Worst. Article. Ever.

This Washington Post article is so bad, so extremely bad, so incredibly bad, that I don't even know where to begin describing it's extreme badness. I don't use words like "idiot" lightly, but, well, here I feel really really tempted.

First, the summary:

But the Internet has changed all that in one crucial respect that wouldn't surprise Coase one bit. To an economist, the "trick" of the Internet is that it drives the cost of information down to virtually zero. So according to Coase's theory, smaller information-gathering costs mean smaller organizations. And that's why the Internet has made it easier for small folks, whether small firms or dark-horse candidates such as Howard Dean, to take on the big ones.

For all Dean's talk about wanting to represent the truly "Democratic wing of the Democratic Party," the paradox is that he is essentially a third-party candidate using modern technology to achieve a takeover of the Democratic Party. Other candidates -- John Kerry, John Edwards, Wesley Clark -- are competing to take control of the party's fundraising, organizational and media operations. But Dean is not interested in taking control of those depreciating assets. He is creating his own party, his own lists, his own money, his own organization. What he wants are the Democratic brand name and legacy, the party's last remaining assets of value, as part of his marketing strategy. Perhaps that's why former vice president Al Gore's endorsement of Dean last week felt so strange -- less like the traditional benediction of a fellow member of the party "club" than a senior executive welcoming the successful leveraged buyout specialist. And if Dean can do it this time around, so can others in future campaigns.

Let's begin with Coase. Coase's primary insight on "The Size of the Firm" was that costly transactions may be easier to do in a centrally planned economy (a company) instead of a market economy. Note that the Internet means smaller companies -- lower information transaction costs do just as much for a large company's internal efficiency as it does for a small company's ability to compete. Ron Coase understands things that remain perfectly opaque to Everett Ehrlich, who perpetrated the article.

Secondly, the article is on crack regarding the viability of third party candidates. In the US, because of the winner take all nature of the presidential contest, there will only be two political parties, and if an independent does run, it will hurt the major party that most closely aligns with his ideology. Perot hurt Bush, just as Nader hurt Gore. The notion that "finally, in the next six or eight presidential elections, a third-party candidate will win the presidency" imagines that a Nader type candidate will grow stronger and stronger as he runs again and again (leading to ever more dramatic Republican victories each time) until he suddenly breaks through and swings the Presidency far left is hallucinatory. A vote for Nader was a vote for Bush in 2000, and will be again in 2004 if Nader chooses to run as an independent again. (Note to Ehrlich -- this will be true FOREVER).

Thirdly, while it is certainly true that the Internet allows more special interest groups to coordinate, it is not clear how this is a good thing. Special interest groups expend resources vying for government favors that benefit them but harm society as a whole. Having more of them may mean that each group is individually weaker (which may be good) or that there are simply more pigs at the trough (which is probably bad) but special interest groups are not going to Save America, and anyone who thinks that they are has not been paying close attention to the corrosive effect that lobbying has on good governance, which is to say has not looked at the functioning of normal government at all.

The core idiocy in the entire article is the belief that somehow The People are just not being listened to, and if they were listened to then everything would be All Better, and the Internet will force people to Listen To The People. Here on planet earth, the two party system is a result of extremely careful arithmetic, which results in third party candidates hurting the party they are affiliated with by dividing their vote, and politicians respond to the demand of their local constituents who happen to be in swing districts and so need to be listened to, and the Internet will not to anything to change that.

So, who is Everett Ehrlich? The byline says he is senior vice president and director of research for the Committee for Economic Development, and that he was undersecretary of commerce for economic affairs under President Bill Clinton. *Phew*. No one consequential.

Now Microsoft too

I wrote that it was all over when HP entered the digital music distribution game. Given that incumbents are making zero or negative margins distribution DRM'd singles, and that existing IP laws suggest this won't change any time soon, entrants gunning for this market are either desperate, or have more money than sense. I would put HP in the former category, but MSFT is definitely in the latter. (Link via the consistently excellent Tomalak's Realm)

Inch scale vs. Foot scale

This gizmodo article points to two pieces arguing that since new smartphones have so much functionality, they may replace laptops. This is wrong. Post-It notes have as much functionality as legal pads, and yet we don't see one replacing the other. People want to do some tasks at the "inch-scale" and others at the "foot-scale" and that's all there is too it. Mark Weiser, and other people in the ubiquitous computing arena, have understood this since Parc. It's as true today.

