Category Archives: Business

Tracking the right metric

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Last week I wrote about the Facebook IPO and how I felt that for the company the shift to stock price metric tracking was a big deal. I said that there has been a shift from what Facebook was and could be to the broader public to how all of its actions impact the stock price for the company. Today, in an article on Forbes they published an article about the impact of what you measure and how it impacts later choices. One of the things they didn’t mention was how frequently this measure or metric is reported. These all matter.

Looking at Facebook, I think it’s rather clear why Zuckerberg has publicly stated that he doesn’t care about the stock price of the company. Stock price is continually reported and when major milestones are passed, either in the positive or negative, everyone is talking about it. Apparently, Facebook dipped below $30/share today. Is this the end of the world? No, but it does mean that a lot of people have lost a lot of money.

Let’s look at stocks. Do they truly reflect the value of a company? I, personally, don’t think so. There are so many factors that shift the price of a given stock in a week, that it’s impossible for the value of the company to fluctuate in such a manner. However, the price of a stock does impact what a business is able to do. Companies are able to leverage their stock values for loans and interest rates, which means that a company can suddenly gain or lose market capital if the stock market swings for something completely unrelated to them and investors sell of their stock.

Despite the fact that, at best, there’s a loose correlation between the actual value of a company and the price of its stock, CEOs are held accountable to this metric by investors. Now, maybe some CEOs do ignore the value like Zuckerberg plans on doing (I’ve heard Jeff Bezos from Amazon does), however, when it’s continually reported and discussed it likely will change some behavior even if the CEO does their best to ignore the stock price. Even if the CEO does ignore it, in many cases the board or the investors will not. They may take serious action if the CEO does not work to ensure that their metric, stock value, continues to increase.

However, this may drive the wrong behavior. Tracking the wrong metric may be answering the wrong question. What increases our stock price may not be the same answer to what keeps our company competitive. A company that reduces work force to cut expenses for the end of the year, may seriously be hampering their ability to compete over the next few years. The change will likely bolster the performance of the stock in the near term but will likely lead to greater drops in the medium or long term.

Company management should not solely be measured on stock price alone and neither should a company. As much as I dislike Facebook and Mark Zuckerberg, Facebook is a company that actually has more value than simply its bottom line. It is able to create new networks and new places for activists to work. Now is this likely to continue? I don’t know. Could another company come along and beat them at it? Definitely. That’s why Facebook bought Instagram and will likely buy other companies that could threaten their market space.

Facebook, IPO and valuing a company

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This week we’ve been hearing about the debacle that was the Facebook IPO.Which has revealed that some of the underwriters for the IPO were doing shady things. Matt Taibbi believes that this indicates that there are essentially two markets. One for the insiders and one for the schumcks, the every day investors.

Why is this important? Well, based on the discussions I’ve read online, there’s a lot of concern of the validity of the whole IPO process, the valuation methods of companies and how investors think of companies. The valuation of Facebook had a great deal of discussion before the final IPO price of $38/share, this was partially driven by two articles that came out. In the first one it was mentioned that GM was pulling it’s account because “Facebook ads don’t work.” The other article of note relates that researchers found that 44% of Facebook users will NEVER click an ad. This research is important because some of the valuation is based on the conversion rates of ad views to ad clicks. On average Facebook was only able to earn around $4.34 per user. The valuation of $100 billion puts the life time earning potential per user at $100 (at 1 billion users). This is pretty low, but at the same time, if only 560 million users ever click ad, that pushes means the people that do click ads need to be earning Facebook roughly $200.

MIT Technology Review discusses how this is an unsustainable growth model for Facebook. Essentially, Facebook will begin to drive down the cost per view for their advertisers to try to increase their total revenue. This falls into the race to the bottom mentality that crushes industries. Advertisers will be able to say to any website, why should we pay you x amount per ad when we only pay Facebook y there is no way that you can get me more views than Facebook. The only way that a site could get more revenue if they can show data for a higher click through and conversion rates than Facebook. That might be tough. The Review article argues that this will eventually kill Facebook and a lot of the ad driven website business models.

The other aspect of the IPO is a difference in the way that business and technology media are reporting on Facebook. Things have shifted from all the non-business related activities to focusing solely on this aspect of Facebook. This will likely shift over time, but I believe that these considerations will be discussed in any article related to Facebook. If Facebook wants to remain a haven for activists it will be difficult if there are potential suits over people being activists. There will be an increase of risk aversion within the “owners” of the company as there will be influence from investors.

