Facebook, Instagram, and the Antitrust Butterfly Effect

As anticipated first on this blog (see here and here), the Facebook/Instagram transaction is undergoing Second Request (i.e., serious) scrutiny by the antitrust authorities.

It should be clear that the transaction does not meet the government’s burden to challenge a transaction, but there is a serious concern in how Facebook handles this investigation in how Facebook will be scrutinized in the coming years.  Think of Google’s pervasive antitrust issues.

The problem for the parties is that statements in documents take on disproportionate importance in such investigations, and both parties have likely made the type of statements that catch regulators’ eyes.  In Facebook’s case “Instagram is a threat to our photo-sharing” and in Instagram’s case “we can be the next great social network.”  There is nothing wrong with these statements, but seen by regulator’s eyes, through the frames of antitrust, the wrong implications are drawn.  In addition, analysts like myself noted when the deal was announced that the effect of this acquisition was to take over something that was taking a lot of Facebook’s buzz by being a better photo-sharing experience.

The real issue should boil down to whether the acquisition is likely to help Instagram achieve its potential by further accelerating its use and by finding a way to monetize it (then the deal should be approved) or whether Facebook is doing the deal to squeeze out a potential competitor.  Startups often need to be handed off in order to continue their disruption; think of Amazon’s acquisition of Diaper’s.com.  Ultimately, in the US, the government has the burden of proof and I don’t think there is any way at the end of the investigation the government can make a case that stands up in court that the deal is merely to squeeze out a potential competitor and there will be a specific cognizable competitive effect that rises beyond speculation.

Ultimately, the most serious threat for Facebook is whether the FTC begins to contemplate, or even imposes as part of its approval here, requirements that Facebook should be treated as an essential platform that must remain open to competitors such as other photo-sharing services, Twitter, Foursquare, and others who have used the Facebook platform to promote both themselves and Facebook.  If so, Facebook could face full-time scrutiny of attempts and accusations of favoring its own services by regulators around the world.  This is the direction in which investigations of Google have gone.  For example, see the EU statement regarding Google here.

Facebook’s arguments now, like the butterfly flapping its wings and causing a hurricane weeks later, will have mega-consequences down the road.  They should take them very seriously.  For further background and analysis, this is a good time to re-read my series of posts on new economy platforms and antitrust including here and here and here and here.

Waxing the Innovation Longboard for the Coming Merger Wave

While bankers and lawyers have been seeing mirages of oases in deal-making for the last five years to quench their parched throats, at some point they will be right.  That point may be in the coming months.

As the Free Exchange column of the Economist recently noted:

These findings suggest conditions are now aligning for a perfect merger wave. A global shock has hit most industries, and there is plenty of spare capacity. Many businesses, particularly in Europe, face deregulation as lagging economies seek to boost competitiveness through structural reform. The merger impulse is there. Many firms are already sitting atop piles of cash. Industries that are fragmented, have firms with dispersed levels of performance and have been hit hardest by shocks are most likely to see mergers.

Macro-economic trends are relevant to micro-level innovation, and a coming merger wave may be particularly significant.  When merger activity returns, corporate executives will be focused on deal-making instead of innovating.  During the consolidation of old industries, and with the full-time management distraction of deal-making and integration, there will be many blind spots in the side mirrors of incumbent management as well as dissatisfied customers facing the arrogance and customer hassle that sometimes accompanies consolidation.  This will be an optimal time for disruptive start-ups to attack incumbents in old industries.  Surf’s up!

The FCC, Innovation Misconceptions, And The Stunting Of Wireless Broadband

Chris Dixon tweets this Sunday that:

The one tech service/product where prices are going up is also the one with the least competition: broadband access.

In part, this is due to a culture of monopoly among the providers: cable and wireline local access players.  In additional part, this is also due to very high almost “natural monopoly” costs of laying those wires to households.

While these traditional broadband providers are still important, with the move to smartphones, wireless is the source of both the biggest problem and biggest opportunity.  Mobile broadband prices have been moving in the wrong direction with Verizon and AT&T having pulled away from their all-you-can-eat pricing.  The type of non-metered pricing that we are moving away from is critical for accelerated innovation along the network.

At the center of the problem is the FCC’s misunderstanding of how innovation occurs.  The FCC assumes innovation will come by getting more spectrum into the hands of the wireless companies, but innovation theory tells us it will come by making it possible for small entrepreneurs to play around with innovative uses of spectrum.  I have previously called this “innovation sandboxes.”

Let me explain.

