In praise of unfairness

Back when I started out as an equity analyst, in the days when mobile operators were sexy disruptive growth companies, my boss was very fond of comparing the number of customers per employee at fixed and mobile networks. People from fixed networks used to complain about this comparison, saying that it was unfair, because they needed lots of people to maintain the copper line network that a mobile network didn't need because it didn't have one.

And my boss would reply "yes, it's an unfair comparison, but it's a relevant one".

I was reminded of this recently when I posted this chart and was barraged with complaints that it was an unfair comparison:

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I also got quite a few complaints about these charts:

The complaint in both cases was that of course smartphone sales are bigger than PCs, but that's unfair - the phone market is just much bigger than the PC market (and the devices are replaced every ~2 years where PCs are replaced every ~5 years). Plus, it's unfair to compare PCs with mobile devices because some of the things you do on PCs are hard to do on mobile devices (at least for now). 

These objections were quite correct  - the comparison is unfair. But it's also relevant. Mobile is now around half of all time spent online in developed markets and will be the dominant global consumer computing platform of the next decade or two. And the sheer scale of the smartphone businesses is driving a reshaping of all the dynamics of the technology industry, while its supply chain is enabling all sorts of new segments that would never have been possible before - drones, wearables, VR, micro-satellites, internet-of-things devices and lots of other things besides.

Hence, another deeply unfair but deeply relevant chart: Microsoft's share of the sum of all personal computing devices: Windows PCs, Macs, iOS and Android devices and Windows Phones (I could arguably include games consoles in here - my inclination is not to, but it wouldn't change the chart noticeably).  

In case it isn't obvious by now, these charts are meant to be unfair - that's the point. Unfair but relevant comparisons are the most interesting and important kinds. An unfair comparison generally means an unfair advantage, and this isn't the Olympics - unfair is goodCustomers don't care if a company's advantage is unfair. Investors don't care. Unfair advantages are often the best kind. They are something that flows structurally from the reason why your business is going to change everything - they flow from a technology change you are building on or a change in market dynamics or consumer behaviour that you're riding, and that your competitors cannot address. Disruption is unfair. Mobile's disruption of PCs and the PC internet is entirely unfair - it's the unfairness of differences like the replacement cycle and subsidy model (amongst many others) that makes it possible. 

So, here are some more unfair comparisons:

  • Apple and Android could enter the smartphone business with Unix-based platforms that leveraged modern hardware while Nokia, RIM and Palm were working with software platforms premised on the hardware constraints of the late 1990s and early 2000s. 
  • Apple can sell $600 phones for (what look like) low prices due to the operator subsidy system, while PCs have to be sold at full price. 
  • WhatsApp sends as many messages as the global SMS system (approximately) with only a few dozen engineers
  • Skype can provide free phone calls because it doesn't have to maintain a physical network
  • SAAS businesses can be much more efficient than packaged software businesses
  • Amazon has a bigger selection and lower costs than any store
  • Airbnb has a wider selection of places to stay than Hilton
  • Android is more fragmented than iOS
  • Android outsells iOS

One of the strands within this is the concept of getting something for nothing. Most obviously, WhatsApp and Skype use the infrastructure others built at great cost to offer voice or messaging for free. But really, that applies to any internet business. That's, well, unfair. 

In mobile, everything is still wide open

The mobile platform horse race is very entertaining, and a very reliable way to get page views. But it’s also, increasingly, a second-order question. So far, Apple and Google are both winning, in different ways. That may change over time - Apple may make a substantially cheaper phone or developers may shift to making Android apps first. But that’s really not a very interesting topic anymore - everything that can be said has been said, and it wouldn't even necessarily change very much unless you're an Apple or Google shareholder.

To me, the first-order issue is the sheer scale of mobile. We’re going from 1.5bn PCs on earth, either corporate and locked down or consumer and shared and in neither case really mobile, to perhaps 3bn smartphones, that are completely mobile and personal. This means that the internet, by whatever metrics you want to use, gets two or three or four times bigger. It also means the internet can 'eat' a lot of new sectors, across things like, say, retail or payments.

