year for NBA rights (contract ends in 2016) link
    • $800 million a year for MLB rights (beginning in 2014) link

    This doesn’t include the myriad of college sports, nor regional deals. It’s a lot of money that is directly connected to rising affiliate fees.

    But great scripted programming is expensive as well. AMC pays an estimated $2.71 million for an episode of Mad Men, and Netflix paid $100 million for two 13-episode seasons of House of Cards (more on Netflix in a moment).

    Anything that conceivably draws customers away from the pay-TV model will need to have compelling content, and said content has a very stiff price of entry.

    Networks matter just as much as content

    Several folks noted that yesterday’s post focused on networks, not shows.

    I think it does hold water, and I’d actually use Silicon Valley as the analogy: what makes Silicon Valley possible, and so hard to replicate, is not just the presence of startups or willing entrepreneurs; rather, the critical factor is Sand Hill Road. Angels and VCs with substantial war chests and the willingness to make ten deals knowing that nine will fail are essential to what makes the Valley go.

    In the case of TV, networks are the VCs. They pay for expensive pilots and concepts, many of which don’t turn out, and bank on making money on the ones that do. They’re just as critical to great content creation as are the producers, directors, actors, etc. And networks love the affiliate system.

    Netflix is just another network

    Netflix famously pivoted from DVDs-by-mail to streaming, but that was only pivot number one. Pivot number two was their transformation from a content delivery provider to simply another network.

    Think about it: Netflix invests millions of dollars in new TV shows to drive growth, and has reruns and old movies as filler. They’re HBO with a unique delivery system. Or, to fit the analogy, Netflix is just another VC, with a war chest built by a completely different business (the aforementioned discs-by-mail).

    Netflix is unique, but ultimately uninteresting, and unlikely to be replicated.

    YouTube is Kickstarter

    One final analogy: just as Kickstarter lets entrepreneurs forego VCs, YouTube lets content creators forego networks. That’s fine as far as it goes, but the likelihood of a breakthrough hit is low, and if one were to occur, it would likely be snapped up by a network.

    This is a three-part series.

    • Part 1: The Cord-Cutting Fantasy. Getting only the content you want without paying for everything is a fantasy. Pay TV is socialism that works.
    • Part 2: Why TV has resisted disruption. Great content is differentiated, has high barriers to entry, and depends on networks.
    • Part 3: The Jobs TV Does. The key question is attention, not set top boxes. What jobs do we hire TV to do?

    Also see Steve Jobs on TV, my Apple TV prediction, and my Additional Notes on TV

    1. This originally said Phineas and Herb. Oops. Thanks to Mike Byrne for the correction ↩

  • The Cord-Cutting Fantasy

    Predictably, television was one of the first topics Tim Cook was asked about at yesterday’s interview at AllThingsD. This followed the rumors of Yahoo acquiring Hulu, and Microsoft’s entertainment-centric Xbox One launch last week.

    It’s all about TV and the imminent age of cord-cutting. On this the blogosphere is certain.

    Except for one little problem: the economics of cord-cutting simply don’t make sense, for neither networks nor viewers.1 Consider two examples: ESPN and AMC.

    ESPN is the linchpin upon which cable television turns. It’s the sole reason many people have cable, and it’s insanely profitable. The vast majority of that profit comes from affiliate fees paid by cable companies on a per-subscriber basis (unless otherwise noted, all numbers are from this Forbes article that combines information from Disney’s annual report and data from SNL Kagan):

    ESPN FY12 Revenue: $9.4 billion

    • Affiliate fees: $6.1 billion
    • Ad revenues: $3.3 billion

    That’s about $508 million per month in affiliate fees alone, from about 100 million households.

    Last week, ESPN averaged 1.36 million viewers in primetime, which is 9.52 million for the week, or about 40.8 million for the month. I think it’s fair to say that most of those are not uniques, to use Internet parlance. If we assume that the average ESPN household tunes in eight times a month in primetime, then that means about 5 million households watch ESPN a month.

    Let’s assume this is true.2 That means:

    • Every household pays $5.13 per month for ESPN in affiliate fees
    • Only 4.8 percent of households watch ESPN. If ESPN were only available a la carte, each of those households would have to pay $101.60/month for ESPN to achieve the same revenue numbers they do currently
    • The 95.2 percent of households who don’t watch ESPN would only see their cable bills decrease by $5.13 were they able to exclude it

    UPDATE: The ESPN numbers were too low; they are closer to $15/viewer. See the update here

    ESPN is a special case for many reasons, so let’s take AMC, a geek favorite. AMC pulled in 460,000 viewers a night last week, yet earned $196 million in affiliate fees last quarter. If we assume that the average AMC viewer tunes in the same eight times a month, that’s 1.73 million households that watch AMC:

    • Every household pays $0.65 per month for AMC in affiliate fees ($65.3m/100m)
    • Only 1.7 percent of households watch AMC. If AMC were only available a la carte, each of those households would have to pay $38/month in order for AMC to achieve the same revenue numbers they do currently
    • The 98.3 percent of households who don’t watch AMC would only see their cable bills decrease by $0.65 were they able to exclude it

    Both these cases are overly simplified, and make a lot of assumptions, and, crucially, ignore price elasticity: at those a la carte prices, both ESPN and AMC would get a lot less viewers, both decreasing advertising revenue and requiring that much higher of a fee to maintain their current revenues.