At the core of the lack of broadband innovation and competition is the FCC’s spectrum policy — under which allocation of spectrum is by auction to the highest bidder, and thus, under auction theory, purportedly the most efficient user of the spectrum.  As government policy goes, this is enlightened as it’s better than allocating a public resource by pure political connections or other corruption.

This policy favors incumbents (or the occasional others with deep pockets), as those are the only companies with the funds to bid for spectrum.  So incumbents — as we see today — have an incentive to throw tantrums about spectrum exhaust, justifying their proposed mergers, rather than innovating to deal with the spectrum exhaust.

The FCC is focused on freeing up more spectrum, by reclaiming it from broadcasters and government uses.  That part is good.  But the presumption is that the freed up spectrum will be auctioned off so the wireless companies will add to their spectrum holdings.  As the Multichannel News reports this week:

But on a serious note, he says that the FCC’s priority should be implementation of the incentive auction authority Congress gave it earlier this year. “With the proliferation of smart phones and functionally similar devices, the increasing use of high-bandwidth mobile applications is straining network capacity,” according to the testimony, which sounds much like his Democratic chairman. “The FCC therefore must do what it can to free up additional spectrum for broadband, and Congress’ recent action has given the Commission important authority to accomplish this objective.”

That presumption is defective. Like most innovation, true innovation in broadband access will come from outside the current system, not from granting spectrum to the incumbents  Instead of pursuing policy that favors incumbents, policy should instead create fertile space innovators to play without upfront entry costs.  My post from last November explains:

Traditional economic theory and policy, focused on a simple model of economic efficiency, usually undervalues what happens at the edge, which is where disruptive potential emerges.  We’ve noted here, again and again, about the power of Professor Christensen’s theory of disruptive innovation in describing how game-changing customer value is created by companies jumping into markets that look already occupied, often with products that can be dismissed as toys or marginal  when first introduced.  See here, for example.  We have also noted how policy often does not understand how important this innovative force is, and how policy must protect space for that innovative dynamic to take place.  See here, for example.

One way to think of this is making sure there are open “sandboxes” in which small entrepreneurs can play.

Fred Wilson has a hugely important post by Professor Yochai Benkler about how important keeping open sandboxes is in spectrum policy, which has been dominated by the flawed theory that the most economically efficient way for society to give access to spectrum is to one-time auctions to raise money for the Treasury.  The problems with that approach include that unless you are an incumbent (or come with a cash hoard like Google), you cannot play in this space because entry is billions of dollars, much of this spectrum in practice is hoarded and unused, and most importantly, actual empirical evidence is that disruptive entrepreneurs have created enormous economic evidence through playing around with “junk spectrum bands.”  Professor Benkler writes on AVC:

These dynamic markets are telling us something new: The future of wireless will likely be mostly unlicensed, with an important, but residual role of auctioned, licensed services. And yet the drive to auctions simply ignores the evidence from actual markets in favor of an outmoded regulatory ideal that is the opposite of what cutting edge radio engineering and dynamic markets show.

Most of these applications were developed using junk bands, where regulators dumped industrial equipment and microwave ovens. They thrived even in these harsh conditions, but in an effort to open up new, less wasteland-like areas for these dynamic, innovative technologies, the last Republican and current Democratic FCC chairs presided over the bipartisan creation of TV White Spaces, a policy that permits device manufacturers to expand the capabilities of unlicensed devices by sharing the TV bands with broadcasters. The TV Band auctions being pushed through the supercommittee threaten to displace these white space devices. As we look at the enormous success of unlicensed wireless strategies across the most dynamic markets, we see that doing so is penny wise, pound foolish.

In order to truly encourage innovation for broadband access — and take advantage of the same innovation dynamics happening in applications on the network — the FCC has to provide wireless sandboxes for young entrepreneurs to play in.  If it waits  for innovation to come from those who can spend billions of dollars of capital on hand to buy spectrum (and not coincidentally those who also have billions of dollars of revenue at risk) in auctions, Professor Christensen’s theory of disruptive innovation tells us pretty clearly that the needed innovation in access is not going to come, and higher prices and lower price for access are going to ripple through the internet ecosystem as wireless users hesitate to try new applications in order to conserve their data allocations.

A Nation of Tinkerers

As I noted a couple of weeks ago, the winds are set to blow more manufacturing back to the US over the next 20 years.

The first reason that I noted in that post is the changing demography of China.

The second reason — and topic of this post — is the changing nature of manufacturing and the opportunities it creates by opening up innovation to a much larger group of people.  Right now, we have an incredible wave of innovation from people who have ideas of digital things or services who can make them into actual digital things and services; think Facebook, Google, Linkedin, Instagram, etc.