Within this, complexity. I think there are three big differences between the desktop and mobile internet: 

  • ‘Pre-Netscape’ - the desktop internet resolved pretty quickly into ‘the web, and everything else’, and didn’t change much for 20 years. Mobile does not have that single unifying interaction model. We have apps and app stores and messaging systems and iBeacon and a lot more besides, and none of this is finished yet - we do not have resolution into one settled way to do things. Everything is still changing. 
  • ‘Pre-PageRank’ - as a consequence of this complexity the door is wide open for ways for people to find and discover services and ways for companies to reach those people. After the early chaos of the web Google’s PageRank gave a single unifying vector - we do not have such a vector for mobile services. Given the much greater complexity and sophistication of the smartphone platform versus the PC web browser, we may never even get that one unified tool. 
  • Identity -  a smartphone is a a social platform in a way that a PC never was - it has an address book and many other features that apps like WhatsApp can leverage. But it isn’t clear what the point of identity that ties all of these together would be - is it the PSTN number? Email address? Facebook ID? Or some shifting mess of all of these? We have Facebook and Gmail, but it's almost as though we're waiting for them to be invented again. 

As platform owners, Apple and Google will play roles in shaping some of these (or, at least, they will try to). But really, the platform wars are over and everything is wide open. What you look at and how you engage with it, share it, find and discover it are all wide open opportunities in a way that hasn’t been true on the web for a long time. That makes this a really exciting time to be talking to entrepreneurs at a16z

Railways and WhatsApp

Once upon a time, someone decided that the train service from London to Birmingham was terrible, and that a bus service would be much better. So they started a bus company. However, once they were up and running, they found that it would be much more efficient if they built big bus stations in the centre of each city. And to get the loading to work better, you want to get 8-10 buses linked together as one vehicle. And then you really need to raise money and build a dedicated road from London to Birmingham...

The point is, buses can be much more flexible or efficient than trains, but you need to be careful you're not actually planning to build a train after all. Are you trying to unbundle an existing product with a more flexible tech that allows a more flexible product - which is where buses beat trains - or to replicate it?

This is a recurrent problem in mobile - there are wireless technologies around that look like they should be able to disrupt cellular operators, but actually they never do, because to disrupt cellular you need another train line, not a bus.

Mobile LOOKS like a tech business where tech should change things, but most of the money in a new mobile network goes on base stations and three quarters of the cost of an urban base station is in the construction and site acquisition, not the equipment (the cost of a national fibre network, meanwhile, is irrelevant). And the number of towers you need to get enough coverage for the first customer to sign up has relatively little to do with the technology you use - it's down to the physics of in-building penetration at the frequency you're using and the number of hills and mountains there are. (Technology has a big effect on the number of towers you need to build later for capacity, of course, but not for coverage.)

Hence the problem with disrupting mobile networks with new radical technology: the notional efficiency gain tends to get buried by the rest of the underlying economics of the system, all of which you need to build just the same. 

Hence, for example, the now totally failed attempts to use WiMax for mobile service were a bit like replacing diesel engines with electric: you might or might not choose to do it if you were building a national train system from scratch, but the real money would be going on tracks regardless. The same applies to wifi, which in which the bus v train analogue is almost perfect - wifi is great, but if you try to use it to offer a mobile service you end up building, well, a mobile network, with no cost savings at all and, in fact, a much less efficient business than you'd get if you'd started with the right technology in the first place. 

Of course, none of this is to say that you can't disrupt the mobile network industry in any given country. But you do it by being a mobile operator - by getting spectrum, and building towers, and (very often) by getting the regulator to put a hefty thumb on the competitive scales in your favour. 

As an aside, one of the things that dropped out of the great MVNO bubble of 7-8 years ago is that a reseller can't disrupt the person whose infrastructure they're reselling - unless, again, the regulator imposes disruptive wholesale rates or the telco screws up and sets the prices too low (as One2One/T-Mobile did for Virgin Mobile in the UK), or just uses MVNOs to fight a price war by proxy (which I don't think really counts as disruption). MVNOs need an angle, whether that's being a supermarket, or targeting immigrants, or something else - just being an MVNO isn't enough. 

The place in which technology really IS affecting mobile network operators, of course, is in what goes over the top - WhatsApp versus SMS, with voice coming next. Unlike a pure infrastructure play, these are essentially unbundling stories, and they’re aiming unbundling at the right part of the system. Of course, that's not how a telco sees them - a telco sees them as arbitrage.