    The truth is that the current TV system is a great deal for everyone.

    • Networks earn much more per viewer than would be sustainable under a la carte pricing
    • Networks are incentivised to create (or in ESPN’s case, buy rights to) great programming; making your content “must-watch” lets you raise your affiliate fees
    • Viewers get access to multiple channels that are hyper-focused on specific niches. Sure, folks complain about paying for those niches, but only because they don’t realize others are subsidizing their particular interests
    • Cable companies know the cable TV business, and would prefer to put up with customer disgruntlement over rising prices than become dumb pipes

    Cable TV is socialism that works; subscribers pay equally for everything, and watch only what they want, to the benefit of everyone. Any “grand vision” Apple, or any other tech company, has for television is likely to sustain the current model, not disrupt it directly.

    This is a three-part series.

    • Part 1: The Cord-Cutting Fantasy. Getting only the content you want without paying for everything is a fantasy. Pay TV is socialism that works.
    • Part 2: Why TV has resisted disruption. Great content is differentiated, has high barriers to entry, and depends on networks.
    • Part 3: The Jobs TV Does. The key question is attention, not set top boxes. What jobs do we hire TV to do?

    Also see Steve Jobs on TV, my Apple TV prediction, and my Additional Notes on TV

    1. Update: It’s been pointed out, correctly, that I’m talking about unbundling, not cord-cutting. That’s technically correct. However, I think folks who talk about cord-cutting still want the same content. That’s the fantasy I’m referring too. Still, I regret the imprecision. Thanks to John Feminella for the correction ↩

    2. It’s not; those numbers were prime time only from a random week in May. The total number of households that watch ESPN is surely higher, but that only changes the dollar figure somewhat, not the overriding point ↩

  • Yahoo, Tumblr, and the Signal-to-ads Cycle

    Tumblr is worth far more to Yahoo than $1.1 billion, and worth far less as a standalone company. That makes this acquisition a win-win; Yahoo is buying three important parts of the signal-to-ads cycle, and Tumblr’s investors are getting a nice exit.

    There are three ways to improve advertising revenue:

    • Sell more ads
    • Sell more effective ads
    • Sell better targeted ads

    Tumblr helps Yahoo on all three fronts, particularly the third, where the signal-to-ads cycle really matters.

    Sell more ads

    The most obvious way to grow revenue is to increase impressions, and fill those impressions with ads.

    Tumblr’s nascent radar advertising already has 120 million daily impressions, but they are having trouble filling it, and they haven’t even touched display advertising.

    Yahoo brings one of the largest ad sales teams in the industry to the table, along with the ability to offer advertisers a full spread of campaign options that reach every demographic. It’s a great complement.

    Still, though, increasing the number of ad slots is ultimately deflationary; it doesn’t do much good to sell 20 ads at $1 each instead of 10 ads at $2 each.

    Sell more effective ads

    To this point, there have been two types of online advertising: display and search. Display is what Yahoo is built on, and it’s fine as far as it goes. Actually, it’s not that fine at all: It’s not very relevant, it drives bad behavior, and, as I just noted, it’s deflationary.

    Search ads, on the hand, are much more effective. The best search ads are super relevant, and that relevance drives the price up, not down. Unfortunately for Yahoo, they gave this business to Microsoft.

    However, there is a third form of advertising that is emerging on Twitter, Facebook, and new-generation sites like Buzzfeed: native.

    Native advertising intermingles advertising and content; the advertising is less obtrusive, and, done well, is just as interesting and readable as everything else in your stream.

    When you consider what has worked on other mediums – voiceover for radio, commercials for TV, spreads for magazines – there’s reason to believe this is the future of online advertising. Tumblr is focused on native advertising, and Yahoo now has a toehold.

    Sell better-targeted ads

    The best paying ads are those that directly hit a brand’s demographics and/or are clicked on, and ads are clicked on when they are personal to you. And so, online advertisers need great signals about who you are, where you are, and what you like.