That same creativity and energy applied to physical objects would be deadly.  The advent and spread of 3D printers allows those with ideas of better manufactured objects to experiment and invent those actual better things.  As I noted at the beginning of the year:

The synthesis of customer expectations that do not need to be compromised along with the artisan instinct to not have to compromise could spark a creative and entrepreneurial blossoming such as we have not seen.

It’s coding real life.  As a special report on manufacturing and innovation in the Economist says, the result of this will make it more attractive to keep manufacturing in the US:

As manufacturing goes digital, a third great change is now gathering pace. It will allow things to be made economically in much smaller numbers, more flexibly and with a much lower input of labour, thanks to new materials, completely new processes such as 3D printing, easy-to-use robots and new collaborative manufacturing services available online. The wheel is almost coming full circle, turning away from mass manufacturing and towards much more individualised production. And that in turn could bring some of the jobs back to rich countries that long ago lost them to the emerging world.

The Enron Problems of Chinese Governance

One of the core challenges of business is keeping managers accountable, focused, and productive.  It’s true at all levels — whether it is the board managing the CEO or the CEO managing his reports or those reports managing their reports.  Think of Jeff Immelt, having to manage numerous GE subsidiaries in many businesses in every possible geography.

The solution of managerial capitalism is managing through targets – whether numerical or otherwise.  If you meet your targets, you are rewarded; if you don’t you are fired.

This an effective way to manage in many ways and perhaps the only way.  The downside is that you get the results you incent for; but, sometimes at the expense of optimal behavior.  People learn to game the results and may act unethically to achieve the results.  Think WorldCom or Enron.

Earlier this week, we discussed how an authoritarian regime achieves the appearance of consensus.  But what happens after consensus, in terms of the implementation of that policy.

An authoritarian society faces a similar issue as corporations in managerial capitalism in terms of how a central authority projects its authority across a society at the most local levels; how do you control millions of local officials?  While similar in concept, the issues are infinitely more complicated in degree than any corporation.  In contrast, democratic, federal societies like the US have an elegant solution; they bypass the agency and command problem altogether by having the people at every level govern themselves through elections.

Ironically, the Chinese Communist party, lacking the elegance of democracy, must rely on the more imperfect institutions of managerial capitalism for the central government to control the local authorities. As described in the Economist, this has resulted in a perhaps unsustainable solution, where local authorities are rewarded for meeting certain subjects, even if it means literally trampling on citizens who stand in the way, including through murder, torture, and kidnapping:

But the emperor does know, and the emperor rewards. Although there has been an expansion of social and economic freedoms in many areas, under the Communist Party’s system of cadre evaluations, local officials are graded on the basis of a series of internal targets that have little to do with the rule of law. The targets are meant for internal use, but local governments have sometimes published them on websites, and foreign scholars have also seen copies. The most important measures are maintaining social stability, achieving economic growth and, in many areas, enforcing population controls. Cadres sign contracts that spell out their responsibilities. Failure to meet targets can end a cadre’s career. Fulfilling them, even if it means trampling laws to do so, can mean career advancement and financial bonuses.

Mayling Birney at the London School of Economics says the system assigns the cold logic of a scorecard to behaviour often dismissed as the excesses of little dictators far from Beijing. Acting in accordance with the law is ranked as less important than other priorities. On one local document seen by Ms Birney, cadres in one township could score only up to 10% of their points for lawfulness, but 40% for economic development. In effect, she says, the party is instructing local officials to break laws when it will help them to meet higher priorities.

Social stability is paramount: authorities in Tibet and in Jiangxi province recently announced that officials can be promoted for “outstanding performance” in maintaining stability. Beijing will supply localities seeking to put down unrest with additional “stability maintenance” funding, which creates a perverse financial incentive to employ repressive tactics. Political careers have been made, not broken, by brutal repression of unrest—in 1989 an official named Hu Jintao imposed martial law after riots in Tibet. Mr Hu is now China’s president. In 2011 a Hu protégé, Hu Chunhua (no relation), burnished his credentials by cracking down in Inner Mongolia.

Sign Up Fatigue

Two weeks ago, I attended a focus group for a friend’s start-up, one of the hottest right now.  It was fun, both in seeing the passion of the founder’s team, learning more about their vision and how it was received by others, and in contributing to something that is more than just a business.  Their vision — in creating a new category based on their individual passions to meet a real collective need and improve life for all of us it — is the type of vision that excites me the most.