Zuckerberg has said that he plans on doing what is best for the long term and try to ignore the demands of investors. He might be able to do that because he still owns 57% of the voting rights for the company. However, it will be difficult for him to avoid the influence of the discourse of media outlets. Even if he gets all his news from his friends on Facebook, there will likely be articles posted that will give him news about the company and things that he probably won’t want to read.

Essentially, discussions will shift from being about the risk of privacy for users to how changes to Facebook will impact investors bottom line. I don’t think this is healthy for businesses, consumers of Facebook or the general public. There are other things companies do that are unrelated to investors that are important for society as a whole. The Facebook coverage really indicates that we don’t look at businesses in a long term sustainable manner. We need to change this if we want to save capitalism.

Continual improvement, Innovation and Modularity

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I’ve been reading Internet Architecture and Innovation which has gotten me to think a great deal about system’s architecture and innovation (shocking I know), but it has also gotten me to think about continual improvement as well. The perspective that Schewick takes for innovation in a system is actually based off of stock options. If you aren’t aware there are two types of options. Each is used in a different circumstance to sell at a certain price or to buy at a certain price. This has been used in some innovation theories for a while it’s called real options, or taking financial options and using them in a similar situation in real life. The differences is that it’s a go/no go choice instead of buy/sell. In terms of innovation it would be a choice between pursuing a new innovation in a system or not. For example. Let’s say you have a watch and you are trying to improve the time on the watch. Using the reals option approach you could figure out how much money you’d have to have for a return on your investment in the innovation, per watch, and figure out how many different types of crystals you would test to improve the timing mechanism. Another example could be a car, where you’re trying to reduce the drag on the car, which could dramatically change the full shape of the car. Whereas with a watch you may only be changing the crystal. 

Essentially, what this means is that you have two different ways of innovating within a system. Change the full system (car) or change a single module of the system (watch). Reducing the drag on a car could require a full system overall, because you’ll be changing the size of the front end, which could impact the maximum size of the engine (or shape of the engine), or could impact the maximum headroom of the vehicle. So, you could have a radically different looking vehicle from model to model. In fact we can see this if we look at the evolution of the car (below). This change is extremely expensive and requires a huge amount of work. It’s not likely that a company would pursue multiple designs beyond the drawing board or initial mockups. It would simply be too expensive to build multiple prototypes that are fully functional.
Evolution of Lamborghini
With watches you could have the exact same watch with several different materials to ensure the watch keeps proper time. In terms of watches there have been several radical innovations, including the wristband and digital. However, if the watch is not digital, the changes in some parts of the watch are extremely easy to test and compare on the market. For instance many pocket watches use rubies to protect the metal pieces in a watch from rubbing against each other. In this case it’s possible to test many different gems to protect the components, it’s also extremely cheap and if something fails completely it would never move into production. However, you could test hundreds of types of gems (sizes or whatever), at a significantly lower cost than testing many different full system designs.
So what’s the difference between the two? In this case we’re changing a full system compared to a module within the full system. Of course changing the gear structure of a watch would require a full redesign, but there are many parts that can be changed independently. In many aspects this can happen with a car, but there are limitations as well.
This modularity allows designers to innovate on separate aspects of the product without decreasing the quality of the overall system. This same idea can be applied in other business settings in terms of rapid and continual improvement processes. Many business processes are systems that integrate many different groups and aspects. Splitting the system into modular components allows continual improvement on many different aspects of the system at the same time. This modularity decreases the cost of improving individual aspects of the system as well as allows for more improvement projects throughout the system. 
Why would the costs be lower? Well, as I mentioned with the watch, it’s cheaper to test different components for the gems, time keeping crystal and face glass than to test a change in drag for a car. The change in drag could require changes to the seat heights, new design for the windshields, possibly an entirely new chassis. In the case of reduced drag, if the design works you may have to redesign all these other components. In the case of the watch finding out that the new glass face doesn’t work wouldn’t impact which crystal works best. This reduces the costs for testing the improved system.

Free-market, Small Government and Regulations

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The free-market has been used to argue against regulations and for small government for years. However, I believe that the major supporters of using the free-market argument are disingenuous in their application of the argument. In addition, the free-market is a flawed theory which needs to be revisited by neoclassical scholars and adjusted.