    This information has traditionally been captured by tracking you across the web; think AdSense, or those Facebook ‘Like’ buttons. But mobile has opened a new treasure trove of information, even as it raises new challenges: specifically, sandboxed apps mean the old methods of cookie tracking don’t work.

    Identity, mobile and the signal-to-ads cycle

    The solution to no cookies is identity; as I wrote last week, this is what Google+ is all about. Google builds best-in-class mobile apps that work significantly better when you log in with the Google+ account you didn’t even know you had.

    The result is the signal-to-ads cycle:

    • Information is gathered from first-party sites via analytics, 3rd-party sites via ads, buttons, etc, and owned-and-operated mobile apps tied to your identity (think Instagram)
    • Highly targeted ads are served in search results, display ads, and natively, primarily on PCs
    The advertising targeting cycle
    The signal-to-ads cycle

    Google is pretty far ahead in this game. They provide best-in-class mobile apps, track you across the web, and then monetize you on their search engine, YouTube, Gmail and AdSense. Everything is connected; it’s either signal or ads.

    Tumblr helps Yahoo catch up. Every Tumblr user has registered with an email address; that email address will be the linchpin for Yahoo’s targeting, especially since they gave up on their own identity system a few years back (YAMM – Yet Another Massive Mistake).

    Tumblr is also a great indicator of interests – you follow certain tumbleblogs for a reason, and the fact every blog will be hosted by Yahoo gives them full access to user analytics. More importantly, Tumblr is mobile, and mobile is an information goldmine (interestingly, the Tumblr app does not currently use location services; look for a new “feature” update soon).

    Looking Ahead

    While I think this is a good move, and affirms that Yahoo is an advertising company, they are by no means out of the woods. The fact they don’t control their own search or identity services is absolutely killer, and speaks to how incompetent Yahoo’s past leadership was.

    Here are how the leading advertisers stack up in terms of the signal-to-ads cycle:

    Tumblr checks a lot of boxes
    Tumblr checks a lot of boxes

    Effective online advertising requires strengths in every type of ad, and mastery of every type of signal. That’s why Yahoo, even with all the benefits Tumblr brings them, are still far behind.1

    In fact, only Google has a full set, which suggests that Tumblr may not be the last acquisition in this space; any missing piece in the signal-to-ads cycle dramatically decreases its effectiveness. It’s certainly worth pondering who might be buying, and who might give in to an offer too good to refuse.

    1. Update: Yahoo actually has a decent 3rd-party play with the Newspaper consortium. Not a ton of sites, but relatively high traffic ones. Thanks to Joel Irwin for the tip. ↩

  • The Android Detour

    Today’s I/O keynote was Google in all its glory. Expansive, overly dramatic, nerdy, impressive, self-unaware, exhausting. It’s no accident that, relatively speaking, Android was nowhere to be found.

    Oh sure, there were the usual perfunctory activation numbers, and a new feature or two, and even a product announcement: the native Android Samsung Galaxy S4. But the S4 cost $649; only the Chrome Pixel was given away for free.

    Google is a web company, and the I/O keynote was about the web and web services. Music, photos, search, messaging, Google Now, maps, Google Play game services: all available on the web and/or cross-platform.

    Services are where Google excels, and it’s where they make their money. It’s why they make the most popular iOS apps, even as their own OS competes for phone market share.

    Apple, on the other hand, makes money on hardware. It’s why their services and apps only appear on their own devices; for Apple, services and apps are differentiators, not money-makers.

    Look again at the Mobile Hierarchy of Needs:

    The Mobile Hierarchy of Needs and how Google and Apple make money
    The Mobile Hierarchy of Needs and how Google and Apple make money

    Apple invests in software, apps, and services to the extent necessary to preserve the profit they gain from hardware. To serve another platform would be actively detrimental to their bottom line. Google, on the other hand, spreads their services to as many places as possible – every platform they serve increases their addressable market.

    So what about Android? I remain convinced that Android was, first and foremost, defensive. To own the bottom of the pyramid is to own access to the top, where Google’s profit lies. Android ensured that no one company would ever monopolize the bottom of the pyramid like Microsoft did for PCs.

    In fact, Sundar Pichai said almost exactly that:

    Most of you in this audience have lived through the PC revolution. An incredibly important revolution in our lifetime. It started around 1980, but if you take a look back, for over 25 years, most people in the world used one operating system, which was Windows. And in terms of hardware form factors, it evolved from desktops to laptops over a long period of time.

    This, from Google’s perspective, was a very bad thing. Windows firmly controlled the pyramid, to the detriment of web-based competitors (Hi Netscape!).

    But fast forward to about seven years ago.

    Google acquired Android in 2005 as a defense against Windows Mobile dominating smartphones just as Windows dominated PCs. When the iPhone arrived in 2007, Google quickly pivoted Android to defuse the new threat. And they were hugely successful.

