Sarbanes Oxley working as planned

Contra Fred Wilson, let me make a case for why Sarbanes Oxley is working as planned with regards to the current Internet market (frothy in private markets, OK in public markets). Fred says:

Marc lists investments like Netscape, Microsoft, Oracle, HP, and IBM as companies that went public at relatively small valuations and grew their valuations in the public markets. I would add Apple, eBay, Yahoo!, Cisco, and a host of other silicon valley success stories to that list...

The Netscape IPO was a genuine event and kicked of the Internet 1.0 bubble of the late 90s. The company was bought by AOL for $10B in 1999, shut down 8 years later, and is now a discount ISP brand. I don't think it ever earned cash to justify it's initial loft valuation, so I'm surprised to see it cited as a market success, although it certainly made it's early investors very rich (including Andreeson). If Sarbanes Oxley was designed to stop Netscape IPOs, then I don't see why that's a bad thing and it's good to see it's working.

Dropbox did a private financing recently at $10bn, Uber did a private financing recently at $17bn, Airbnb recently did a private financing recently at $10bn. All three of those deals could have and would have been an IPO in the 1980s or 1990s.

Agreed, but you can also add Pets.com, Kozmo.com, and even Netscape in that same category. If the private markets today are making the same mistakes public markets made in the late 90s, then that's hardly an argument that public markets are worse than they were.

The question of course is whether the private valuations are accurate, and even if they are accurate, they strongly suggest that companies are getting fully valued out before they trade shares publicly. It is possible that Airbnb may go from being a $10bn company to a $100bn company, but I don't think that individual retail investors are best positioned to speculate on that nor do I think enabling that is important for markets.

Turning to look at private markets then, it's worth noting that just as sky high valuations were tied to small floats back in the late 90s, today's valuations may be more a sign of entrepreneur strength than actual valuation per se. Palm had a massive valuation when 3Com span it off, but the number of shares available were pretty small and everyone thought mobile computing was going to be big. The combination of strong demand and limited supply pushed the ticker price about $95.

In the private technology market, there are only a small handful of usual suspect companies with material traction, so there must be oceans of promising start-ups that aren't getting traction (cue complaints about Apple's iOS discovery support). So if you are a private investor and you want more start-up exposure, you only have a handful of options, so entrepreneurs may be able to get the cash they need without having to give up much of the company, with the resulting valuation being very high. There may not be much more to this story than limited supply, not much cash needed, and entrepreneurial savvy and bargaining strength.

More on disrupting Aereo

In my last post, I spoke about how the Supreme Court disrupted would-be regulatory arbitrageur Aereo by saying that if it wanted to be a cable company, it would need to pay the same re-transmission fees that other cable providers do.

Mark McKenna writes on Slate that:

It would be one thing if the consequence of this approach were simply to block Aereo from offering its services. That would be a loss to consumers who don’t want to pay $150 a month for cable subscriptions, but at least the damage might be contained. Unfortunately, the problem is bigger than that, for in glossing over technological details, the opinion potentially implicates a wide range of other services. What about Dropbox and other cloud computing services, for example, all of which use their own equipment to retransmit what they receive to their customers, often transmitting many user-specific copies of the same works? How do those avoid liability? Not to worry, says the court, those technologies might be different. Why? Because cable system.

Nonsense.Dropbox is in no way coming anywhere close to the sort of copyright infringement that Aereo was, and everyone knows it, including Dropbox which is why they didn't bother building the crazy Rube Goldberg contraption that Aereo had hoping that minor technical distinctions would get them off the hook for what was plainly cable company operations. This is not to say that the regulations around cable or OTA operation in the US make any sense, they don't, but to make some kind of slippery slope argument that the Aereo ruling imperils a company like DropBox is fear mongering and suggests that the court ruled correctly.

The Supreme Court disrupts Aereo

Just when you thought Silicon Valley has cornered the market in disruption, SCOTUS pops up and does a little disruption all of it's own:

CBS and other broadcasting and media stocks are up in early Wednesday trading after the U.S. Supreme Court ruled that Web TV startup  Aereo could no longer capture their signals  and stream them over the Internet to subscribers.
The court ruling upholds contentions by broadcasters and the Justice Dept. that Aereo’s streaming service violates broadcasters’ copyrights. The Supreme Court agreed, reversing a lower court ruling that sided with Aereo and would have cut into broadcasters’ retransmission fee revenue stream.

Aereo is a service which let customers view programs that were once broadcast over-the-air via the internet. They positioned this as a "cloud DVR" hoping that since DVR was OK (via the original Betamax case 30 odd years ago) and cloud is OK, cloud + DVR was OK. Apparantly the majority on the Supreme Court disagreed.

I'm not going to argue the merits of the case or the decision -- legal history around copyright, broadcast rights, cable and fairly insane -- but I would like to highlight a couple of things which I think are interesting in light of the media discussions I see around the tech industry currently (which I did not see in the late 90s bubble).