The free-market theory comes from the idea that there is an invisible hand that guides the market towards equilibrium between supply and demand. This assumes that once the equilibrium is hit it will stay at that point until there is some shock to the system which would find a new equilibrium. Each time that there is a shock, the invisible hand would push the market into a new equilibrium. This idea came as a side comment in the Wealth of Nations. This idea has become enshrined in the minds of neoclassical economics in a manner that Newtonian Physics was presumed to be accurate. In both cases the theory is incorrect. Relativistic Physics has replaced Newtonian, but in Economics the free-market is still the prevailing mechanism for policy creation. There has been no evidence for an invisible hand at all. In fact Metcalf created the theory of a networked economy which argues that the value of a good becomes more valuable as more people use it. I’ve mentioned this in the past. Essentially, this will prevent any equilibrium from every being found as the price can increase and people will still adopt the networked item because it’s becoming more valuable to the user. Or the price can remain constant even when it should drop for other factors such as a reduction in cost of production. A perfect example is the iPhone. According to research Apple has a whopping 72% margins on the iPhone, even if production was moved to the US Apple would still make 42% margin on the iPhone. There also is an over production of the iPhone and strong competition, which would indicate that the iPhone should drop prices as they are capable with that large of a margin. This market has a great deal of competition and has a large number of companies producing, which indicates that it Apple should be under pressure to drop prices. However this isn’t happening because of the networked value of the iPhone. There are a huge number of apps for the phone, the apps are high quality and the product works well with other iPhones. The market has had no impact on the cost of the iPhone.

However, free-market champions would look at any effort to change the labor practices of Apple as wrong headed and regulation that isn’t required. The Market isn’t demanding any change to labor practices because the market can bear the current prices and the demand indicates that people don’t care about labor practices. However, it’s well known that there are no alternatives to Apple’s iPhone that are produced in an ethical manner. So voting with your money wouldn’t actually work here. The problem arises because there is something of a monopoly in the manufacturing of the smart phones in FoxConn. In this case there is a market failure. Which is something that neoclassical theorists argue cannot occur. The market cannot send a signal to firms because there is no mechanism in which the market could send a signal. This is can be understood if you view this industry as a networked economy. Where you see the ties between manufacturers and handset companies, which would show a massive connection to FoxConn.

Efforts to regulate the manufacturing of devices have been argued as the reason for moving the manufacturing to other countries. However, this is not the case in the case of Apple, as they would still have huge margins. It’s because the company is attempting to maximize profits, not reduce costs to be profitable. The same arguments have been used to argue for smaller government. Saying that since there are no market failures the government should not intervene in the industry.

The unfortunate thing is that these arguments immediately disappear when it comes to protecting the profits of record industries. The same free-market advocates then move to argue that intellectual property must be protected. Essentially, creating protection for a specific product through IP causes a market failure and prevents the market from operating at its most efficient because there are not other competitors in the market. Creating IP requires a huge regulatory framework from the mechanisms of registering, logging complaints and prosecuting actors that infringe on the IP.

This type of industrial policy is typically derided by the small government fans, as it is a type of regulation that selects a “winner” (IP owners) over “losers” (non IP owners). Which may be fine. However, whenever this selection pushes our government to select a winner (Music) over the fastest growing, possibly only growing, part of our economy (internet based companies) there is a serious risk to the future. As I’ve mentioned before these laws represent huge risks for innovation.

These laws are SOPA and PIPA, which I’ve discussed extensively. However, the next round of internet regulations come in the form of CISPA. This bill, which requires allows companies to share extensively with government agencies. This type of sharing of user data and information about the activities going on at the company would not go over very well from the the free-market advocates if this was a request for data about customer data for car dealerships or steel mills. Essentially, this is going to increase the cost of doing business in the US. This may prevent companies from working in the US and prevent innovation. If I was to create a company that dealt with social data I would not want to do so after the passing of this bill. It would be likely that I would be blackmailed into giving the government data about my users that I had no desire to give them.

The internet is the perfect example of a networked economy. Facebook’s value comes from the fact that it has a huge user base. This is true for Google, Amazon and Instagram (List of companies that support CISPA). Without the users the services is literally worthless. With the users a company without any revenues can be worth $1 Billion (Instagram). The difference between this bill and other bills like SOPA and PIPA is that the agreement is bidirectional. The government will likely help Facebook and Google fight Chinese attacks and give information to each other about the activities of online hacktivist groups like Anonymous. It is likely that 4chan will end up giving over IP data and other information related to anonymous and Anonymous users.