    With the advent of smartphones. there’s been an explosion of devices. Phones and tablets and increasingly new types of devices. People are adopting these devices at an amazing pace because it has a profound impact on their daily lives…the world has changed pretty dramatically just in a span of six to seven years.

    And no one company controls that world, thanks to Android.

    We are very very fortunate at Google to have two platforms…Android, and Chrome… Android and Chrome as I said before are really designed for people to build amazing experiences on top. We at Google are working hard on top of these platforms. We call this the best of Google. We are building products like search, maps, youtube, Google Now, and many more new things that you will hear about later today. So we are working hard on top of these platforms to push the journey of computing forward.

    For Google, Android was a detour from their focus on owning and dominating web services; it ensured that those services would be freely accessible in this new world of computing, including on the iPhones and iPads that were used liberally in nearly every keynote demo. And, now that Android is successful, Google is back to focusing on “the best of Google”.1

    1. This was almost certainly the reason for Andy Rubin’s departure ↩

  • The Facebook Flop

    I’ll admit it: I’m rather enjoying the Facebook Home/First flop.

    First off, it’s always fun to say “I told you so.” Specifically, pre-launch I questioned Mark Zuckerberg’s assertion that people, not apps were the center of our smartphone experience in Apps, People, and Jobs to be Done:

    Apps aren’t the center of the world. But neither are people. [Jobs are.] The reason why smartphones rule the world is because they do more jobs for more people in more places than anything in the history of mankind. Facebook Home makes jobs harder to do, in effect demoting them to the folders on my third screen.

    Second, this flop was in many ways a validation of what I want to accomplish with this blog: highlight all the factors beyond product features that go into the success or failure of a product. Things like brand, marketing, channel, distribution, strategic positioning, retail experience, etc. With regards to the Facebook Home, and the HTC First in particular:

    This stuff matters just as much as the product itself (it’s why, for example, I think it doesn’t matter that the Galaxy S4 design stinks).

    Third, this entire episode exposes the cavalier way too many in technology approach design. Look, I’m glad we all agree that “Design isn’t how it looks, it’s how it works.” But that’s not enough.

    Design is about identifying, understanding, and ultimately feeling your end users’ needs, and then meeting those needs. Facebook Home, like countless SV startups, looks beautiful, works elegantly, and doesn’t meet any needs.

    (Actually, that’s not strictly true: Facebook Home happens to perfectly align with Facebook’s business-model-driven need to monopolize user attention. User needs, not so much. An immediate red flag.)

    There are really only two proven methods for building breakthrough consumer products:

    1. Build something to meet your own needs and find a market with the same needs
    2. Find a market, then do real, qualitative, ethnographic-driven research that lets you truly empathize with said market and understand their needs

    Notably missing from this list is build something pretty for a platform you don’t even use.

    Facebook didn’t realize just how important widgets, docks, and app folders were to Android users, and that leaving them out of Home was a huge mistake. That’s because some of the Facebookers who built and tested Home normally carry iPhones, I’ve confirmed. Lack of “droidfooding” has left Facebook scrambling to add these features, whose absence have led Home to just 1 million downloads since launching a month ago.

    That’s not design; it’s a glorified art project.

  • Adobe’s Subscription Model & Why Platform Owners Should Care

    It’s difficult to overstate the significance of Adobe’s announcement that all of their products will be solely available through Creative Cloud. No longer can you buy packaged version of Photoshop, for example, that are yours forever. Instead you can subscribe to different individual apps or suites. What makes this so interesting is that while companies come out with new products all of the time – this is the 20th version of Photoshop! – very rarely do they come out with new business models.

    There are several obvious reasons for this move:

    • Smoother revenue streams are much more preferable than launch-driven spikes (just ask Apple!)
    • This will significantly reduce piracy (although that may have unintended consequences)
    • Just as it’s easier to sell to your existing customers, rather than get new ones, it’s easier still to ensure existing subscribers don’t unsubscribe

    However, there are a couple of bigger picture factors at play as well.

    The PC as Humpty Dumpty

    As I noted yesterday, the jobs we hire a PC to do are being increasingly done by dedicated devices. If Adobe wants to be relevant in a world where users interact with as many as five different devices in a day, then a per-device licensing model is clearly unsustainable.

    Enter the SaaS model. Users can use Adobe products on as many devices as they wish. It is, ultimately, an obvious and necessary shift, and kudos to Adobe for doing it. (Update: You can only use the apps on two PCs, and you still have to pay for the tablet apps. Still better than now, but “kudos” should probably be singular – kudo?)

    Even so, their aggressiveness – there will be no more packaged software, period – seems surprising, but the truth is Adobe is probably thrilled with their new model.