The classic telco arbitrage story was long distance and international. Long-distance and international connections used to be very expensive, no longer are, but telcos pricing had not fallen to match, and first calling cards and then Skype arbitraged the difference between the list price and the real economics of long-distance or sub-sea fibre. Mobile messaging apps do something similar for data, arbitraging the gap between the economic cost of a few K of data and the price charged for SMS.  As cellular data speeds go up, we should expect voice apps to take off in a big way as well: the pricing gap is not as big but things like on-net/off-net call pricing will also go away (with both positive and negative margin effects for telco, for reasons I won't go into here). 

(Incidentally, VOIP annoys mobile operators on principle since it tends to use several times more radio network capacity than a circuit-switched call, as it's not optimised for how the network functions (this will change with LTE). Hence VOIP on cellular is an interesting example of new technology that actually has worse real underlying economics than the product it attacks.)

How much does this matter to mobile operators, though? There's also another train analogy that's applicable here: Roald Dahl wrote a story about a character who made a living by arbitraging railway luggage fees. He had noticed that, while you had to pay the railway a luggage fee based on what your luggage weighed, if the scales showed a negative number then the railway company had to pay you. So he travelled everywhere with a large suitcase full of helium and charged the railway company a fee. 

The idea that OTT messaging services pose some sort of existential threat to telcos remind me a lot of this story. If the railway company can't change the pricing system and everyone goes out and buys a helium suitcase then yes, they're screwed. But telcos can and do change their prices. And that helium suitcase doesn't somehow change the cost of coal or locomotives. You're not using innovation to uncover a new set of economics - you're just hacking the pricing plan. 

Hence, the challenge for mobile operators is to change their tariffs. WhatsApp and Facebook Messenger do not change what it costs to provide you with a pipe. If the technology now means that the pricing scheme is no longer aligned with the economic cost of the network, you need to change the pricing scheme. 

There are two problems in this, though. The first is that repricing a business whose main competitive dynamic is complex and highly-wrought pricing schemes is a nightmare. In the short-term churn will shoot up and in the long-term moving to unlimited bundles means you cap the ARPU from your whales - all those people currently paying €200/month for voice calls will drop down to your €50 unlimited plan. You may well end up with a lower ARPU than before. The second is that if you have less freedom to offer complex pricing schemes you face the risk that the market will move to much more commoditised, easily comparable pricing, with a consequently much higher likelihood of price wars. Both of these issues are essentially transitional, and will vary a lot by country - in some places the transition will be fairly smooth and in others it’ll be painful and result in a step change downwards in ARPU. The arrival of data bundles is a great example - US operators added them to people's plans, pushing ARPU up, but European operators weren't able to get away with a price increase because the markets were much more competitive. The end of separate SMS pricing will see similar differences. 

The big problem that these products pose to MNOs, it seems to me, is not actually the threat to SMS revenue. Rather, it’s the threat to identity. We do already have number portability, but changing your number remains a major frictional issue reducing churn. But if your contact point moves to FB Messenger or some yet-to-be-founded app that explodes in the next few years, then the SIM you have in your phone today doesn’t matter at all, and you could swap it in and out from week to week depending on which mobile operator was offering the best deal - a great recipe for truly murderous price wars. For a really killer effect, of course, you’d have to combine that with an end to the subsidy + contract model, which is far from certain (and would also be terrible for Apple and Samsung). But that’s the threat. 

Notes on TV

One of the reasons it's difficult to talk about the future of TV is there are really several separate sets of issues that are in play, which are pretty much self-contained, and depend on quite different factors, and all of which need to move before things can change. 

The US problem

First, the USA is a massively over-served Pay TV market. Pay penetration is very high (90%+), ARPUs are very high by international standards, bundling is very rigid, and so there are lots of people who feel obliged to buy much more than they really want.

Hence, there is a lot of pent-up demand for some sort of unbundled approach - to be able to get just the channels that you want and pay less. But the bundling model is very deeply embedded in the structure of the US TV market, at multiple levels of the value chain, and there are some very strong incentives for a lot of industry participants to continue with the status quo. In other words, everyone hates the way the US TV industry works, except for the US TV industry. This makes the current model very rigid, but also of course potentially very brittle. 

Tech industry attacks on this model have tended to come from the distribution side - they put together a new distribution platform and then go and ask content owners to give them the content to offer an unbundled service. But they very quickly discover that coming to Hollywood with a distribution platform doesn't get you a cup of coffee - you need to propose a more profitable economic model, and back that up with cash on the nail. A physical distribution platform itself is not where the value is - it's the possession of a huge audience or valuable content that gives you power. And it's tough for a platform with no customers to offer better economics than a platform with tens of millions. 