Direct to iTunes

The Red Hot Chilli Peppers have released their "Greatest Hits" album on iTunes. It's interesting that their management agency initially tried to stop this, arguing that per-track online sales should be discouraged to preserve the album format. Albums are valuable because they 1) bundle tracks (to increase the overall willingness to pay) and 2) increase profits by making the physical media distribution more efficient. Digital per-track sales erode both of these effects. It's worth thinking about what the "single" based music act looks like -- more experimentation? More one-off collaboration? More corporate sponsorship?

"A touching faith in arithmetic"

There is so much hot air in the media about which political party truly represents the people etc., that it is great to see the actual numbers that drives elections and therefore policy. Not that I don't think the hot air has a use -- I would not want those passions expended anywhere else.

Great news!

Saddan Hussein has been captured!

Steve vs Arnold

Rolling Stone has a nice interview with Steve Jobs where he talks about his discussions with the labels regarding the contracting terms around iTunes music store.

He's being polite when he says that the labels can pick musicians, but aren't good at technology, because I'm not sure how good they are at picking acts (by the same token, VC's only have about 1 great company in 10, so I'm not sure what the right base rate is).

Arnold Kling is unimpressed by the interview. He does not believe that record companies invest in unknown artists the way Jobs claims they do. He says that unlike VCs, record companies do not give big up front advances to unknown artists.

I think this is unfair. Firstly, record companies do at the very least finance artists at a rate better than other sources, we know this because artists go to labels for backing instead of borrowing money from a bank and paying for their own act. Secondly, labels do put big money behind albums, and there have been notable busts there. The money might be going into failed albums, not failed bands. Arnold argues that the distribution costs of moving plastic around are the big cost, but I am skeptical. There are plenty of goods, of similar size, weight, volume, and fragility, available on the shelves for far less than CDs. If the distribution portion of the cost is the same, why is the price so different?

The fat lady just sung

An old-ish story now, but HP is entering the online music distribution business, just like Dell, Apple, and a host of others. I don't know how they think they are going to make any money doing this, but they are desperate these days and probably willing to try anything.

It's kinda like Gateway entering home electronics -- why do they think they will succeed?

New Time religion

My buddy RE sent me links to three speeches by Michael Crichton. It seems that Crichton has had good scientific training and thought about what science actually is, and, as a result, has very uncomplimentary things to say about what some branches of it are up to now.

For example, Crichton argues that science has proven that DDT is not harmful, religion has caused it to remain banned even though this results in the death of millions from malaria. Similarly, the jury is out on global warming through greenhouse gases, but people want to destroy 5% of GDP fighting the "problem" by delaying emissions by 6 years. Rationality cannot explain this behavior, on totemic, unshakable belief, so Crichton rightly calls it religion.

Three links:
Environmentalism & junk science

Global warming

The inanity of the media

I think he's being a little unfair to the media though -- there has been no decline, they've always been inane. Orson Scott Card has a good essay on the consequences of this current flavor of media inanity.

Presence

This post scoffs at technology that replicates the actions of an individual at a distance to create the illusion that they are there via "connected furniture". I think that presence, the feeling that someone else is near, is valued by people.

I heard about some doo-hickey in Japan (where else) that connects an electric kettle to a light, so relatives can tell when their grandparent is making themselves a drink. I actually think this is pretty neat. In addition, most of the value I get from IM is the little green lights letting me know my friends are just a click away.

Forecasting happiness

Economists use the term "happiness" (or "utility") to explain why people make the choices they do. A person picks A over B because A makes them happier than B.

Behavioral economics questions some of the logic behind this by pointing out that people are often disappointed after making their choices, and feel let down after their initial expectations were too high ("buyers remorse").

It's hard to know what to do with these findings. One of "Thaler's Rules" (U Chicago behavioral economist Dick Thaler, my former teacher, had a bunch of rules that served as memonics) was that "If you spot a bias, de-bias. If you can't de-bias, re-bias". Applying that to correcting "buyers remorse" leads you to some peculiar places.

If people recalibrate their increased happiness after a raise or winning the lottery back down to normal, then it means that, broadly speaking, having more money does not make you any happier. This is not an argument for higher wealth redistribution though, because any increase in consumption for poor people through transfers does not make them any better off either! Indeed, if individuals cannot be made better off by more, maybe the best thing would be zero redistribution, because then at least society as a whole would have the maximum ability to produce new things that you could use to pay for healthcare. (Everyone prefers being alive and healthy to being sick and dead).

Musicians go it alone

A nice piece in, of all places, American Airline's inflight magazine, outlining how some small musicians are making a reasonable living off live performance, direct album sales, and merchandise. If their music is distributed online, well, that's just valuable free advertising.