    The Problem With Monetizing Productivity

    Productivity apps have never been a good fit for the packaged software model.

    The reason has to do with what is called Economic Surplus. From Wikipedia:

    Economic surplus refers to two related quantities. Consumer surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay. Producer surplus is the amount that producers benefit by selling at a market price that is higher than the least that they would be willing to sell for.

    I’ve illustrated what this looks like for packaged software:

    Productivity apps sold as packaged software have a lot of surplus
    Productivity apps sold as packaged software have a lot of surplus

    Imagine how this plays out for Photoshop:

    • Consumer A rarely edits photos, which means a photo-editing app is worth maybe $20 to him. Yet, he buys Photoshop anyways for $499. In this case, Adobe is, in effect, charging $479 too much.1 The consumer is getting a bad deal.
    • Consumer B is a graphic designer. She uses Photoshop every day, for hours a day. Without Photoshop, she couldn’t do her job, for which she is paid $60,000 a year. In this case, there is a consumer surplus of $59,501. Adobe is getting a bad deal.
    • Consumer C is a student. He has aspirations for being a photographer, but is just getting started. He buys Photoshop, but finds it very hard to use; in fact, he is losing time trying to figure it out. Yet, over time, he becomes proficient, and eventually an expert. The economic surplus shifted from producer to consumer, even though there was no transaction.

    How do you price a product to best monetize these three very different consumers? If you price too high, you may never acquire Consumer A or C (And Consumer C is a big loss). If you price too low, you are effectively subsidizing your consumers, which may make them feel warm and fuzzy, but not your shareholders.

    Why Subscriptions Are Better

    Moving to a subscription vastly improves this model, for both users and Adobe.

    The subscription model more closely matches revenue with value, meaning less surplus.
    The subscription model more closely matches revenue with value, meaning less surplus.

    Consider again the three types of consumers I listed above:

    • The price is much more approachable for Consumer A.2 He can “try out” Photoshop, and if he ends up not using it, he can simply end his subscription. More importantly, there will be a lot more Consumer As, and some of them will stay subscribed.3
    • Consumer B will get a great deal right off the bat, but as she uses Photoshop throughout her career, Adobe will be along for the ride, making revenue every month as opposed to every few years.
    • Consumer C is similar to A: Photoshop will be much more approachable, and there will be a lot more Customer Cs. As they become real users, Adobe moves with them.

    Moreover, Adobe is well-incentivised to maintain the app to reduce churn, and users always have the most recent version. It really is a win-win.4

    Thinking About Apps

    The challenges facing Adobe are shared by almost all productivity apps.

    • Productivity apps are indispensable (and thus priceless) to some users
    • Productivity apps usually have high learning curves
    • Well-done productivity apps require significant investment up-front
    • Productivity apps require regular maintenance and upgrades

    Unfortunately, app store economics don’t really work here.

    • If you have a low price, you need massive volume to make up for the upfront costs
    • If you have a high price, users are much less likely to buy your app, especially since there is likely a learning curve
    • If you can’t monetize over time, your users are extracting MUCH more value than you are receiving in revenue. That’s great if you’re a user, up until the company you love sells out because they can’t make money. Sparrow is the canonical example here. How many Sparrow devotees would gladly pay $5 a month to have the app available and continually updated?

    Trials do ameliorate the pain a little, particularly if you pursue the high price option, but they don’t address the time mismatch: as a productivity app becomes more valuable, the developer doesn’t get a dime of more revenue.

    Why Platform Owners Should Care

    For the most part, I tend to turn a deaf ear to developer griping about App Store policies. The purpose of iOS, Android, Windows Phone, etc. is not to make developers’ lives easy; it’s to attract users for the purpose of making money for Apple, Google,5 and Microsoft, respectively. Adopting developer-friendly policies only makes sense to the extent it will attract more users, and most of what developers want doesn’t qualify.

    This is an exception. Platform owners should add subscription support for productivity apps.6

    What makes monetizing productivity apps so tricky is that they are indispensable to some consumers, yet overwhelming to others. It’s that indispensable part, though, that should matter to platform owners. If a user comes to depend on certain productivity apps that are only available on one platform – and, in general, mobile productivity apps are much more likely to be monogamous – then that user is effectively bound to the platform, and won’t even consider another platform when it comes time to upgrade.

    The opportunity for growth in smartphones is increasingly previous-smartphone owners (as opposed to new smartphone owners). Keeping those owners around should be a top priority for every platform, and one of the best ways to do so is fully supporting a subscription model for productivity apps. It will make them more successful and thus stickier, ultimately to the platform’s long-term benefit.

