the art and observations of Ranjit S. Mathoda

As iPhone excitement reaches a fever pitch, let’s take a moment to ponder what Steve Jobs called Apple’s “hobby”, Apple TV (product page). Jobs explained to Walt Mossberg that Apple TV is not another set top box or a set top box replacement, but is “sort of a new DVD player for the Internet age.” Jobs also said Apple TV is a product that will evolve over time.

Many people in the developed world have a DVD player. It’s not as big a market as cell phones, but it is a huge market. It’s historically been a pretty bad business, unless you’re the low cost manufacturer, because the format in which DVD discs are encoded is a standard that any manufacturer can create a device for.

Toshiba and Sony each saw a solution to the commoditization of DVD players: create and control a new standard for a new type of DVD disc that carries a lot more data, enough to carry movies in high definition. Toshiba, with its HD DVD standard, and Sony, with its Blueray standard, are fighting a pitched battle over who gets to control that high definition DVD disc future. A good amount of their fight has been over convincing the movie studios to back their respective standards. Yet the confusion over which type of player to buy has kept many people from buying either type of player. And when hackers cracked the digital rights protection on high definition DVDs, Fox stopped distributing high definition movie discs.

Meanwhile, Apple and startups like Vudu (see my prior post on Vudu) are seeking to use Internet connected boxes that would replace the DVD player entirely. Is an Internet connected box a better approach than a high definition DVD player? For any type of content, to me it seems the Internet is a better medium than a physical disc in 4 ways and a worse environment in 3 ways.

The ways the Internet is superior are:

1. Marketing. It’s cheaper to do marketing. You can tease people with parts of content and it’s easier for people to share what they like. With community features like YouTube ratings and the Facebook social graph, you can let people know what content their communities prefer.
2. Upload, storage, distribution. It’s easier to allow people to upload. In the physical world, only a select few get DVDs made. In the Internet world, anyone can share their video. The technological costs of storing and distributing that video are rapidly decreasing as the Internet evolves.
3. Encryption. It’s technologically easier to create an encrypted environment on the Internet because you control the software on both the server, client, and data packet sides. In the physical world it’s harder to update broken encryption systems once part of the encryption scheme has been shattered.
4. Update the interface. The interface for Internet based solutions can be revised and updated, as we see in the rapid changes happening to websites. This advantage of the Internet will spread to Internet connected consumer devices.

The ways the Internet is inferior are:

1. Technologically it’s cheaper to move large amount of data by moving discs than by copying bits. High definition video takes up a lot of data space. For a long time it has been cheaper to move that data around by truck than by a network because each physical disc can store tremendous amounts of data. The advantage trucks enjoy is diminishing, however, because the Internet is evolving swiftly and peer to peer file sharing systems dramatically lower the technological costs of distribution.
2. Legally it’s cheaper to move discs then to copy bits. For professionally produced content it’s a bit more expensive to buy or rent movies than it is to share physical discs (thus the current disc through the mail business models of Netflix, Blockbuster, Gamestop, LaLa). This is because although technology makes it cheaper to copy bits electronically then to move them physically, the law of copyright requires you to obtain rights to copy bits electronically but often lets you move them around physically without seeking permission. Therefore, despite the greater technological costs of moving discs, they have less legal costs, and therefore potentially less total cost.
3. Painful to hook up. It’s a bit difficult to connect the Internet to your high definition television type displays. The interfaces on the devices currently used to make this hookup are generally pretty poor and keeping the Internet connection live adds a potential point of failure.

Yet that’s just where things are currently. In the spirit of Wayne Gretzky, let’s ask where the puck is going.

Are physical discs going to become better at marketing, upload (openness), storage, encryption, or changing their interface, than the Internet? It seems to me self evident that the answer is a resounding no.

Is it going to get technologically and legally cheaper to move discs onto the Internet relative to the legal cost of moving physical discs? The discrepancy in technological and legal cost will likely diminish, but it’s unlikely for the legal cost advantage of physical distribution to disappear unless more and more content is unencrypted.

There are multiple approaches to dealing with the legal cost of moving content around. Apple is trying its best to get around this disadvantage by creating one environment (iTunes) to serve content (music, video, games, software) to a multitude of devices (the desktop, laptop, ipod, iphone, Apple TV). Internet stores selling professional content in a digital form may be able to leverage their growing market share (see story) to diminish their legal cost disadvantage. Like Apple, Joost has created an encrypted hard to upload environment, but there are also unencrypted easy to upload environment (think YouTube), or encrypted easy to upload environments (think Brightcove), which all circumvent some of the legal cost disadvantages that the Internet has over physical distribution. The growing size of the Internet advertising market also potentially will draw more professional content onto Internet based distribution systems.

