Weighing in on Amazon/Macmillan Pricing Debate

If you are following the eBook pricing dispute between Amazon and pretty much all the major book publishers, you know that this is indicative of the struggles most traditional media companies are having in adapting to lower-cost digital distribution outlets. As a quick summary, Amazon has been buying eBooks for its Kindle from the book publishers on a wholesale basis (reportedly around $12 – $15 per book). The publishers are hopeful Amazon would them mark the eBooks up and sell them for the same price as hardcovers, around $18 – $25 each. Amazon, with an eye towards building a large eBook market, and with all of its pricing data culled from its more than 90MM users, believes the right price for most eBooks is $10 or less. And as such, they have been willing to sell many eBooks at a loss, hoping to eventually force publishers to sell eBooks at a lower, perhaps optimal price. They would know. They sell gabillions of items to about 100MM consumers every day. Between them and eBay, they probably know more about the price elasticity of most goods than every good manufacturer out there.

Remembering your Econ class, you also know that most goods are elastic; as price lowers, demand increases. An optimum point exist that maximizes profit. I am pretty sure that the book industry, like the music industry before it, has not maximized profit by finding the optimum price. This is generally because the book publishers are not retailers — they have never forged a relationship directly with a customer. To optimize pricing (particularly on a per title basis), you need to conduct lots of tests and analyze lots of data. Amazon does this in near-real time and, I am told, is constantly optimizing pricing, page layout, merchandising, bundling, shopping cart path, and many other ecommerce variables.

While Amazon may have other motives for pursuing lower-priced eBooks (to sell more Kindles?), they are smart enough to know that once a market is established, it is hard to raise prices when competition exists. And with Apple entering the iBook/eBook market, they know they will have competition.

So, why would publishers NOT want Amazon to find the optimal profit-maximizing price? Because, like many entrenched media companies, they have massive legacy cost structures that don’t support selling books at, say $6 wholesale. They offer many unreasonable arguments against this: books are “worth” more, authors won’t make enough money, it’s bad for the industry, etc. These are not economic arguments, but are meant to maintain the status quo economics as long as possible. And it’s ultimately bad for them. The music industry has held firm that music is “worth” $1 – $1.30 per song, regardless of the track. For 7 years, they would not experiment with pricing under $1. (eMusic just convinced Sony and Warner last year to try…and I understand the results are positive.) But is all music really worth $1 a song? No, it is not. We know hundreds of thousands of tracks have sold 10 or fewer units digitally. That is the market telling you something.

As a way forward, Macmillan adopted Sony Music’s agency model which allows Macmillan to actually set the selling price for its eBooks and pay a sales commission to Amazon. You would expect that Macmillan would then be interested, since it controls pricing, in finding the optimal price. But I suspect its Amazon partnership does not allow it to get real-time feedback from price experimentation. And if they really were experimenting, you would expect that some people would see a title for $10 and others for $18.

The bottom line is that “value” or “worth” is not decided in a board room, it is decided by the market. And low-cost digital distribution, where the marginal cost of each incremental item sold is zero, brings consumer expectation that price must fall. They don’t care if the rent on your offices at 50th and Broadway are $8M a year. Traditional media companies whose products are going digital must accept lower unit selling prices and massively cut their operating costs in order to survive. Trying to play hardball with the market ultimately won’t work. See the music industry whose sales are now $20B worldwide, down from $40B, and I think are going much closer to $10B – $12B before finding bottom.

For more reading on this, see my post on piracy in the book industry, the movie industry ignoring market signals from Redbox, and a reminder of what we went through at eMusic with the music industry.

Here Ye, Here Ye, Now Comes Curation

I love Twitter and the real-time web. I am more connected to and better informed by those people and information sources whose thinking I admire. David Carr has a nice overview today in the NYT of how Twitter, for those who use it regularly, becomes a powerful and somewhat transformational tool the more you use it and prune it. I feel exactly the same way and find much of the same benefits he describes. Twitter, for me, is nothing like Facebook and far more useful for my professional and intellectual pursuits. Indeed, it is not a social network, but an information network.