    1. Were Adobe willing to sell at their marginal cost (which for software is effectively $0) + consumer value, the producer surplus would be $479 ↩

    2. To be fair, it’s significantly cheaper to pay annually, which defeats some of the advantages ↩

    3. A lot of Consumer As buy a version of Photoshop and hold onto it for years. They are understandably upset by this change, but the truth is Adobe probably doesn’t mind losing them, given the other benefits of subscriptions ↩

    4. So why did Adobe wait so long? Truthfully, the technology just wasn’t there until the past few years ↩

    5. Well, Android is more ambiguous ↩

    6. Apps can obviously implement this on their own on the server, but that’s impractical for many small shops that specialize in these types of apps. I’m talking about full-blown app store support. ↩

  • The Intel Opportunity

    A new CEO has taken over Intel. Their core business, upon which the company has been built, is floundering. Does the new CEO, who is not really new at all (he’s the current COO), have the vision to ensure Intel’s continued success?

    I’m not talking about Brian Krzanich, who today was promoted from COO to CEO at Intel. Rather, I’m talking about Andy Grove, who took over Intel in 1987.

    Intel’s Identity Crisis, v1

    Intel originally found success as a memory manufacturer. It’s 1103 chip was the first commercially available DRAM memory, and the DRAM business led massive growth throughout the 1970s.

    By the 1980s, though, it was the microprocessor business, fueled by the IBM PC, that was driving growth, while the DRAM business was fully commoditized and dominated by Japanese manufacturers. Yet Intel still fashioned itself a memory company. That was their identity, come hell or high water.

    By 1986, said high water was rapidly threatening to drag Intel under. In fact, 1986 remains the only year in Intel’s history that they made a loss. Global overcapacity had caused DRAM prices to plummet, and Intel, rapidly becoming one of the smallest players in DRAM, felt the pain severely. It was in this climate of doom and gloom that Grove took over as CEO. And, in a highly emotional yet patently obvious decision, he once and for all got Intel out of the memory manufacturing business.

    Intel was already the best microprocessor design company in the world. They just needed to accept and embrace their destiny.

    Intel’s Identity Crisis, v2

    Intel reaped the benefit of Grove’s repositioning for 25 years. Their chip designs were the foundation of the PC era, and while they faced nominal competition from AMD, they gained many of the economic benefits of a monopolist. But for a brief spell around the turn of the century, a “good” computer required an Intel chip, and they charged prices befitting their place in the PC value chain.

    Throughout the PC period, Intel invested heavily in their chip design. They learned the lesson of DRAM, and were determined to never be commoditized; their microprocessors would always be superior performers.

    The problem with setting such ambitious goals, of course, is that you are usually successful. Intel chips have no rival when it comes to PC performance; unfortunately for Intel, PCs are in decline. Mobile devices, such as phones and tablets, are in ascendance, and there Intel’s core strength in all-out performance is a 2nd-order consideration. Power consumption is critical, as well as custom logic for specific functions such as graphics and media decoding. General purpose performance is nice-to-have.

    Intel’s identity as a chip designer is increasingly irrelevant.

    The Commodification of Chip Design

    Most chip designers are fabless; they create the design, then hand it off to a foundry. AMD, Nvidia, Qualcomm, MediaTek, Apple – none of them own their own factories. This certainly makes sense: manufacturing semiconductors is perhaps the most capital-intensive industry in the world, and AMD, Qualcomm, et al have been happy to focus on higher margin design work.

    Much of that design work, however, has an increasingly commoditized feel to it. After all, nearly all mobile chips are centered on the ARM architecture. For the cost of a license fee, companies, such as Apple, can create their own modifications, and hire a foundry to manufacture the resultant chip. The designs are unique in small ways, but design in mobile will never be dominated by one player the way Intel dominated PCs.

    The Rise of Manufacturing

    It is manufacturing capability, on the other hand, that is increasingly rare, and thus, increasingly valuable. In fact, today there are only four major foundries: Samsung, GlobalFoundries, Taiwan Semiconductor Manufacturing Company, and Intel. Only four companies have the capacity to build the chips that are in every mobile device today, and in everything tomorrow.

    Massive demand, limited suppliers, huge barriers to entry. It’s a good time to be a manufacturing company. It is, potentially, a good time to be Intel. After all, of those four companies, the most advanced, by a significant margin, is Intel. The only problem is that Intel sees themselves as a design company, come hell or high water.

    Back to the Future

    Today Intel has once again promoted a COO to CEO. And today, once again, Intel is increasingly under duress. And, once again, the only way out may require a remaking of their identity.