Is it going to get less painful to hookup the Internet to your high definition television type display? Undoubtedly. User interface design in consumer devices is something that Apple is very good at, but it’s not beyond the capabilities of a TiVo, Microsoft, Google, or other party to innovate in such a space. And one significant advantage of building consumer electronics devices with a built in Internet service to distribute media is that you can continuously upgrade the interface of that device. We’ve seen this in the desktop, the laptop, and hints of this with Apple TV and the iPhone. Device development goes from a relatively slow iteration hardware model to a super fast iteration web site like model.

Although leadership in the Internet age can change rapidly (see my post on Murdoch’s statement “They’re all moving to Facebook now”), it is possible to create competitive advantage in the Internet. Apple has shown they can do it by coupling beautiful hardware, elegant software interfaces, a minimalist aesthetic approach to what a customer actually finds most useful, and a growing library of professional content that it has the rights to distribute (iTunes) and amateur content (YouTube through Apple).  Internet connected consumer electronics devices is certainly a better business than being a commodity DVD player manufacturer, if you can get traction with the consumer, and can maintain a proper pace of innovation. This is a point that Toshiba and Sony, with their massive initiatives on a waning medium, would do well to heed.

Update, 1-9-08: An alternative to Apple TV or the various Windows extender devices is to attach a full computer to the television.  See http://scobleizer.com/2007/12/27/the-macmini-hdtv-revolution/

Update, 3-14-08: An even better alternative may be to get Netflix’s streaming movie service ($13.99 a month for 2 DVDs in the mail AND unlimited streaming of about a third of Netflix’s movies) onto your television. Currently this requires a Windows PC (thanks to Apple’s refusal to license digital rights management to Netflix), but in the near future this Netflix service is expected to appear on other consumer products devices.

In my prior post (http://www.mathoda.com/archives/160), I stated that the most impressive web company today is Facebook. They have created a clean, elegant interface, populated it with an ecosystem of other companies, and have an incredible core value proposition they call the social graph, which lets you easily see what your friends and acquaintances are up to in their lives.

Rupert Murdoch is a very savvy businessman, and he’s often credited for moving fast to snap up MySpace at what seemed like a foolhardy price, until it wasn’t. However, one reason he is a good businessman is because he doesn’t fool himself when it comes to business matters.

In an interview with the Wall Street Journal (a company he’s trying to buy) (http://online.wsj.com/public/article/SB118115049815626635.html), here’s what he said about Facebook:

WSJ: The Tribune company was shopped around for quite a while.

Mr. Murdoch: Yeah, but there weren’t any buyers.

WSJ: There was one in the end.

Mr. Murdoch: For $90 million. Risk. That’s in the figures …

WSJ: Why didn’t you do it?

Mr. Murdoch: Don’t want to spend the rest of my life going through that, getting rid of people, ugly. I think they’re in decline, they can fire a few hundred people everywhere, save a couple of hundred million dollars … I guess they will have a billion a year to pay down the debt, that’s what it sounds like. No, a bit less. I would have thought that, although the decline in readership will probably go on.

WSJ: They’re all going to MySpace.

Mr. Murdoch: I wish they were. They’re all going to Facebook at the moment.

And here’s what he said about Google and Microsoft:

WSJ: Then what’s the opportunity for you? Digital?

Mr. Murdoch: I think it’s in the digital area, digital and TV. And I think we’ve got to pour some money into digital. We’ve got to do a lot of things there… There’s so much going on on the Internet. We’ve got to find new ways and new business models to get revenues. Or else the world is going to be owned by Google. I was asked at this investment thing I had to go to, what competitors I see I would have in five years time. Globally. I said I’m sure they’ll be a lot of them. I know one is Google. It’s just getting so strong, so powerful. And I know the guys, and like them. They’re friends of mine. But it is a big fact of life. They sort of just hit the mother lode of search advertising and they’re just destroying Microsoft search, hurting Yahoo’s and making others irrelevant. I don’t understand the technologies but whatever their technology is, it seems to be producing a much higher margin of profit. What are they going to do next? I saw in the New York Times today they’re devising certain, a lot of computer applications which would directly challenge Microsoft, which they’ll give away. So it’s going to be very interesting. Four or five years ago we were all convinced Microsoft was going to take over the world. Now we’re all convinced it’s Google. But that’s another subject.