Twitter is powerful because, as a platform, it is what we make it out to be. We, the users, provide the content, the links, the data, the meaning. Twitter just gives us some tools. Actually, Twitter really doesn’t give us tools, it provides a set of APIs and 50,000 other developers have created the tools that make it a useful platform. I bet Twitter power-users never even visit twitter.com except to search the firehose, and that will soon happen at Google.

The next step in its transition from experiment to enduring information platform is curation. Yahoo began as a human-powered directory of web sites. They categorized the web. This primitive curation was essential to the adoption of the web as a useful medium. It was not really crowd-sourced, as we think about that term, but it did require human intervention. This is what is now starting to happen on Twitter. By pruning and tuning the people/brands we follow, and selectively retweeting those tweets we find most compelling and interesting, we, collectively, are curating the real-time web. But I think this individual approach is going to fall by the way-side now that Lists are beginning to see more adoption. It does feel like brands and information sources will now build and prune lists as an important means of curation. Much of my thinking here has been influenced by @jonathanglick and @gregory who have each produced Tlists and Listorious respectively, two leading efforts at curating lists.

As Twitter soon passes 100M users, and Facebook, LinkedIn, Myspace and other social nets publish into the real-time web, curation becomes more and more important. And we are all part of the solution. We just need the right tools. And they are coming.

Areas of Focus

With one-quarter of a cup of coffee left, my fingers are jumpy as my mind turns to next year. In my first full year as a VC, I have been humbled by the great entrepreneurs I have met (and those I haven’t!), the brilliant colleagues of mine who help guide me, and the powerful teams of people who make startups work. I have started to hone my thinking about investment areas and although this is a never-ending process, here are some areas about which I am continuously excited:

AdTech

All advertising is asymptotic to performance-based buying. No matter what those who have sold CPM TV advertising for fifty years tell you, advertisers want performance metrics with meaning. Google proved it was possible on the demand fulfillment side of the equation. The next wave of innovation, fueled by fantastic availability of data coupled with network and social theory algorithms, is the science of assembling audiences ripe for your brand. These are audiences who may not yet know about your brand or product. This is the demand creation side of the marketing coin. But advertisers will get real honest-to-goodness performance-based buying here too. And this, not just the availability of online video advertising at scale, is what I think will help alter the “only 8% of brand dollars are spent online yet 35% of our time is spent online” imbalance. The entrepreneurial ecosystem  focused on this opportunity is quite literally filled with some of the smartest computer science people around, and the density of startups is greatest in NYC.

Video Ad Tech

When you apply the innovations coming out of the effort above with the right video ad units online, you have the future of TV advertising (except it won’t take place over cable wires and terrestrial broadcasts). That’s a big market. Really big. And I like it.

The Disruption of Big Data

As I have discussed before, the challenges introduced by the amount of data we emit as humans attached to so many gadgets is disruptive to the systems we have used to process and serve web data and applications for 15 years. Turns out these are hard computer science problems and require different thinking. (In fact, it even requires a different engineering degree! Apply here and see if you can get in to Penn’s new Market and Social Systems Engineering elite program.) You see this first in mobile, social, real-time and network applications. As more and more sites incorporate both feedback and content from the real-time web, their system architectures will change, their approaches to databases will change, and this creates opportunities for startups servicing these areas. One such startup, Cloudera, has commercialized Hadoop to address the needs to operate and distribute large data sets. Here is a nice overview of Hadoop’s architecture.

Social Media and the Enterprise

The impact of social media on our societies cannot be understated and has been so well-expressed by so many (see this brief, popular prez as one example.) The impact of social media on how we run our companies, make decisions in the enterprise and manage teams is an area of focus for me. We need new decision tools, collaboration tools (Facebook doesn’t attempt to solve this, see this post) and new ways of communicating with our teams, partners, and most importantly, our customers (who become our partners). (Actually, customers always were our partners, but we never really treated them that way. Now we have to, thanks to the power of social media.)

The New Marketing Department: Our Customers

Well, good marketers know that customers always were the best marketers for a brand, product or service. With social media, the power has fundamentally shifted from company-has-megaphone to customer-has-megaphone. Some companies still choose to ignore this (often at their own peril, see “United Breaks Guitars“) but many don’t and are clamoring for tools, methods, and best-practices about how to engage their customers across social platforms. I think it requires a structural change in our approach to marketing and communications. And with this change comes new value creation opportunities for startups. Think about all the newswire companies and how likely they are to be disrupted here. Press releases? The only function they serve in the new world is regulatory (must get info to the market simultaneously) and even that will change.