1. The CEO of Aereo, while rightly disappointed at the ruling, is a little over-the-top in his public response:

Court decision denies consumers the ability to use a cloud-based antenna to access free over-the-air television, further eliminating choice and competition in the television marketplace

New York, New York (June 25, 2014) – The following statement can be attributed to Aereo CEO and Founder, Chet Kanojia:

What is a cloud based antenna? Sounds like a rhetorical device used to make a bunch of hard drives recording content in various warehouses seem like a metal rod sticking up into the sky. I'm sure Kanojia would like this to be true, but it's certainly open to interpretation, and that incidently is exactly what the Supreme Court did.

Also, I don't think lack of choice in media options is a major issue in the US today. There are genuinely oppressed people in the US, but not TV watchers.

“Today’s decision by the United States Supreme Court is a massive setback for the American consumer. We’ve said all along that we worked diligently to create a technology that complies with the law, but today’s decision clearly states that how the technology works does not matter. This sends a chilling message to the technology industry.  It is troubling that the Court states in its decision that, ‘to the extent commercial actors or other interested entities may be concerned with the relationship between the development and use of such technologies and the Copyright Act, they are of course free to seek action from Congress.’ (Majority, page 17) That begs the question: Are we moving towards a permission-based system for technology innovation?

I'm sure the decision is a massive setback for Aereo and it's investors, but I'm not sure the American consumer will feel set back very much. Aereo's goal to comply with the law is a good one, and the law probably makes no sense, but they didn't meet the mark and I'm pretty sure they knew they were skating close to the lines. That might be why their taglines are "Record & Stream Live TV Online with Aereo Cloud DVR" and "Watch live TV online. Save shows for later. No cable required" -- they were aware that this was going to be a potential issue and were careful to position it was something different.

I cannot see why Aereo's business was a disruptive one in the Clay Christensen sense, it seems more like regulatory arbitrage in the same vein as Uber and AirBnB. “Consumer access to free-to-air broadcast television is an essential part of our country’s fabric," which is politically uncontroversial, although may not be actually that true, but following it with "using an antenna to access free-to-air broadcast television is still meaningful for more than 60 million Americans across the United States" is the kind of wrapping the flag exercise which has been used to justify all kinds of nuttiness in regulating communications in the US.

Most importantly, the tech industry needs to realize that it's in the same boat as all the non-tech people around them, regardless of how much they may wish to exit. Getting to grips with that reality, and learning how to navigate it skillfully, may be the next major milestone as the industry continues to mature.

Silicon Valley, the New Yorker, and Disruption

A nice piece by Jill Lepore on "Disruption"; key paragraph:

A pack of attacking startups sounds something like a pack of ravenous hyenas, but, generally, the rhetoric of disruption—a language of panic, fear, asymmetry, and disorder—calls on the rhetoric of another kind of conflict, in which an upstart refuses to play by the established rules of engagement, and blows things up. Don’t think of Toyota taking on Detroit. Startups are ruthless and leaderless and unrestrained, and they seem so tiny and powerless, until you realize, but only after it’s too late, that they’re devastatingly dangerous: Bang! Ka-boom! Think of it this way: the Times is a nation-state; BuzzFeed is stateless. Disruptive innovation is competitive strategy for an age seized by terror.

I think that Clay Christensen, in the Innovator's Dilemma, was tackling a very particular business puzzle which was why incumbents don't necessarily continue their dominance when their industry undergoes a technological platform shift. After all, they begin with all the advantages in resources, talent, channels, etc. Why can't they adapt?

Clay's answer to this was very interesting, and actually quite specific. For example, I don't think Uber is "disrupting" the taxi business with their app in the CC sense. I think Uber is engaging in regulatory arbitrage by using technology to take advantage of a loop hole in the law. The law may be wrong, Uber may be right to want to replace the system with something more consumer friendly, but this is not "disruption" in the CC sense. Also, it will predictably hurt both the medallion cartels (yay!) and the drivers (boo!) who end up being price takers in a market with easy barriers to entry and exit. Micro 101 would have predicted this, but you can also do the math yourself. This is not any sort of judgement on Uber, or its critics and champions, but merely an observation that "disruption" in the CC sense is quite narrow, and the term is being used very broadly in Silicon Valley today, and it is being used in a way which connotes "refusing to play by the rules and blowing things up."

Set aside the problems one may anticipate from such a tin ear, or a lack of appreciation of the interconnectedness of a society, and look at how the overly broad use of the term dumbs down the discussion itself. A nice comment on the article from a friend of mine who is in this field and currently a professor at a well known B-school:

Okay, I had a seminar on innovation with Clay during my PhD, and studied a related field with lots of the other key academics who research innovation. I think this article is totally fair to Silicon Valley and totally unfair to Clay and the concept of "disruptive innovation" as used in academia. (I do not research the topic anymore, so I have no particular dog in this fight)

Yes, "disruptive innovation" is based on case studies, but Leporte is completely off base when she says that "The handpicked case study, which is Christensen’s method, is a notoriously weak foundation on which to build a theory." In fact, handpicked case studies are a terrific way to build initial theory. In fact, one of the most cited articles is recent social science discusses exactly this point. Case studies are terrible at proving theory, but they serve as a great way to think through a problem.

