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April 23, 2010
My canonical paradigm

A Chinese American entrepreneur engineer named Henry Gao has written a Chinese book paralleling, enriching and affirming the more far reaching propositions in Telecosm.

His theme is that the history of communications networks has passed through three eras: 1) the telegraph (data with delay and buffering); 2) the public switched telephone network (PSTN for real-time two-way voice), and 3) now back to the telegraph (the data-rich Internet protocols and layers, with many asynch buffers and best efforts and lost bits).

Today under the stress of an interactive video exaflood, there is a new fork in the road. On the one hand, the industry wants to continue on its current path back to a new video best efforts telegraph--an ever more complex Internet patched and epicycled and upgraded for interactive video. This is the current choice.

Continue reading "My canonical paradigm" »

October 3, 2009
Short life of exclusivity

Morgan Stanley analyst Kathryn Huberty believes iPhone sales could double if Apple ends its exclusive partnership with AT&T.

Huberty cites a 136 per cent increase in the iPhone's French market share after the ├╝berpopular smartphone became available from SFR and Bouygues Telecom after initially being limited to Orange.
* * * *
"In the top six iPhone markets that are still exclusive," she writes, "we believe that Apple's market share could rise to 10 percent, on average, in a multiple carrier distribution model from 4 percent today."
The FCC shouldn't follow the French example of prohibiting iPhone exclusivity. Appearances to the contrary, this isn't a regulatory success story. Regulation just happened to be in the right place at the right time.

Generally, exclusive distribution benefits novel products but handicaps established products.

Innovators pursue exclusivity so distributors and retailers can recover investments they make to promote the product and provide optimal service quality. Otherwise, these partners could be undersold by free riding competitors and the investments would end. Exclusivity means that the innovator doesn't have to bear the entire risk of a product failure.

After a successful product launch, exclusivity tends to foreclose additional sales. When the value of foreclosed sales exceeds the value of the special efforts by distribution or retail partners, the market discourages exclusivity. Huberty apparently believes the iPhone has crossed that line.

French regulators were lucky as a matter of timing. Regulation didn't boost iPhone sales in France, exclusivity was no longer particularly helpful to drive sales.

If regulation killed exclusivity prematurely, sales would have tanked. If regulators allowed exclusivity to run its course, exclusivity would disappear without government intervention.

Everett Ehrlich, Jeffrey A. Eisenach, and Wayne A. Leighton provide further explanation in a recent paper why exclusivity helped the iPhone.

Promotion and service quality are especially important for new entrants offering new products, and the iPhone was an especially complex case, requiring extensive coordination between manufacturing, software, network and retail activities. Accordingly, contrary to what may be popular perception, Apple sought out an exclusive distributor for the phone -- not the other way around -- and ultimately chose AT&T. As detailed by Hahn, Litan and Singer, Apple's demands included maintaining strict control over the applications that would run on the iPhone, controlling branding, and working directly with customers on maintenance and service issues. Ultimately, of course, Apple's strategy worked: Its de novo entry into the wireless handset business was one of the most successful product launches in U.S. history, with more than one million iPhones sold in 74 days. (footnotes omitted.)
The Rural Cellular Association is urging the FCC to prohibit handset exclusivity arrangements. But Apple doesn't need the FCC to tell it when exclusivity is no longer in Apple's economic interest. Apple is capable of figuring that out for itself, and iPhone exclusivity will be terminated when it does. Meanwhile, it would be good for the economy if innovators can continue to make use of exclusivity for legitimate purposes.

Exclusivity drives innovation. Once demand is established, producers have every incentive to cut prices to expand sales of a successful product.

September 28, 2009
Mobile money

The Economist has a great special report on mobile phone service in developing countries.

For one thing, "mobile money" is transforming the lives of ordinary people in areas with poorly-developed banking systems.