Real-time, Baby!

I am fascinated by the real-time nature of the new web. In some ways, I always have been. In 1993, I had this game concept of “flight simulator meets the real world”. The idea was that if you took a flight sim game and plugged in real-world, real-time data, everything changes. Real weather, real traffic, real news events. Imagine flying over NYC and seeing the real world conditions mirrored in your game environment. In my small head, that was the beginning of this fascination. Couple that with the well-understood appreciation for the value of crowd-sourcing and you have the real-time web. Soon, this will be billions of people acting as the world’s best information and entertainment curators, filtered through your social graph. It dwarfs and upends every form of editorial filter that has come before. Apply this to business information and Bloomberg is disrupted. What media company isn’t challenged by this notion? And every communication company? And every company that guards a monopoly over its distribution channels? With a mobile, social, real-time web, we can always find a way around every barrier. It’s so powerful. And I love it.

So Happy New Year everyone! I am excited to work with you on the inevitable progress and disruption coming our way in 2010. Time for another cup of coffee.

Shocked at Apple buying Lala

I was wrong. I told Brad Stone at the NYT that I was 98% certain Apple would not buy Lala for three reasons: 1) Apple wouldn’t be buying them for the streaming licenses, since Apple has better negotiating power to get better deals and these licenses are never transferrable to an acquirer without permission, 2) it’s just not that hard to build the infrastructure and applications for a streaming music service, and Apple can certainly do as good or better job than anyone else has. Also, Lala never reached anything close to scale, so their infrastructure is unproven. And, 3) Lala never demonstrated consumer traction, so Apple certainly isn’t buying them for their customers.

According to Brad’s article, Eddie Cue likes the engineering team and one of Lala’s founder, Bill Nguyen. This makes more sense. As Fred Wilson just blogged (as always, good timing, Fred!), HR acqusitions are a common reason for smaller acquisitions, and I guess that is what happened here. We may learn more as time goes by, but I am shocked Apple bought a digital music company. One thing I heard about a year ago from Apple employees was since the launch of iPhone, huge swaths of engineers from iTunes and other parts of the company were all shifted to iPhone, leaving less resources for the iTunes store and music service. This might also shed some light on the acquisition.

In any case, I was wrong. Mea culpa.

UPDATE: Ian Rogers has a nice analysis here.

Hopping on the Big Data bandwagon

Oracle is in danger.

In 13 years we have gone from 100,000 websites to more than 180 million, with more than 22 billion pages (Google indexes about 15.5 billion of them, maybe more). But this is mostly static data. The pages are made and are then indexed. With the emergence of the real-time web, however, we are creating far more amounts of data than just the growth of the pages on the internet. And the data changes constantly. It is a stream, as John Borthwick so elegantly describes. It’s harder to store, index, access, backup, guard against (and restore from) failure, and analyze. Measurements of the amount of data being created is hard to come by. We know Facebook stores and analyzes petabytes of data, as their 300M users log 8 billion minutes per day on the site. Twitter, with only about 70MM users so far, generates more than 1M tweets per hour and more than 27M tweets per day, and they are just getting started.

Data is more than just our explicit posts, tweets and photos, however. Just by carrying a mobile phone around, we generate thousands of discreet data events a day (phone checking in with tower, etc.) By surfing the web, we each generate thousands of additional data events a day (cookie written, ad served, ad clicked, page requested, cookie read, logged in somewhere, searched, etc.) Throughout our travels in the interactive ecosystem, various parties are logging this data. And this is where the problems emerge. It’s getting harder to do. Much harder.

Vulnerabilities surround us. Gmail, Twitter, Microsoft/Danger’s Sidekick cloud service, Amazon S3 and EC2 have all had outages. We hear about these services when they fail, even for an hour or two. Most of the failures are due to the sheer size and complexity of the undertaking.