    It is into a climate of doom and gloom that Krzanich is taking over as CEO. And, in what will be a highly emotional yet increasingly obvious decision, he ought to commit Intel to the chip manufacturing business, i.e. manufacturing chips according to other companies’ designs.1

    Intel is already the best microprocessor manufacturing company in the world. They need to accept and embrace their destiny. 2

    1. Of course they keep the x86 design business, but it’s not their only business, and over time not even their primary business ↩

    2. Hopefully Krzanich is as inspired a choice as Grove was; in fact, he may have to be even better. The transition I’m calling for will be harder than 1987. That transformation was from a low margin volume business to a high margin one; Wall Street loves that. To go in the opposite direction will take incredible intestinal fortitude ↩

  • The Truth About Windows Versus the Mac

    Ben Evans wrote the article I’ve been wanting to write about why the phone market is fundamentally different than the PC market. I’m glad he did; his version is even better that what I had outlined. A quick taste:

    In the 1990s, the PC market was mostly a corporate market (roughly 75% of volume). Corporate buyers wanted a commodity…Meanwhile with no internet, home buyers were mainly interested in a PC that ran the same software they used at work (and all of the games were for PC).

    Hence, in this market all of Microsoft’s advantages were in play, and none of Apple’s. Apple, in Steve Blank’s phrase, did not have product/market fit. The Open model deployed by Microsoft and Intel produced a generic commodity product that was exactly what the market wanted: Apple’s model did not. Fundamentally, Apple’s selling points were irrelevant, invisible or both.

    It’s a must-read; I agree with every word.

    There is one more point worth adding, in the interest of putting this myth that phones = PC’s fully to bed. Specifically:

    Apple didn’t lose the PC market to Microsoft; they never owned it in the first place.

    You’ve heard the phrase, “No one ever got fired for buying IBM.” That axiom in fact predates Microsoft or Apple, having originated during IBM’s System/360 heyday. But it had a powerful effect on the PC market.

    In the late 1970s and very early 1980s, a new breed of personal computers were appearing on the scene, including the Commodore, MITS Altair, Apple II, and more. Some employees were bringing them into the workplace, which major corporations found unacceptable1, so IT departments asked IBM for something similar. After all, “No one ever got fired…”

    IBM spun up a separate team in Florida to put together something they could sell IT departments. Pressed for time, the Florida team put together a minicomputer using mostly off-the shelf components; IBM’s RISC processors and the OS they had under development were technically superior, but Intel had a CISC processor for sale immediately, and a new company called Microsoft said their OS – DOS – could be ready in six months.2 For the sake of expediency, IBM decided to go with Intel and Microsoft.

    The rest, as they say, is history. The demand from corporations for IBM PCs was overwhelming, and DOS – and applications written for it – became entrenched. By the time the Mac appeared in 1984, the die had long since been cast. Ultimately, it would take Microsoft a decade to approach the Mac’s ease-of-use, but Windows’ DOS underpinnings and associated application library meant the Microsoft position was secure regardless.

    Evans is correct: the market today for mobile phones is completely different than the old market for PCs. And, so is Apple’s starting position; iOS was the first modern smartphone platform, and has always had the app advantage. Neither was the case in PCs.

    The Mac didn’t lose to Windows; it failed to challenge an already-entrenched DOS. The lessons that can be drawn are minimal.

    1. Sounds familiar! ↩

    2. In fact, they didn’t even have an OS. They acquired the foundation and built it to order ↩

  • Two Bears

    In fact, Evans wrote two bear arguments.

    Bear Argument #1

    Bear Argument #1 is the imminent collapse of the iPhone in the face of significantly lower-cost alternatives:

    As the industry moves on from converting featurephone buyers to fighting for replacement purchases, what happens to value? Growth for any given manufacturer necessarily becomes a matter of taking sales away from other smartphone manufacturers, not featurephone manufacturers (i.e. Nokia). Moreover, Moore’s Law is at work, driving down prices; you can now get a 4.5″ dual core Android phone from Huawei for just $200, and one from a generic Chinese manufacturer for $120-$150.

    This is clearly a challenge for any handset OEM, but especially for one at the high end. There are fewer and fewer new high-end buyers coming into the market and the ones you sold to in the past may increasingly be tempted by ever improving cheaper phones. So a high-end phone maker risks losing sales if it stays at the high-end, or losing margin if it makes cheaper phones, or both.

    In case it isn’t obvious, this is the essence of the bear story for Apple.

    Bear Argument #2

    Bear Argument #2 is the end of growth for the iPhone:

    Smartphones sales may be approaching saturation (especially in the USA), but iPhone sales at the end of 2012 were just 10% of global phone sales – and 17% of global contract sales, which is more relevant since it reflects the subsidised market (of course, the possible decline of subsidies is another, rather separate bear story for any handset sold for over $200).