One of the most interesting insights from the focus group was also the most applicable across startups.   A sign up button — as a gateway to seeing what the site is about — is like a stop sign or a barbed wire fence. It sends the message that users are unwelcome.  Even when there is a smaller bypass link nearby.

The group seemed unanimous on this point.  There’s a fatigue to another sign up — another password, more emails.  We are hyper-sensitive and it that leads us to see barbed wire fences even in cases when they are not there.

This is obvious in many ways, and it has been for many years.  But I think the success of some daily deal sites in getting your email address before showing their wares suggested otherwise.  In order to overcome the fatigue and the natural suspicion of handing over your personal information, you must put up a billboard-sized welcome sign, the red carpet has to be rolled out through wide-open doors, and you need people to see and taste the feast inside,  Maybe multiple times.  And then you have to ask them to sign up in a subtle way.

This is less of an issue after you have created the category — think Facebook — but a real issue when you are still trying to create the category.

Brian Lamb For The Internet Age

As long as I am on my run blogging politics right now, here is an im chat I was having with a friend a few weeks ago:

me: relatedly, you know what would be a cool project — is a crowdsourced structure to get draft bills read in real-time. one of the most disturbing turns that american democracy has taken is that no one (i.e. legislators or citizens) reads the bills, and we only have a sense of what’s in the bill by some often inaccurate headline provided by the proponents. often what we find is that there are all sorts of nonsense — intended and unintended — that has been hidden into the bill.
someone should get that started and win a genius grant for doing so

friend: yeah
that’s a great idea
it would also help
with calling out
politicians
sneaking shit into bills
at the request of lobbyists

me: it’s an internet age c-span — a transparency maker

friend: there’s no mechanism for that now?
it probably doesn’t happen in real-time
but there’s no place to go to get the full explanation for legislation?

I hope someone is doing this or does it soon.

The Underlying Instability of “Managed Chaos” in Authoritarian Societies

In life — whether in business or politics — it is deep in our humanity that “command and control” only goes so far because some of us inherently have dissent programmed deep within us.

In nations that are authoritarian, as Americans, it can be hard to conceptualize disagreement for leadership and on core issues.  If you veer from the authoritarian leader, don’t you die?  Just by scanning the newspaper, it is obvious that this does not explain things.  Think just in the last couple of weeks: about apparent disagreement between the Ayatollah and Ahmadinejad in Iran about the nuclear program, the struggle between Putin and Medvedev over the presidency of Russia, and the drama around the disposal of Bo Xilai (and his family) in China.  All these societies have also seen a dramatic uptick in citizen action  over the last few years, whether it has been dissent on the street or in social media.

These incidents suggest another potential model of disagreement in authoritarian societies: massive disagreement behind the scenes, while publicly maintaining the illusion of an authoritarian unity.  That illusion has to be maintained, because if disagreement becomes public, this invites disorder, for if there is an ongoing debate about power and the future, why shouldn’t it be more open and why shouldn’t the citizens be involved more directly and broadly?

The Weekend FT recently had an incredible piece about the process in Russia.  Here are some relevant excerpts:

However, Andrei Kolesnikov, who has covered the Putin beat at Kommersant newspaper for the past 12 years, and wrote the first authorised biography of Putin, said that maintaining the placid exterior was the central principle of competition within the Kremlin. “The various teams are expected to fight with each other, to compete for everything on behalf of their boss,” he said. “But the cardinal rule is that the principals should never be dragged into these battles unless they want to be.”

Konstantin Remchukov, the editor and owner of Nezavisimaya Gazeta, the influential Moscow daily newspaper, said that competition among staff was obvious. “Putin would make an appointment to see a minister at 10:15 in the White House, in downtown Moscow, while Medvedev would make an appointment with the same minister a few hours later at his residence outside the city,” meaning it was nearly impossible for the minister to make both appointments on time. “It was a kind of managed chaos,” said Remchukov.

….

A forceful, merciless and omnipotent ruler has been a near-permanent fixture inside the red brick walls and onion domes of the Kremlin since it was first built in the 15th century. And yet, this image of the tsar has always been at least partly the result of a co-operative effort by the Kremlin court, in which the notables and barons conspired to make even the weak, sickly, absurdly young, or the utterly disinterested in ruling appear fearsome, while painting themselves as quivering supplicants.

In a classic essay published in the 1970s, at the height of the cold war, Harvard historian Edward L. Keenan argued that the notion of an omnipotent, autocratic tsar has largely been a myth throughout 500 years of Russian history; instead, the rule has been a system of Kremlin court politics, within which the guiding principle is consensus. Clan politics within the Kremlin, he wrote, was “symbolically expressed in a kind of self-imposed fictional subservience to an autocratic tsar, and ensured by the awareness that the fiction was the central element of a conspiracy against political chaos that would ensue if clan were to be set against clan”.