Tellingly, I have not heard of any of the artists profiled. File trading alone is not a good way to build visibility -- you need promotion (like being written-up for inflight magazines) as well.

Thankless work

I'm amazed that Ken has the stamina to trawl through editorial pages, score op-eds, and then keep records. But it's data like that which makes his rebuttal to Brad DeLong so solid. Brad argues that since the Economist only named one Krugman critic (Ken) and hinted at others, their claims are baseless since (presumably) Brad can name many supporters. But Ken isn't just any critic, he's systematically recorded 372 (372!) columns and this is how the numbers turn out. If you don't like them, run your own numbers, but you can't dismiss (or confuse) this sort of data collection as opinion.

(I will add that Krugman's stock had fallen very low at U Chicago amongst those who knew that supply curves sloped up, and demand curves down. By the time I graduated, he had become a joke.)

It's worth thinking about opinion. I am no expert on this subject, but I've been to enough debates to know that, well, debates don't change anyone's mind about anything. Neither side, nor spectators, come away thinking anything different from what they felt going in.

So if arguing does not work, what does? My personal hobby horse these days are bets -- after all, if the other guy is such an idiot surely you can get some money off him, and if it turned out you were wrong, well, consider it paying for knowledge, always a worthy transaction.

One way to think of the way Reagan won the Cold War was as a bet -- communists believed (as many people still do) that a centrally planned economy outperforms a market economy and Reagan believed the opposite. This was a bold belief at the time, btw, as conventional wisdom was firmly on the USSR's side. The way Reagan placed the bet was through an arms race that would bankrupt the less productive economy over time. He won the bet.

I don't know what the central bet is between Islamic fanatics and the free world, but thinking about that clearly is probably a better way to understand what's going on and avoiding futile arguments.

Happy Thanksgiving

To all US readers -- Happy Thanksgiving!

Bloggers and politics

Andrew Sullivan has a good piece outlining how Dean's campaign used the Internet to bypass the DNC and built a cheap, grassroots machine to drive the very successful campaign. Sullivan thinks this trend is good for Democracy:

That means real dynamism in the campaign next year. With the web operation in place, a burst of enthusiasm after an early primary win could mean an instant infusion of web cash that could then cover a key state with advertising and keep the momentum going. One good showing in a debate and, again, the response is instant. This insta-democracy could well have its disadvantages, of course. It could remove some of the barriers that deliberately slow democratic decision-making to avoid too much fad and not enough substance. But there is no denying its power"

Firstly, I must admit that I am less impressed by current democratic decision-making than Sullivan because I don't believe that making it more faddy and less substantive would alter it in the least. Indeed, I don't think anyone would even be able to tell the difference.

Secondly, while the Internet is good at making activist voters contribute money, I would try to be realistic about how much influence money really has on elections in the US. (U Chicago economist Steven D. Levitt has tried to quantify it here (.pdf) -- hint: it's pretty small). And while these online activists bring cash, they also bring ideological baggage that would be harmful in a genuine election. Given voter participation rates in the West, anyone thinking about or supporting politicians 18 months before the election is clearly an outlier.

Lastly, it would be nice if people just dropped the pretension that democracy can somehow be improved by "bringing it closer to the people" or "getting people more involved" or whatever the power-to-the-people sentiment of the day is. Ken Arrow (U Chicago, econ, nobel prize) mathematically demonstrated that voting systems simply cannot be perfect because it is impossible to produce a decision, through polling, that is intransitive. The fact that Nader supporters voted for Bush is a fundamental feature of the system, not some aberrant flaw. Given that the election winner is an artifact of the voting schedule, you have to wonder how the quality of the inputs matters much one way or the other. This is without going into the fact that, given how unimportant the marginal vote is, and the tremendous disutility associated with listening to politicians drone on and on, and only rational decision is to ignore the whole business. Empirically, this is also the popular choice.

I don't think the web nature of Dean's campaign is revolutionary in the way people seem to think it is, because I don't believe that the "authentic", "grassroots" support it has is anything more than a new special interest group that can now work the system. I think it will help and hinder Dean to the same extent any special interest group helps or hinders a candidate.

Three cheers for ESR

Eric Raymond has finally completed "The Art of Unix Programming". It's a pity O'Reilly did not publish it -- I'd be interested to find out why.

Cellphone pricing

With number portability set to hit this Monday, and the fact that Sprint cannot reach my new basement apartment Boston, I've been looking into getting a new carrier, along with a new phone and plan.