What’s happening here? Well, the tools and methods we have used since 1995 to manage web infrastructure are breaking down at this new scale. Some parts of the chain distribute quite nicely when we throw more iron at the problem, like Apache and other web servers. And application servers generally follow suit. But two main areas, in my mind, are particularly vulnerable to the challenges of scaling, and that’s the database and methods to traverse data.

Database

Scaling the database has always been a challenge. Oracle offers RAC and other clustering solutions which can achieve scale but not often the performance optimized for low-latency, high-read applications. These are very expensive and have their own set of issues. But more generally, SQL databases and other relational database solutions really don’t scale horizontally, transparently to the application, and don’t eliminate all “single points” of failure. Others have gone into more detail here. Open source alternatives to Oracle, like MySQL and Postgres have not solved this problem.

I am not the first to recognize this problem. In fact, the NoSQL movement has been active for some time, developing alternate non-relational database solutions in the name of producing truly scaleable, high-performance databases (while giving up some of the elegant features of relational databases). Key-value store non-relational projects like BigTable, CouchDB, HBase, Voldemort, Dynamite, Amazon’s Dynamo, Cassandra, and Mongo offer different approaches here. There is something very interesting here. Facebook, Digg, Google, Twitter and many other large-scale internet properties are adopting these non-traditional database solutions for various services within their architecture.

Traversing Data

Large sets of data are a challenge to analyze and process. Basic computer science brute-force algorithms break down (or at least perform sub-optimally) at these scales and are not optimized to work in a distributed basis. One key example is the search index. To deal with the enormous size of search indexes, Google developed MapReduce which led Doug Cutting at Yahoo! to develop Hadoop, a Java framework to make it easy for data-intensive apps to work in a distributed manner. But these are not the only companies burdened by web-scale data problems. Some smart folks figured this out and formed Cloudera to commercialize Hadoop. I have been kicking myself for missing that investment opportunity. It is sure to be a winner. A number of our portfolio companies now use Cloudera’s Hadoop.

So, big data is revealing itself to be a disruptive phenomenon. I haven’t really done the topic justice, so I would very much appreciate your point of view in the comments below. I am committed to digging in deeper here.

Some iPhone Gripes, Part 1

I love the iPhone. But it is a work in progress, let’s face it. I wanted to quickly list a bunch of my specific issues with iPhone in the hopes that someone at Apple is listening out there (crazy assumption, I know…). First post of several:

1. When connectivity is limited and I choose to read/delete email, must you pop up seven different dialog boxes in rapid succession telling me “can’t get mail” and “can’t delete message”? Is that really relevant? Can’t you just queue my requests and actions and re-submit them once connectivity is re-established? Blackberry has been doing that for more than a decade. They even clue me in that a task is queued with a clock icon next to an unsent message.
2. When I am on a call and you pop a calendar alert or a text message arrived, must you make me deal with the alert before you let me have access to the phone controls again? Why force me out of the context of the phone call? Why can’t I access things like “speaker” and “end call” before I have responded to a calendar alert or a new arriving text message.
3. Push email is not compatible with the battery capacity you have chosen. Turning on push (for exchange servers) will kill the battery within 3-4 hours, rendering this feature completely unusable. Either fix it or warn users more prominently about this.
4. Why must I enter my iTunes account password every time before downloading free apps?
5. It takes 4-5 steps to delete a calendar event. Really? That’s the best UI you can come up with?
6. New calendar events: can’t I please click the hour on which I want the new event scheduled before clicking the “+” button to create a new event? The interface for setting the time is so tedious, I should be able to tell you when I want the event schedule by a simply gesture.

How to Monetize Social Networks

As comScore and others have reported, we are spending far more time on social networking sites than on any other sites or web activities today. From eMarketer today:

Time spent on social networking sites is increasing steadily, taking users’ attention away from sites such as portals. According to comScore, the top 20% of social network users visit networking sites 2.4 times per day, on average, and spend 31 minutes on them—twice as long as the same users spend with e-mail or instant messaging. And that, in turn, means more time with ads.

The problem is, this inventory is sub-optimal for display and text advertising. The same article discussed the challenges of low CPM inventory. Users are too engaged in social communications and games to click away on ads. Also, when we are reading about friends, we are not demonstrating intent like we do in a search query, so ad targeting is harder.