We live in interesting times, where mega-billion dollar market cap companies arise in very short time frames and fall from relevance even before their cash flow drops. I wonder how long it will take people to catch on to how fleeting competitive advantage can be on the Internet, even for what seem today to be the titans. It’s something to think about the next time someone bemoans corporate power or monopoly status of a company in the software industry.

Update, June 25, 2007: My friend Danah (danah.org) points out that MySpace and Facebook have different levels of popularity in different social classes: http://www.danah.org/papers/essays/ClassDivisions.html

The laws that protect copyright are the harshest in the land.  Particularly, they can carry significant jail sentences (10 years) and can have a huge dollar value penalty ($100,000) that gets multiplied by EACH illegal copy.  Even if you agree that copyright should be enforceable (as I do), it’s astonishing to think that the punishment for copying songs from a family member could exceed that levied for a violent felony.

The Bush Administration is proposing the Intellectual Property Protection Act of 2007.  Among other things, this law could make it a crime with a punishment of LIFE IMPRISONMENT if you use pirated software to provide a health care service.

The justification for such a punishment is that pirated software isn’t safe.  The truth is that pirated software is usually just as safe as the non-pirated version that was copied.  If there’s a bug in Windows: no worries. But if there’s a bug in someone’s stolen copy of Windows used by a hospital: life in jail.

For more: http://news.com.com/8301-10784_3-9719339-7.html

My friend Jon points out in critiquing my post about Vudu (see http://www.mathoda.com/archives/146) that physical box distribution business is not only very tough, and potentially a commodity business, but also that secure content systems like Joost and iTunes are maturing on the PC side, which may be where the real energy for video distribution lies. Om Malik similarly points out that the cable companies are potentially even better situated than Vudu to provide such a service (see http://gigaom.com/2007/04/29/vudu/).

I agree that distributing boxes as a business is tough. Vudu has to convince people to shell out $300 when it initially starts selling boxes. Historically the cable companies and satellite companies (and now the telecom titans) have been able to eventually/slowly copy the features and are in a better position to promote it to their customers before the mass market really catches on. That’s what happened to Replay & Tivo. The only area in which being a box provider has been a huge
success is (a) with the Slingbox where you just pay for a box that lets you stream your TV content to your PC, not the service, and (b) the major videogame console manufacturers, where the box is subsidized by the closed environment for game software sales.

However, while box distribution is a challenge, I think Vudu has a shot, particularly if their patents on this type of instantaneous p2p caching holds up to scrutiny. The growth of video of all kinds on the PC through systems like youtube.com, iTunes, and Joost is an important story, but the mass market has avoided tying their PC to their large
screen televisions, and the mass market isn’t particularly happy with having to wait for a movie to download. While it’s great having all kinds of video on a PC, and movies are okay to watch on a PC (yay for Netflix), movies definitely also should be on the large screen, and they should be available instantly.

The customer ease of use (not having to configure with their wireless network and iTunes account, ala Apple TV or deal with the terrible menu systems to watch the movie they want as is the case with cable co and satellite channel lineup menus), the secure environment for copyright holders (with a Vudu box being an even more closed system for copyright than Joost or iTunes, as you can see from all the major studios and even alot of the minor ones signing up with them, the
holders of the highest popularity content agree: according to NY Times article, Vudu has 5,000 titles licensed, 10 times more than the 500 films Apple offers), and the instant start for a movie download, are all advantages that I think counterweigh the cost of box distribution.

However, even if Vudu itself fails, the basic idea of having a dedicated hard drive hooked directly to your TV and broadband which can instantly serve you movies due to clever p2p caching is an important idea, particularly if coupled with a closed environment in which the content holders feel secure.

One interesting point is that historically the cable cos have held tight control of their infrastructure. however, if you look closely at what they’re doing now, they and the telecom titans are trying to create more open APIs so that startups can come to them with ideas for which they can get more revenue. So maybe, as the NY Times profile of Vudu mentions, Vudu chips would be added to existing HD digital vide recorders by the cable and telecom titan companies.

Of course alot depends on (a) how Vudu’s patents on their p2p caching technology holds up to scrutiny, and (b) how much the mass market becomes comfortable with attaching their PCs to their TVs directly. Eventually I presume the community feel of youtube and Joost will come to the living room TV, and that may require a full PC hookup.