... a new opportunity beckons: mobile money, which allows cash to travel as quickly as a text message. Across the developing world, corner shops are where people buy vouchers to top up their calling credit. Mobile-money services allow these small retailers to act rather like bank branches. They can take your cash, and (by sending a special kind of text message) credit it to your mobile-money account. You can then transfer money (again, via text message) to other registered users, who can withdraw it by visiting their own local corner shops. You can even send money to people who are not registered users; they receive a text message with a code that can be redeemed for cash.
Mobile money could also transform the lives of many people in the developed world who are without bank accounts, haunted by poor credit scores or would just appreciate a convenient alternative and more competition in the financial services sector.

But it look's like we'll have to wait a while.

Given all of its benefits, why is mobile money not more widespread? Its progress has been impeded by banks, which fear that mobile operators will eat their lunch, and by regulators, who worry that mobile-money schemes will be abused by fraudsters and money-launderers.

January 9, 2009
Cornucopian Realm of Bioscience

Perhaps the most interesting man I met in Israel on my recent trip was Martin Gerstel. Alone on the cover of Business Week when he graduated from Stanford Business School in 1968 (as the nation's most promising MBA student), he founded Alza Corp. with Alex Zaffaroni and built it into a major pharmaceutical devices company. It was sold in 2000 to Johnson & Johnson for $14B.

In 1993, he moved to Israel, the home of his wife, and discovered a cornucopian realm of new technologies, leavened by the arrival of a million highly educated people from the former Soviet Union. He resolved on Compugen (CGEN) as the most promising. It came public as CGEN in 2000 with a valuation of close to $400M.

At the first of the year, with the valuation down to $14M, he returned to the company to become its CEO. This guy is for real. He is convinced that CGEN has technologies that are unique over the entire span of the biosciences--that most of the rest of the industry is working with erroneous models. CGEN has created unique in silico computer models of the
genome, the transcriptome, the proteome and what they call the peptidome (peptides or protein fragments that are critical for modulating what are called the GPCR receptors in the body).

Rather than discover through experiment the peptides that modulate these receptors as the rest of the industry does, Compugen's algorithms predict and select them. Half of all drugs operate by impacting GPCRs. The issue is sorting out the peptides that modulate GPCR receptors in the body. The CGEN algorithm working on the model of all the peptides in the peptidome found some 30 that according to the model would address the body's
receptors. Gerstel reports that the results are in and that of the 30 peptides found by the model 8 were validated.

Gerstel told me: "The average in the entire industry is two a year. We found 8" in one processing of the peptidome through the algorithm.

July 7, 2008
Evolving theory of network effects

Should antitrust enforcers be concerned about entry barriers in the search ad market? Some believe the market exhibits "network effects," according to the New York Times.

Although traditionally applied to Industrial Age industries with high fixed costs like railroads and telephone exchanges, anything now exhibits a network effect if its value increases because more people use it. Network effects are "everywhere," according to a top former antitrust official. Coke and Pepsi drinkers, for example, "benefit from the network of their fellow consumers because Coke and Pepsi are widely available in restaurants and in vending machines," claims Timothy J. Muris.

A preexisting network of vending machines is admittedly tough for soft drink imitators to replicate. But a barrier to imitation can also be viewed as a spur to innovation because it acts as a reward which inspires creators and investors. Not an incentive to create a barely distinguishable alternative, to be sure, but to create something transformative.

The alleged network effects in search advertising are more subtle than in the case of railroads, telephone exchanges or soft drinks (in fact, they even bear a striking resemblance to what one might term legitimate and hard-won competitive advantages).

[E]conomists and analysts point out that Google does indeed have network advantages that present formidable obstacles to rivals. The "experience effects," they say, of users and advertisers familiar with Google's services make them less likely to switch. There is, for example, a sizable cottage industry of experts who tailor Web sites to get higher rankings on search engines, which drive user traffic and thus ad revenues. These experts understandably focus their efforts on the market leader, Google -- another network effect, analysts say.
This sounds remarkably like how the European Union sees the market for streaming media players. The EU prohibits Microsoft from including a free player with its PC operating system because its competitors couldn't give away enough copies of their own media players.