This is regulation that the internet doesn’t need and will stifle innovation. The government already has these powers, which maybe why the Obama administration is opposed to CISPA. It is also ironic that Obama plans on sanctioning countries that use Tech to abuse human rights specifically committing genocide. A whistle blower has recently announced that the NSA has intercepted 20 TRILLION emails and likely has copies of all of these stored somewhere. The passing of CISPA and any other law of similar persuasion  would likely protect companies like AT&T from future lawsuits for being complicit with these activities.

For devotes of the Free-Market these laws create market distortions and will cause serious harm to innovation on the internet. For people that understand networked economies, this will greatly undermine the value of these networks as users will likely change their behavior to mitigate the amount of information the Government can compile on them. CISPA and its sister laws SOPA and PIPA represent big government actions attempting to control and regulate industries that do not need to be regulated. In this case there is no market failure that needs to be addressed. Privacy is something that the users have been pushing for and Facebook and Google have steadily improved on those accounts. Surprisingly industry is doing a decent job at regulating itself. Finally, regulations being pushed by advocates of small government and free-market smack of hypocrisy and a lack of understanding. These laws require a deep understanding of the internet and how the market of the internet works. Without this understanding terrible laws will be passed that will damage our privacy and freedoms. For the issues that this law would protect from there are other methods that could be employed to gain the desired results without passing laws.

Contact your congressional members to fight against this bill.

If I made video games, this is how I’d deal with Piracy

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Piracy is something of a real issue. It can impact the livelihoods of artists as well as the big companies. However, the methods that companies go to when fighting piracy are extreme and infuriate end users. The people that listen to music or play games for the love of music or video games.

My friends over at KMBOD have written in the past about how horrible some of the Digital Rights Management (DRM) systems are on video games. These systems require continual verification that the game has actually been purchased. In some cases it makes the game unplayable or extremely difficult to play. In some cases the user must be online the entire time regardless of the type of game the user is playing. It makes sense for the game to be online if you’re playing multiplayer games, but if you’re playing a single version of the game why would you need to be online? Why should the game suddenly crash if you get disconnected from the internet? These types of things anger the gaming community and drive them away from specific titles and potentially entire publishing companies. Some publishing companies are Electronic Arts and Valve.

I don’t think that DRM is the right system to use. For one it’s easy to get around if you really want to and many players kind of look at DRM as a challenge something they should get around and publish online as a community service. It’s not just video games that do this, but also DVDs, Blu Ray and CD’s. In fact in the US it’s illegal under the DMCA to circumvent DRM.

So what would I do instead? Since there are a fair number of pretty easy distribution channels for video games now. There’s Steam, EA’s origin and a few other ones that I’m not really aware of. There’s also buying it from Amazon, Best Buy, Game Stop and a bunch of other stores. So access to the game is pretty easy. Price might be an issue, but for good games people are willing to pay a premium, just look at the sales of Skyrim and Modern Warfare 3. Huge blockbuster games. These changes are mostly for First Person Shooters, but similar type changes could apply for other types of video games, such as RPGs or strategy games.

Despite the ease of access people still pirate because they want to try before they drop $60 on a game. So what I’d do is make it as easy as possible to access both legally and illegally. I fully believe in the try before you buy model. However, for copies that weren’t installed from a CD or downloaded from an online distributor like Steam the game quality would be diminished. For instance many gamers complain about the number of frames per second for a game. Video is shot at 60 fps and the human eye can’t see much faster than that, but we can tell the difference if it’s much slower than that amount. In the illegal versions I would make the game run at 30 fps, but it would initially start at the 60 fps and over the course of a minute or two and have a little note flash that if you buy the game you can get the full 60 fps.

Another feature that gamers complain about is the perspective within the game (field of view FOV). They describe it as feeling like your playing with your head in the monitor. basically it’s restriction on peripheral vision. Again I would start the game out with full vision and then slowly move the POV into the “monitor” restricting the view and giving the paying customers an advantage over the pirate customers.

I would also make the user do less damage than their paying counter parts. This would reduce the number of kills and make the player less effective on the playing field and more likely to die and less likely to kill. Finally, the last thing I would do is to have a little pirate flag next to any player that didn’t legally purchase the game so all of the other players would know when some one hadn’t bought the game. In games where kill counts matter this could cause users to be banned from servers and reduce the ease access for playing.

None of these things would ruin the game to the point that some one wouldn’t want to play it. What it would do though is push people towards paying to be able to compete at the same level as everyone else.