The truth is that we do demonstrate intent, authority and endorsement while on social networks. We demonstrate who our closest friends are, we share links to goods and services we like, we click on links shared to us by friends we trust. We throw off all sorts of useful data for ad targeting. But social networking site inventory is not the inventory on which to display such targeted ads.

The solution here is to use social networking data and re-target existing customers, prospects, and friends of prospects. This allows highly relevant ads to be delivered to customers on inventory less likely to be interrupting task-based or conversational behavior. Media6Degrees, a Venrock portfolio company, is doing exactly this. And they are not dependent on a single social network, but instead have amassed a meta view of our connections on the web. They are building custom audiences for brands that are highly scaleable. The 50 or so advertisers who have used them have seen dramatic results. There are others working on the same problem. 33Across and Lotome are focused on a similar problem. And I wouldn’t be surprised to see Facebook launch social ads on an AdSense-type distributed platform in the future.

The Book Industry is in Trouble. But Piracy is Just a Symptom.

Randall Stross has an article in the NYT this morning suggesting that the book industry may soon get “Napsterized” — suffer the disastrous fate of the music industry, all because of piracy. This article performs revisionist history on the explicit actions of the music industry underlying its decline. Piracy has been a convenient culprit for media industries as their distribution shifts to digital, but it is not the only cause of their problems. It is largely a symptom of traditional market issues.

In the physical goods world, media companies maintain a monopoly over the distribution of their content. They control who can sell it, they price it at whatever level they deem appropriate and they determine if and when a consumer can buy it (think release windows). As all media goes digital, this monopoly quickly melts away. The content owner cannot control distribution (it’s too easy to copy a digital good) and as such they cannot control availability. When this control erodes, pricing pressure follows as consumers have a choice between buying and stealing.

The music industry, after the emergence of MP3 encoding in 1996, did not internalize this fundamental change. They believed they could maintain their monopoly on distribution by suing consumers who engaged in piracy, controlling release windows and limiting licenses to only a few digital outlets at the same prices of the physical goods. Consumers inherently knew that the digital good should be less expensive than the physical one (there are no hard good costs, after all) and demanded widespread access to digital downloads. It took the music industry seven long years until they broadly licensed Apple in 2003 with their full catalogs. In that time, consumers found the alternative — Napster, Gnutella and Bit Torrent. By the time iTunes took off, it was too late.

The book industry, with all this learning behind it, is making similar (but not identical) mistakes. They have licensed some of their catalog to a few eBook retailers. But there are still millions of titles not available for legitimate download. In addition, they have tried to hold pricing for the eBook at the same level as the physical book. Jeff Bezos knows consumers expect to pay less. So he subsidizes the price of eBooks in order to get the price to about $10 a book. When free is a few clicks away, convenience rules. The publishers should flood the market with their entire catalogs and price them at dramatically low prices. There should be hundreds of places to buy them online. They should make it painfully easy to buy an eBook, even risking the cannibalization of their physical books. They need to make the legitimate good superior to the pirated one.

The digital future for all media companies is likely a smaller market with inferior economics than the monopoly physical one they enjoyed for decades. To survive in this new world will require lower cost structures. But the result of not embracing this future are clear: just ask the music industry.

The Impact of Social Media on the Enterprise

For decades, companies have been defining the channels their customers must use to contact them. Social media challenges the long-held notion that companies control the conversation. “We are available by phone weekdays from 9am until 4pm Eastern Standard Time” is quickly becoming a thing of the past. “We will attempt to answer the emails we receive within 48 hours, but times vary based on incoming volume” will be no more.

In a world where any customer can, in seconds, tweet or post to Facebook a pithy product review or share an experience they had with a brand, companies are forced to entirely rethink how they interact with their customers. Step one, probably the hardest step, is realizing they are no longer in control. The power of social media has empowered the consumer to reach literally hundreds or thousands of people in seconds. And because we know a consumer’s closest friends are three to five times more likely to share the same preferences for products and brands, this newfound power is not to be underestimated.