Network effect theory overlooks whether, perhaps, there are no other objective differences in the value propositions of the competing products. If consumers have a choice between a superior product versus an inferior product which most of their neighbors are using, the theory assumes most consumers will choose the latter. Thus, there is no incentive for anyone to design a superior streaming media player for a desktop PC.

But that may not be a bad enough thing to warrant letting politicians and bureaucrats rearrange the market. It is inherently destructive to innovation to allow them to do that, because they principally serve constituencies who are more interested in preserving the status quo.

June 6, 2008
Telecosm recap

You should have been there! Telecosm was thrilling. I will list the ways, in chronological order in two or three posts over the next few days. (Below is Part 1.)

1) Lawrence Solomon, author of The Deniers, demonstrated, beyond cavil,
that nearly all the relevant scientists, outside of the government
echo-chambers, completely repudiate the climate panic. He concluded by
pointing to evidence for a cooling trend ahead.

2) After I presented the statistics showing that most of the global
economy is driven by innovation in the Telecosm--teleputers, datacenters,
optical fiber, fiberspeed electronics--Steve Forbes gave a magisterial
tour of the world economy. Relevant to the debates on the Gilder Telecosm
Forum subscriber message board was his assertion that the Fed had been too
loose in the face of a collapse in the demand for dollars caused by the
muddled cheap dollar leadership from the administration. Later in the
conference, in an incandescent speech mostly about the amazing expansion
of freedom and supply side economics in China, John Rutledge maintained
that the Fed had been too tight, measured by the flat monetary base. But
then, as far as I could grasp, Rutledge contradicted himself by showing a
dramatic surge of bank lending to small and midsized businesses. If it was
caused by the collapse of other lending sources, he did not give any

3) Nicholas Carr gave a suave and lucid presentation of the themes of his
The Big Switch book, comparing the emergence of cloud computing to the
rise of the centralized power grid. Raising an issue that recurred
throughout the conference, our regnant expert on the power grid, Carver
Mead, dismissed the analogy as simplistic, since one-way power delivery
and two-way information transfer are radically different processes. Bill
Tucker, author of the forthcoming Terrestrial Energy, pointed out in a
compelling speech that Moore's Law is about miniaturization of bits while
the energy industry is better described by a Law of More--more power and
more efficiency. He explained that all the energy in the atom is in the
nucleus and pointed to the immense heat caused by nuclear fission and
fusion within the earth. Then he impugned the venture capitalists'
compulsion to waste arable land and space twiddling with electrons and
photons and presented much evidence that solar energy in all its forms
would never provide adequate power for an ever growing economy. Physicist
Howard Hayden of Energy Advocate enthusiastically confirmed this view.

4) Andy Kessler followed with an uproarious investigation of Who Killed
Bear Stearns?. His answer pointed not to the usual culprits (though he did
politely finger front row auditors me and Bob Metcalfe) but to Bear
Stearns' itself. After preparing a feculent feast of sub-prime pork ("they
knew better than anyone else what was in it"), then packaging it all into
putatively succulent AAA delicacies, they totally lost it and ate their
own sausages.

5) The Exaflood Panel presented Andrew Odlyzko's dour but learned analysis
of Internet traffic, which concluded that the real danger is not too much
traffic but not enough to sustain all the businesses in the sector. Joe
Weinman, a brilliant strategist from ATT, however, confirmed the Exaflood
thesis, and Johna Till Johnson of Nemertes offered compelling evidence
that the best way to examine the issue is from the supply side. If you
don't build it, they definitely will not come. Traffic in the core is
dependent on access from the edge, which still lags in the US, as even
Odlyzko showed rates of usage in Korea and Hong Kong six times US usage
rates. Lane Patterson of Equinix confirmed aggressive estimates of traffic
growth and still more ambitious growth of Equinix datacenters, but said
that patterns of traffic confirm that the core is being starved by
inadequate access on the edge.