It's been very complicated. The plans themselves are so difficult to understand, that I feel like I'm buying an airline ticket.

Perhaps this is because the cellular phone business is like the airline business. David Anderson, who I've known for a while, has written a good piece outlining why this is so. Essentially, David points out that a wireless network, once built, is a sunk cost and that only the variable costs associated with utilizing that network should be considered -- and they happen to be zero. This is like airlines in that the planes are sunk but empty seats cost the airline money, so airlines should be built around maximizing capacity utilization -- ie. having planes filled with passengers in the sky at all times.

This model applied to phones would focus on getting 1) maximum revenue per customer and 2) getting the customer to use the phone as much as possible. So, when designing phone services and figuring out how to price them, we move from cost/megabyte to revenue/subscriber communication.

Camera phones seem to be popular now, and actually I think they are pretty cool myself, but I would prefer a simple phone with long battery life and ubiquitous reception. It seems that building out reception is actually expensive compared to getting people to shove more data through the pipe they already have, all wrapped around complex pricing schemes, so I don't think I'll see my ideal phone any time soon. Pity.

Mutual Fund Scandals

Three cheers for Michael Lewis. Lots of people at U Chicago reckon that mutual fund managers aren't worth the money, and have run lots of numbers looking for places where they earn their keep. They don't find any. More worryingly, this seems to also be true in the private equity business, except some people there actually do seem to outperform but then take all that performance back through hefty fees, bonuses, and salaries. Good for them, not so good for the investor. Is it any wonder that most of my classmates were very excited about PE jobs and less interested in the mutual fund business?

Michael Lewis nails the real scandal in the mutual fund industry -- that people waste their money investing in them at all. The really smart money is in the "carry" ("carried interest") of very competant investors who supplement their skills with institutional cash. These guys outperform, and pocket their winnings. The rest of us should have our money in broad index funds and pay accountants to sheild us from taxes.

WSJ note on the Post-iTumes Music Store World

The WSJ has a note echoing my recent observations on the post iTMS world (see below). Since you need a subscription, yadda yadda, I'll post an excerpt:

Crowded House: With the Web Shaking Up Music, A Free-for-All in Online Songs --- Companies Race to Stake Out Turf in Fledgling Market; A Shakeout on the Way? --- Sony vs. Wal-Mart vs. Apple

11/19/2003, 17:59 [The Wall Street Journal]

When Apple Computer Inc. started selling songs over the Internet for 99 cents each, the company had the field almost to itself. Now, just seven months later, so many competitors are jockeying for position in the music-download business that a brutal shakeout is all but certain.

A half-dozen companies have already followed Apple's lead. Roxio Inc.'s Napster, the once-renegade pioneer of Internet music, now lets you download songs at 99 cents a pop. And some of the biggest names in retail, technology and media -- including Wal-Mart Stores Inc., Microsoft Corp. and Sony Corp. -- will soon jump into the fray.

It's a rare moment in which technology has jolted an industry's business model and past practices, kicking open the door to a radical new distribution strategy. For decades, retailers have dominated the sales of physical copies of music on compact discs, vinyl and other formats. As more music fans download songs over Internet connections and organize music collections on their PCs, it suddenly isn't clear just who will sell music to consumers in the future and how.

But even as companies race to claim market share in what has rapidly become one of the hottest sectors of the Internet, online music remains unproved as a business. Profit margins appear to be so thin that many companies see song-selling sites as loss leaders to help them hawk other products.

Executives predict that the sheer number of companies rushing into the market and the likelihood of price battles will further crimp profits, leaving only a handful of significant players standing. "I think we will shrink within 12 months down to five or six or even down to three" companies in the online music market, says Sean Ryan, vice president of music services at Seattle-based RealNetworks Inc., an Internet software and services company that will soon begin selling song downloads through its Rhapsody subscription service.

...

But as they fight bootleggers, the record labels have finally given up on their long-held resistance to establishing a legitimate online music business. For years, the major record labels balked at licensing their song catalogs to legitimate music sites, and most of them burdened the music with unwieldy technical safeguards that prevented consumers from recording songs onto CDs or transferring them to portable music players.

Now, the labels have gone headlong in the other direction. Increasingly, the recording industry has made attractive licensing agreements far easier to come by, as it grows more comfortable with the Internet, and the terms of the contracts it strikes with online distributors become more routine.

...