More broadly (i.e. beyond just the US bundling issues) it's helpful to think about TV as a virtuous circle. Audience gives revenue, revenue lets you buy great content, and great content gets you more audience. This is self-sustaining at each level. A big TV channel is big because it's big, not because it has access to a linear distribution path. 

This is a little like orbital mechanics: if you want to go to orbit you need to burn a lot of fuel, and the higher you want to go the more you need to burn - and having a better-looking rocket doesn't make much difference. Money for content is the fuel of the TV business. 

Hence, the interesting thing about Netflix is not so much the physical distribution platform as the use of data to attack the cost of content - if you can make hits more reliably you can get the same audience for less money spent, since you waste less of it. To the TV industry Netflix would look like just another TV channel without the use of data.  

Finally, if the US TV market is over-served, most others are not. The UK is arguably a 'goldilocks' market - half of households have pay TV and are broadly happy with it, and half don't and are broadly happy with that. Meanwhile some European markets are probably underserved for pay TV - more people might like a pay TV product than are currently being given one. So the whole US 'cord cutting is the future' discussion is not necessarily broadly applicable. But the size of the US market (and the physical location of most of the tech industry) tends to shape the debate. It may also focus attention on the wrong problems.

The user experience problem

Next, there is the user experience. It seems pretty clear we're in a 'pre-iPod' phase at the moment. That is, all of the technology is in place, more or less, but no-one has quite managed to package it up in the right way to give the right user experience. There isn't yet a totally fluid way to browse, choose and display what you want on your TV. Lots of people are poking around it (including Apple and Google) but it doesn't seem like we have that magical 'aha' moment just yet.

There are also a bunch of route-to-market problems here. Integration inside a TV is great but TVs are only replaced every 5+ years. Pay TV tech, unlike mobile, is a balkanized mess of standards, with no GSM/UMTS that you can implement and sell globally. Pay TV operators are the gatekeeper to any other equipment in the living room (at least in markets where pay has a large share) unless you can make it really cheap - a couple of weeks before the Chromecast launched I suggested that the next Apple TV should be a $50 HDMI dongle, and the tech for that is moving forward in interesting ways. And of course we also have tablets themselves, which are certainly replacing second TV sets and may take a real share of primary set viewing too.

At the moment there are a lot of rumours that Apple has a new product - but the rumours mainly focus on how it would deal with the unique US content ownership and distribution structures, not the user experience, which is actually the real question. That is, in the US a big part of the user experience gap is the simple availability of content per se, but elsewhere that is much less of an issue. In the UK, for example, all the main broadcasters put the last 7 or 30 days of content online for free, on any device, with no restrictions or messing around. iPad, iPhone, Android, Smart TV, games console - anywhere, any device, any time. And yet peak streams on the BBC's iPlayer service are 600k or so, where peak linear TV viewing is over 20m, and linear TV viewing shows no sign at all of declining. 

How do people really want to watch?

This in turn points to another question, and perhaps a slightly subversive one: how do people actually want to watch 'TV' (or whatever we call it)? Hundreds of millions of normal people really do just come home, turn on the TV and watch whatever's on - if you offered something less passive, do we really know how many would do it? That is, the idea that no-one would watch linear broadcast TV if on-demand worked 'properly' (whatever that might mean) is really just an assumption. 

The really big question here is how TV viewing would change if you did move from the current model of TV as a largely undirected, passive experience, to one that required (/'allowed') you to make choices. If you come home and turn on a random piece of generic light entertainment you'll watch it, but you might never choose to watch it, much less search for it. So is that a bundling problem or a recommendation problem? Should we think of TV viewing hours as propped up by filler shows in the same way that CD albums were full of filler tracks, and that if we go to a fluid on-demand environment people might just stop watching that filler? Or would the right passive programming system - 'Pandora for TV' replace one passive experience with another, more tailored and targeted one, with the greater accessibility of long-tail content taking up the slack? Of course, a lot of TV channel branding and programming is about just this - in effect a lot of TV is 'Pandora for TV'. Either way, this is really about unbundling shows from TV channels, not unbundling channels (or on-demand channel brands) from cable TV subscriptions. And (looking back to Netflix) how would that cascade back though the TV production system? How many fewer shows might be made? How would they be funded? And what would happen to the 'golden age of TV'?