March 3, 2008
Chaos and opportunity

Referring to Bret Swanson's and George Gilder's prediction U.S. IP traffic will reach an annual total of 1,000 exabytes, or one million million billion bytes by 2015, Ethernet inventor Robert Metcalfe foresees a terabit-per-second Ethernet, according to Telephony. Although not sure eaxctly when, Metcalfe predicts --

New modulation schemes will be needed for the coming network, he said, as well as "new fiber, new lasers, new everything."

The need to replace existing technologies will create "chaos," Metcalfe said, but also opportunity for equipment vendors.

February 1, 2008
A Breakdown of the Innovation Culture?

In preparation for the "Exaflood" paper, I read the November 2007 paper by Nemertes Research -- "The Internet Singularity Delayed: Why Limits in Internet Capacity Will Stifle Innovation on the Web." It is an exemplary supply-side work (low utilization rates signify inadequate bandwidth rather than lack of demand). Failure to invest in infrastructure will produce not a breakdown of the Internet but a breakdown of the innovation culture of the net that brought us YouTube et al.

I recommend the paper to all as a guide to the prospects of our network processor and hollow router paradigms. It contains a number of obvious errors (dates reversed on charts (p.22), confusions between zettabits per second and petabits), and a "What me worry?" approach to huge conflicts between Nemertes and Odlyzko estimates of global capacity in 2000 (Odlyzko 85 pettabytes per month; Nemertes 61 exabytes!). Today global access capacity is around a zettabyte (10 to the 21) per month (2 plus petabits per second), with the U.S. commanding only one seventh of it (300 Tbps) or 14% while our GDP was close to 20% and our market cap 40% (adjusting for dollar doldrums).

Meanwhile, U.S. investment in infrastructure (capex only) was roughly $5B out of a global total of $20B and U.S. investment in access equipment (again capex only) was under $1B or about a fifth of global access investment in capex ($5B plus). But the U.S. out-invests the rest of the world in edge router/switch connectivity for the metro and high-end enterprise. Enterprise IP traffic is estimated to be about 1.5 times Internet IP traffic, but convergence continues.

On page 29, the report contains a breakdown of core and edge router/switch unit growth that is relevant to our network processor paradigm. On the order of 10 to 15 thousand core routers are sold annually, compared to between 30 and 60 thousand edge and metro routers and literally billions of access nodes of all kinds. The NPA is a key product for volume production of NPUs for scale and learning curves.

The other insight is that IPV6 meets the need for addresses but does not respond to the expansion of router tables that will slow the net in coming years if it is not remediated. The conclusion is a large need for CAMs, Knowledge Processors, and other memory and lookup table accelerators.

Nemertes declares that the U.S. confronts a coming bandwidth crunch in 2010, when access constraints will begin seriously to limit investment in Internet service innovation. The argument is that Moore's law increases in capacity will yield rising utilization rate and that traffic is supremely sensitive to utilization rates. In other words, as bandwidth increases we use it more and innovate more. I believe this. Others don't.

"If we build it, they will come," is the underlying assumption of Nemertes and me. People laugh but it is true over any run longer than a year or so.

January 25, 2008
Work, Invent, Invest

Driving the economy are not dollars in peoples' pockets but the ideas in their heads. Not buying-power but incentives impel people to take risks and make efforts and investments. More dollars may even reduce peoples' incentives to work and invent and invest. Every dollar rebated to a consumer comes from another consumer or investor. You cannot increase spending power (real income) without first increasing output. Supply creates its own demand. Demand does not increase supply except to the extent that the demand symbolizes previous productive efforts that expanded output.

Democrats and wobbly Republicans are panicked by class rhetoric from lowering the top rates which most affect incentives. These top marginal rates yield all the revenue (the lower the rates the more the revenue--see Art Laffer's superb piece in today's Wall Street Journal). Therefore the pols lower "business" taxes, helping profitable established businesses compete against fast growing new businesses, such as our technology companies.