    Is 17% the total potential market for a premium phone? Will market share only move from $600 phones to $300 phones, and never the other way? That might be the case if phones were fungible commodities, but they clearly aren’t – otherwise $600 Android phones wouldn’t sell at all. It is entirely possible that the premium phone market is here to stay, and that it could expand significantly.

    In this case, the iPhone has saturated the high end, and while current iPhone users replace their iPhones, their overall numbers don’t increase significantly.

    To my mind, this is the far more reasonable position. iPhone penetration seems to closely track carrier average revenue per user:

    iOS Browser Share Roughly Tracks Carrier ARPU — Click for original article
    iOS Browser Share Roughly Tracks Carrier ARPU — Click for original article

    The largest remaining carrier without the iPhone – China Mobile – is solidly on the right side of that graph, along with most of the other high-growth countries. Apple may need to produce a lower-cost iPhone to compete, which will of course put significant pressure on their margins. It’s fair to ask if iPhone profit growth has peaked.

    Only Bear Argument #2 Makes Sense

    Bear Arguments #1 rests on the assumption that the iPhone is competing on hardware, and is therefore susceptible to lower-cost alternatives. However, the iPhone is not simply a device. Rather, it’s a ticket into an ecosystem (characterized here as the Mobile Hierarchy of Needs):

    The Mobile Hierarchy of Needs - click image for original article
    The Mobile Hierarchy of Needs – click image for original article

    This ecosystem is sticky, and users want to stay. According to the Yankee Group:

    Of those surveyed, 91 percent of iPhone owners intend to buy another iPhone, while 6 percent plan to switch to an Android device with their next purchase. In other words, more than nine out of 10 iPhone owners are loyal to the platform. Once you buy an iPhone, chances are high you’re going to buy another.

    That’s not quite as true for Android. Yankee found that 76 percent of Android owners intend to buy another Android phone. A big number, sure. But it means that 24 percent of Android phone users plan to switch to another platform. Guess where the majority of those professed switchers are going — 18 percent to iPhones.

    Current iPhone customers aren’t going anywhere, even if Android continues to fall in price.

    Almost all industries have two tenable positions: the differentiated high-end, and the low-cost low-end:

    Sustainable Competitive Advantages
    Sustainable Competitive Advantages

    The iPhone faces little threat in the differentiated high-end of the market. Suggesting this market is limited in size is fair; counting the days until customers flee for cheap phones is silly.1

    The Bear Argument for Samsung

    That’s not to say that Bear Argument #1 is invalid; in fact, it’s the Bear Argument for Samsung.

    There is precious little that differentiates high-end Android from low-end Android. The second, third, and fourth layers2 of the mobile hierarchy are identical; the difference is the hardware, and not only are low-end devices increasingly “good enough,” they’re also impossibly cheap.

    I’ve written previously about MediaTek, the Taiwanese chipmaker that dominates this space, but Qualcomm wants a piece as well. From (always questionable) Digitimes:

    Qualcomm and Spreadtrum Communications have both cut prices for their quad-core products to better compete against MediaTek, which controls half of the smartphone-chip market in China, according to industry sources.

    Qualcomm recently quoted its quad-core solutions at less than US$10, slightly cheaper than MediaTek’s offerings, the sources indicated. Meanwhile, Spreadtrum has lowered its quad-core processor prices to similar levels. Both firms are trying to gain market share through aggressive pricing, the sources said.

    Chinese OEM’s you’ve never heard of are making millions of smartphones using these chips. The largest of these is China Wireless. From Bloomberg:

    China Wireless Technologies Ltd., the nation’s third-largest smartphone vendor, said it will eventually overtake market leaders Samsung Electronics Co. and Lenovo Group Ltd., helped by demand for low-cost phones.

    A 50 percent surge in smartphone shipments will allow China Wireless to pass Lenovo for the No. 2 spot this year, while catching Samsung will take longer, Chief Financial Officer Jiang Chao said in a Bloomberg Television interview yesterday…

    Total smartphone shipments in China will rise 44 percent to 300 million units this year, driven by handsets costing about 700 yuan ($113), researcher IDC forecast in December. Demand is surging as China Mobile Ltd., the world’s largest carrier by subscribers, aggressively encourages users of second-generation networks to upgrade to third-generation service with low- and middle-end smartphones. China Wireless, formed in 1993, has sold phones through China Mobile for a decade.

    $10 chips, $113 dollar phones. No differentiation in software, apps, or services. Samsung actually sells most of their devices on the low end, but this low?

    While the iPhone may have plateaued, it’s Samsung that should be worried about a cliff.

    1. To be clear, from conversation, I don’t think Evans subscribes to this theory, but others do ↩

    2. In fact, the fourth layer, especially in China, is very differentiated, but that is (mostly) to the benefit of users ↩