Selling song downloads turns out to be a low-profit-margin business. Of the 99 cents Apple and other sites charge for a song, the companies pay anywhere from 65 cents to 79 cents in wholesale costs to music companies, analysts and industry executives say. Credit-card processing fees, bandwidth charges and costs related to customer service can, in some cases, eat up whatever profit is left over.

...

Competitors argue that Apple's dependence on the iPod is treacherous. Apple for now commands a premium for the device, but the iPod advantage may be short-lived, as competitors gradually improve their own music players. That will, in turn, increasingly put pressure on iPod profits for Apple, which has a long history of seeing its technical innovations copied by competitors. Already, competition is getting more intense: Dell Inc. recently began selling a portable music player that costs $50 less than the least expensive iPod. Samsung Electronics Co. makes a music gadget bearing the Napster logo.

Sony could make life even harder for Apple. The Japanese electronics giant has said it will introduce a competitor to iTunes in the spring that it is for now calling Music Box. Sony will also offer a family of portable music players, including a device that sells for $60, a fraction of the iPod's price tag. The company has hired Jay Samit, a music-industry veteran who worked for years on Internet deals at EMI, to help run Music Box.

Not Useless

I actually kinda like MSFT's SPOT watches idea, except I would want the watch to provide a more convenient screen for my phone and palm pilot. I would prefer to get my appointment alerts and incoming phone numbers on my wrist.

The Post-iTunes Music Store World

OK -- iTunes music store (iTMS) is now available for both Macs and PCs. There is broad agreement that it combines reasonable value ($1/track, good selection) with reasonable protection (burn to your hearts content, then re-rip if you really want to, otherwise tricky to share). iTMS is tightly integrated with the iPod, but the software is free, runs on the vast majority of computers, and good. So the overall strategy is to make the fairly popular iPod even more desirable than other mp3 players.

The iPod is kind of a surprise hit for Apple, being the first true piece of consumer hardware that the traditional PC hardware company has ever produced. People are talking about Sony being on the ropes, while others opine that AOL, MSFT, Yahoo!, MTV etc. will dominate.

This is all a little nuts. There are three pieces to this technology stack -- the music copyright holders, the network distributors, and the hardware playback manufacturers. Napster played in the middle, was great for the hardware guys, but seriously threatened the copyright holders, who have since used the fact that copyright infringement is illegal to shut the system down.

Apart from lawsuits, the RIAA has also begun to license music for various online systems, and they do not seem to be very exclusive about who they offer distribution rights to. This suggests that copyright holders do, in fact, hold all the cards and they want to commodify the distribution and hardware parts of the stack down to marginal cost so they can re-licence their content at 100% margin. If a distributor (or hardware producer) enjoyed market power, they would require the copyright holders to give them exclusive rights to the song, weakening rival distributors (or hardware producers).

There are two different models of hardware producers -- integrated and high price (iPod+iTMS) and open and low price (Dell, or Gateway, if they have one). Sony briefly flirted with an poorly integrated and high price option which looked pretty but was horrible to use and thankfully is no longer for sale. We've seen the integrated and high price strategy play out for Apple in the PC market, and we'll see what happens with music. With the consumer electronics business being as cutthroat as it is, and the labels holding all the cards around distribution, neither of those are going to make any profit long term as separate segments. So the only person left to create the sort of ease-of-use and value that makes the for-pay music biz compete with the P2P networks is the RIAA, which means they are a cartel that play nice sometimes and fight other times. If the RIAA does not create standards that allow easy integration and commodification down the distribution and hardware parts of the stack, someone like Apple can potentially take some of their profit from them by building a powerful enough distribution+playback system.

So, expect consolidation within the RIAA, which I believe we see through the Bertelsmann/Sony deal. Look to see many more distribution services and hardware producers, and the labels license their music more aggressively and desperate PC manufacturers enter the mp3 player market. A standard, single price rate (ideally enforced by law) would cap the cartels power, and allow it to collude on prices with the government acting as contract enforcer.

All Apple can do about this is reduce the copyright owner's power by giving distribution ability to more desperate copyright holders. So look to them cutting deals with small labels kept out of the big stores. Apple is limited in how much it can do in this area because it costs them real money to host and deliver each song -- they can't drop the iTMS price to zero even if the copyright holder wants them to because it costs them more than that to offer the song. Apple could integrate P2P functionality within iTMS that would let people share free (non-RIAA) mp3s between each other, and this would require the very strict sort of DRM that a combined distributor-playback company can offer. It is strong DRM that makes it tough for the RIAA to open the floodgates to all distributors and hardware manufacturers, and it is strong DRM that is best made convenient by integrated distribution/hardware companies.