The fact is that the only way to get more revenues without hurting the economy is to lower the rates on the rich. Cutting corporate rates is an indirect way of doing it.

In the political debate it is worth recalling that so-called Bush's tax cuts on capital gains and dividends were in fact proposed by Bill Thomas on Ways and Means and merely signed by Bush, after he proposed wimpy phased reductions of income taxes. The Bushes all consult Yale Keynesians who know nothing about the economy. Bush's entire administration, including its ability to prosecute the war in Iraq while drastically reducing the deficit, was fueled by Bill Thomas's revenue gushing tax rate reductions on capital gains and dividends.

March 15, 2007
Digital Prosperity Report Concludes IT Investment Critical

Policy makers should recognize information technology as the centerpiece of economic policy and develop their plans accordingly, concludes the Digital Prosperity study published this week by the Information Technology and Innovation Foundation.

"In the new global economy information and communications technology (IT) is the major driver, not just of improved quality of life, but also of economic growth," writes Foundation president, Dr. Robert D. Atkinson, author of the study.

Atkinson is a widely respected economist who formerly served as project director of the Congressional Office of Technology Assessment, and is the former director of the Progressive Policy Institute's Technology and New Economy Project of the centrist Democratic Leadership Council.

Based on reviews of other studies, and Atkinson's own research, the report maintains, "IT was responsible for two-thirds of total factor growth in productivity between 1995 and 2002 and virtually all of the growth in labor productivity" in the United States.

Continue reading "Digital Prosperity Report Concludes IT Investment Critical" »

March 6, 2007
Growth and Jobs for Europe?

EUROCHAMBRES, the association of European chambers of commerce, has a new report out measuring the EU's progress achieving its ambitious plan of becoming "the most dynamic and competitive knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion, and respect for the environment." Unfortunately, the report concludes that the EU is still losing ground.

In two years' time, the gap EU-US (sic) has widened for all economic indicators:
  • Income (GDP per capita). The current EU level for income was achieved by the US in 1985. Since the first edition of the study, the time gap has increased by 3 years;

  • Employment and R&D. Both the current EU levels for employment and R&D investment per capita were reached by the US in 1978. (+3 years and +5 years respectively);

  • Productivity (GDP per employed). The current EU productivity level was achieved by the US in 1989 (+3 years).

  • The current EU level of Internet users per capita was reached by the US in 2002. The gap for this indicator was assessed for the first time in this edition of the study.

  • European leaders are attempting to overtake the U.S. without cutting taxes or reducing regulation. That's what they mean when they talk about sustainable economic growth, social cohesion and respect for the environment. I hope they're successful, but I fear they've set unrealistic goals and will continue to punish innovative American companies as a result. After accusing Microsoft of market dominance for commanding a mere 34% of the server market in the aggregate, European Union regulators have turned their attention to other successful American companies. Qualcomm, which offers discounts on bundled products, and Intel, which offers volume discounts, are both under investigation as a result of complaints the EU has received from American and European competitors. This is because the current generation of European leaders, like their mercantilist forbears, possess a vision of finite possibilities in which one country's success comes at the expense of another's. At least that's how I interpret the following passage from a high-level report prepared by the EU in 2004:
    Europe has to develop its own area of specialisms, excellence and comparative advantage which inevitably must lie in a commitment to the knowledge economy in its widest sense -- but here it is confronted by the dominance of the US. The US threatens to consolidate its leadership. The US accounts for 74 % of top 300 IT companies and 46 % of top 300 firms ranked by R & D spending. The EU's world share of exports of high-tech products is lower than that of the US; the share of high-tech manufacturing in total value added and numbers employed in high-tech manufacturing are also lower. In a global economy, Europe has no option but radically to improve its knowledge economy and underlying economic performance if it is to respond to the challenges of Asia and the US.