The reason they are bad at proving theory is exactly the issues that Leporte raises: establishing clear historical facts is hard, and sometimes slippery. I think she has some valid points on the history, but does miss the fact that there is a difference between firms and individuals, and that fact that Shugart had to start multiple firms to compete in hard discs was the point - the organizations couldn't always deal with technological change.

However, she makes it seem like academics (and Clay) basically stopped working on the topic in 1999. One need only look at the Google Scholar cites to see that this is wrong. Since Clay's initial book, a huge amount of empirical evidence has been amassed on this topic, and discussion has become a lot more nuanced. We talk about modular, sustaining, incremental, and discontinuous innovation, and about how to manage the issues that cause firms to fail to innovate: absorptive capacity, ambidexterity, and problemistic search on rugged landscapes. I throw out this jargon not to be overwhelming, but because these are, by and large, ideas that have followed on the work of Clay (and other scholars working on the topic at the same time). It is incredibly unfair to point at one concept, as introduced in one book, by an academic with a long career and yell "the emperor has no clothes!"

Now, the criticism of the popular view of disruption strikes me as right on target, but I think it is like a lot of academic topics that become part of the pop intellectual landscape. They quickly become cultural shorthand with little to do with the original ideas. For what it is worth, Clay is a humble guy who has never seemed to claim that he has it all figured out, and, quite frankly, no one in academia feels like "disruptive innovation" as he introduced it is still at the cutting edge of theory.

That being said, it is still a powerful way of thinking about a really, really important question: "Why don't incumbent firms always win?" Clay was one of the first people to ask why firms with the best people and most resources don't innovate over and over again: why did Kodak fail to create digital cameras? Why did DEC not come up with the PC? Disruptive innovation is one piece of the answer to this puzzle, and to attack it in isolation, or to blame Clay for annoying startup guys, seems disingenuous.

Bizarrely enough, there seems to be some noise around this in the case for the iPhone, namely, why is android not disrupting the iPhone? The real question is, why is it important to someone that Android is, or is not, "disrupting" the iPhone? Why is disruption important here, instead of more prosaic measures such as stealing market share, or mind share, or developer support, or whatever is actually important? To the degree that these two are imperfect substitutes, how much are they even in the same market? Most importantly, why is this the framing at all? When it comes to mobile and the changes it is bringing, surely there are more important questions than "Apple vs Google".

Pfeffer on Amazon

Jeffrey Pfeffer, who oscillates between Machiavellian calculation and almost gullible open-heartedness, as a good article on why Amazon is more ruthless than Walmart:

But it’s Amazon’s relationship with its suppliers that makes the company worse than Walmart. There’s no doubt that Walmart pressures suppliers for the lowest possible price. But once the products are in the stores, both Walmart and the chosen suppliers’ interests are well aligned — to sell as much as possible of the stocked items. It costs money to build stores and ship products to them. Having chosen a supplier and negotiated a deal, there is at least some degree of temporary commitment by Walmart to the vendor.

By contrast, Amazon — with no stores and an IT infrastructure that makes the cost of adding items to sell close to zero — doesn’t care what you buy, or even which of their online partners you use, as long as you buy the product through Amazon. Simply put, Amazon has less incentive to make any specific supplier successful. To Walmart, for books or anything else, selling a million units of one item is great; selling one unit of a million items is impossible in its physical stores. For Amazon, who cares?

To a certain degree, Walmart and it's suppliers are dependent on one another, while Amazon's suppliers are more interchangable, and thus, disposable. Walmart also engages in extensive supply chain integration requiring co-investment, and this co-dependency means that Walmart really does not want suppliers to completely fail. Not so with Amazon.

I would guess that reporters who write critical stories about Walmart tend not to shop there, but they do shop at Amazon. I'll be curious to see how, if it all, that influences how they choose to frame their articles.

Cantor and McArdle

My old friend Megan McArdle has a nice article on Eric Cantor's recent loss to Dave Brat. She writes:

If it is true that money can at least help buy elections, and if this is a factor in the fact that American politics leans toward the concerns of the wealthy, then getting the money out of politics would produce a Congress more inclined to raise the minimum wage, as well as create more generous unemployment benefits and richer national health-care benefits -- but also one that is more nativist and socially conservative. If Brat did indeed win because he went after Cantor on immigration, this exemplifies what those candidates would look like.

I'm not sure what she means to say here. Surely a higher minimum wage and more generous welfare state goes hand in hand with nativism? Wouldn't a more socially conservative society, be able to broaden the welfare state further?