Sure companies have Facebook pages and Twitter accounts. Yes, a few thousand companies are already searching Twitter for mentions and engaging customers. This is but a start. The real transformation happens when the companies let go of the conversation and instead work to nurture it. The brands who offer tools to their customers to increase the amount of conversation and encourage their customers to discuss the pros and cons of their products will be the winners who emerge from this disruptive time.

Companies like Get Satisfaction and UserVoice offer tools that change the balance of power between a company and its customers. Get Satisfaction has a fantastic manifesto, or “Company-Customer Pact” (http://getsatisfaction.com/ccpact), which defines a new relationship between a brand and its customers, encouraging public dialog, warts and all, but expecting productive discussion in return for the company’s helpful engagement.

While product forums from companies like Jive Software have been around for many years, I believe public conversations about brands will now be distributed in nature, spread across the web into thousands of tiny corners. The challenge for companies is figuring out how to manage this. A conversation could start with a tweet, be directed to a help forum, be responded to in email, updated in a blog post, and then broadcast on Facebook. How will this be tracked, measured and monitored? This market is ripe with opportunity for both brands and software platforms built to nurture the distributed web-wide conversation. And brands who are seen supporting a public dialog will engender more respect from their customers than those who turn a blind eye to it, or worse, try to shut it down. Ultimately, companies become more customer-centric from this disruption. I am sure United Airlines wishes they had just paid for the passenger’s guitar they broke now that the music video he recorded chronicling the ordeal spread virally and has been viewed more than five million times!

The company/customer relationship is but one relationship forever changed by social media. Similar transformations are happening between companies and their employees and companies and their vendors. New companies and tools will emerge to address these situations. At Venrock, we are looking for the entrepreneurs that are pioneering this space and embracing this opportunity. I would appreciate your point of view.

(This post appeared on Fast Company.)

Ignoring Market Signals

I am fascinated by the Hollywood studios’ war with Redbox. Today’s NYT has a nice overview and my friend Rich Greenfield at Pali Capital has been covering this for some time (registration required). Most of the attention is falling on two issues: (1) Hollywood hates the one dollar per day price point, and (2) also hates that Redbox breaks their windowing strategy by offering new releases as rentals immediately as the DVD hits the market.

Redbox’s CEO, Mitch Lowe, knows he has stumbled on a model to which millions of consumers are responding. There will be more than 22,000 Redbox kiosks by December in places like supermarkets and Wal-Mart stores. Their volume is sufficient to scare the studios. The studios’ fears? Cannibalization of DVD sales. Their argument? DVD sales are down 13.5 percent for the first half of 2009 over last year and some titles are selling 25 percent fewer copies than expected while rental income is up 8% (NYT, Digital Entertainment Group).

What baffles me is that the studios still think they are in control. The only reason this model exists, like Netflix, is because of the first sale doctrine. This section of copyright law makes it permissible for anyone who buys a copyrighted work to resell it. Therefore the studios can’t stop a wholesaler or retailer, to whom they have sold a DVD, from selling it to Redbox. And they can’t stop Redbox (or Netflix) from renting DVDs, even though they hate the practice. In the digital world, there is no first sale doctrine, and that’s why your choices of which movies to rent or buy online are terribly restricted and unreasonably priced. The studios set the terms, and no unapproved and unlicensed model can emerge.

Redbox, and Netflix before them, have found models that consumers love. They are based on low price points and high consumer convenience. Time and again we know consumers respond to these models. Consumers don’t respect windows and profit skimming (even though these are intelligent business models). In the digital world, consumers have too much choice to adhere to restrictions imposed by copyright owners. Why buy DVDs when you can download any number of the 65,000 apps in the iPhone app store? Why pay for a digital rental that expires in 24 hours when you can watch six simultaneous channels of the U.S. Open on DirecTV for no extra charge?

We now live in an attention economy. The studios haven’t yet learned that they are dramatically competing for our attention, not just our wallets. To be successful, they must look for market signals, and man is this a big one: consumers will rent more DVDs when you price them low, put them at locations where they already are, and offer the newest releases. The alternative? We’ll just do other things. That is, until the transition to the digital world is complete. Then most of these models will go away if the studios have their way. Then, like the music industry, piracy becomes a better choice and a superior good (no restrictions, low-price).

I have talked before about the need to read market signals. Note to studios: here is a big one. You should be excited, not scared.