    In fact, "economic integration runs deep," as the EU commissioner for the internal market and services, Charlie McCreevy, noted this week in a Wall Street Journal column comparing Sarbanes-Oxley to the Europe's more cautious approach in regulating financial markets. The EU resisted the temptation to impose Sarbanes-Oxley regulation and this is a key reason their capital markets are thriving and outperforming ours as a result. Some Europeans are celebrating, but McCreevy pointed out "anything that hurts U.S. capital markets also hurts European companies and our economy." That's how the U.S. and the EU need to view antitrust and competition policy. Since we're economically integrated, anything that harms innovation on one side of the Atlantic hurts companies and the economy on the other side. And obviously the reverse also must be true.

    February 5, 2007
    Health IT Creating a Buzz

    Patients, adept at using the internet to schedule travel, conduct business, and access information with the click of a mouse, are now driving changes in the way state and federal policymakers address health care reform.

    "Health IT" is the new buzzword for health care, and information technology proposals for healthcare reform are sprouting like daffodils in April!

    Tennessee Gov. Phil Bredesen

    So far this year, the National Governor's Association has announced the creation of the State Alliance for E-Health, co-chaired by Tennessee Gov. Phil Bredesen and Vermont Gov. Jim Douglas. Their purpose is to bring together office holders and policy experts to, "address state-level health information technology (HIT) issues and challenges to enabling appropriate, interoperable, electronic health information exchange (HIE)".

    As quoted in the National Journal's coverage of the event, Gov. Bredesen explained, "...the states can move much more quickly....I don't trust the federal government to actually do anything on my watch."

    Continue reading "Health IT Creating a Buzz" »

    December 7, 2006
    Price controls destroyed European pharmaceutical innovation

    Eli Lilly CEO Sidney Taurel's observation about the effects of price controls in the pharmaceutical industry in a recent Wall Street Journal interview is worth remembering.

    I've seen the bad effects that government policies of price controls and overregulation can have. When you look at Europe 30 years ago, that was where most of the innovation in pharmaceuticals used to take place. When I joined the industry the No. 1 was Roche and then it was Hoechst and Bayer and all these companies, which today are not as big. What 30 years of price controls have done is more and more of the research has come here. I think only about 25% of the total research in the whole industry is done in Europe.

    November 4, 2006
    Discovery Promoting New Gasoline-Saving Technologies

    At Discovery Institute, we are promoting transportation technologies that can help the United States break free from dependence on volatile parts of the world for oil and gas. (See this post at

    Computers and network servers use enormous amounts of electricity, so prudence requires support for conservation--and major new sources of energy--wherever possible.

    October 18, 2006
    Innovation killer

    Economist Larry Hunter, an old friend, zeroes in on the real threat posed by the Medicare Part D prescription drug benefit -- price controls. Potential House Speaker Nancy Pelosi doesn't call them prices "controls" of course. She calls them "negotiations" and says she'll institute the change in her first 100 hours in office. Hunter reminds us of past intrusions into the crucial information-processing realm of prices:

    These "negotiations" would have terrible consequences: They would create shortages, stunt new development, generate red tape, increase government intrusiveness into patients' health-care decisions and eventually raise drug prices.

    The historical record is clear: Price controls always have the opposite of intended effects.

    Airfares were higher, not lower, after price controls were imposed in 1938. When price controls were finally removed from the airlines industry 25 years ago, prices fell dramatically.

    Price controls imposed to stop skyrocketing inflation during the 1970s were also spectacularly unsuccessful. When President Reagan removed price controls on gasoline, long gas lines evaporated and the price of gasoline fell sharply.

    I would add telecom to the mix. Price controls known as TELRIC and UNE-P, disguised as competition promoting mandates, were the key cause of the 2000-2002 telecom crash.