Keenan’s conclusions appear every bit as valid today as they did 30 years ago. While Putin is unquestionably the most powerful figure in Russia, it is clear he doesn’t entirely lay claim either to the aura of absolutist tsar, as projected by his supporters, or autocratic despot, as proposed by his detractors.

“You know, Putin is not in fact a dictator,” said Oleg Vyugin, chairman of MDM Bank, and former deputy head of Russia’s central bank. “A dictator is when you really do control the elite, and each day decide, ‘Today you’re getting this and tomorrow you’re getting this, and you’re not getting anything’… For Putin, the situation is more complicated. Putin has to take into account very many different interests in politics, and try to combine them.”

Instead of an Olympian throne, it would seem that Putin sits at the nexus of modern-day boyar clans in perpetual conflict, in the form of the state corporations, oligarchic financial-industrial groups, bureaucrats and the police.

Who’s Going To Say It First

Many of us got our first taste of social networking with Friendster. Friendster is now a social gaming site popular on Malaysia. The cause of its social downfall was poor performance as its servers could not keep up with the load of its users logging on.

Fast forward to now. With Facebook, it has been building but it has been particularly pronounced the last few weeks. The mobile app has become frustrating with long delays in logging in and in updating the app. There is no excuse, on the eve of a 100 billion dollar IPO, for this. If it doesn’t get fixed fast, no one should be surprised if Facebook follows the Friendster trajectory.

Hacking Campaign Financing 2016

In 2000, I was involved with  a seed-stage startup looking to revolutionize campaign finance by moving it to the Internet.  We didn’t quite succeed at that time and encountered a skepticism as to whether and to what degree that shift would happen.

There was a vision beyond that business plan (our customers were conventional politicians in the Democratic and Republican party).  Using today’s terminology, it was also supposed to be a Kickstarter-like movement, making it easier for candidates — bypassing more conventional roads up the ladder —  who represented movements to break through when enough people thought such momements should exist.  Democracy — according to some definitions — should be the ideal forum for authentic talent for the people to emerge, bypassing the traditional smaller, and more conventional (cynical?) subset of kingmakers, deep pockets, and political insiders.

So after we failed, then came  Howard Dean in 2004 and his short time in front of the pack, in part fueled by his Internet fundraising.  This showed there was something to the thesis, but it was just a ray peeking through the clouds of conventional campaigning.  In 2008, with Obama’s massive success with fundraising on the Web, and the defeat of the invincible Hillary and then McCain, there was a vindication as Internet fundraising became major.  And there are other examples where the Internet arguably looks like it has played a major part in changing the game — think Tea Party, MoveOn, Ron Paul, and potentially the Santorum candidacy and playing a thorn in the side of  Romney for longer than expected.

But consider these observations from this election cycle, and you realize it has not changed.  The internet fundraising has become as inauthentic as direct mail.  It’s meant to elicit a Pavlovian response — have dinner with George Clooney, Barack Obama is a socialist, etc. etc.  It too often amplifies the worst knee-jerk tendencies.  It’s not often authentic or real.

But the internet, falling short of its potential, is dwarfed by even other more depressing changes in fundraising making politics even more about kingmakers, deep pockets, and political insiders.  To matter now, at various presidential fundraisers I have seen, you must be a max donor — $35K (remember when $2300 meant something).  That gets you a few minutes of intimate time with the President,while 15K or so gets you a picture, and 5K gets you attendance as part of a large crowd.  And then as Lessig points out, this is just small beans to what is happening in today’s SuperPac world — 196 Americans have given 80% of SuperPac money, and single Americans — witness casino king Sheldon Adelson and Newt Gingrich — have driven significant political campaigns.

The Internet, utilized correctly, should make politics passionate and alive; but, instead politics is largely becoming even more stagnant, even with the occasional examples of a refreshing oasis in the desert.  I know there are forceful counter-arguments revealing my naivete: money is speech, fundraising whittles down candidates, plenty of candidates with money lose, you need to have a message even with money, and on and on.  Some will say, the current system may be cynical, but it’s realistic and for the greater good.  It’s hard to prove that is the case, but it’s hard to disprove it either.

Despite these arguments, my personal bottom-line comes down to this: it’s depressing.  The power of the Internet in terms of giving people voices, disrupting middlemen and institutions, and organizing people in networks means we can do a lot better in the one area where perhaps it matters most — governing ourselves.