    Although the Medicare prescription drug benefit irresponsibly adds large unfunded liabilities to our national balance sheet -- maybe as much as $20 trillion -- that has not been my primary worry. We are a wealthy nation, and we often ignore the large and growing asset side of the national ledger. The ultimate threat of Medicare Part D is as an innovation killer.

    Price controls also would create other huge disincentives for companies to develop new life-saving drugs. Not only would price controls curtail overall research but they also would divert it into less risky and less promising areas -- particularly with regard to seniors.

    In other words, if drugs that are primarily used by seniors suddenly are made unprofitable by federal decree, the drug industry would lose all incentive to develop new cures for diseases -- such as Alzheimer's -- that affect mostly senior citizens. Companies instead would focus on developing cures for which demand is more evenly spread among different age groups.

    Such government-imposed distortions would compel the drug industry to shift R&D resources out of the seniors' market. The end result would be a stealth form of drug rationing to old people.

    Larry ominously points out that a crash of health care innovation could lead to nationalization of the entire health care system -- just what Pelosi and others really want.

    -Bret Swanson

    October 10, 2006
    Dynamist Nobel

    10_wd_phelps_4.jpgYesterday, Ned Phelps of Columbia won the Nobel Prize in economics for his critique of the Philips Curve, one of the worst (and still persisting) ideas in the sad history of 20th centrury macroeconomics. Read Phelps's terrific celebration of dynamic capitalism -- and powerful critique of European style corporatism -- in today's Wall Street Journal.

    -Bret Swanson

    April 26, 2006
    Microsoft v. EU, Part 1

    Microsoft's legal challenge to the European Commission's antitrust ruling got underway this week in the European Court of First Instance. At issue on the first day of the hearing was the requirement that Microsoft separate its media player from its operating system. The commission's ruling and subsequent enforcement gets more absurd every day, and I can't imagine it would have been taken seriously by any competent court of law in the U.S.

    Jean-Francois Bellis, an attorney for Microsoft, told the court that 1,787 versions of Windows without Media Player (Edition N) have been ordered, compared with 35 million versions of Windows with Media Player, the Financial Times reports. The lawyer for the European Commission conceded that "I am afraid we cannot say our remedy has had any real impact, as far as we can see," according to the the Times of London. Then he hinted that the commission may regulate how Microsoft prices the two products, according to the International Herald Tribune, to entice consumers who otherwise lack any compelling reason to buy the stripped-down version. This case is thus a classic example of regulatory quicksand, or the inexorable tendency of regulation to degenerate into micromanagement.

    This all may seem like good news to Microsoft's competitors, but its certainly a defeat for consumers and investors. When bureaucrats, here or there, attempt to suspend the laws of supply and demand, we all suffer.

    Does the Bush Administration realize this?

    March 29, 2006
    EU Treating Microsoft like a Utility

    Microsoft has been warned by Commissioner Neelie Kroes of the European Union that there are some features it should not bundle into its new operating system (see, e.g., "European regulator warns Microsoft about new operating system" from European Business News Online). The EU's competition directorate has already decided that competition could be costly and involve risk for Microsoft's competitors. Yes, it sounds ridiculous -- but essentially that's what it is. Kroes' warning may indicate that Microsoft is losing its freedom to innovate and in effect will now be required to obtain preapproval from the EU for any new product design. If so, the EU could be doing to Microsoft what the FCC did to the Regional Bell Operating Companies by forcing them to share every element of their business. Commenting on the folly of the FCC's grand strategy to achieve a state of perfect competitive equilibrium in telecom, Justice Breyer noted that forcing firms to share every resource creates "not competition, but pervasive regulation."

    Supreme Court considers "automatic" injunctions in patent cases

    Yesterday the Supreme Court heard arguments in eBay v. MercExchange, where both sides agree that the courts nearly always issue an injunction anytime a patent is infringed. It is argued by Nathan Myhrvold (see "Inventors Have Rights, Too!" in today's Wall Street Journal) and others that without a strong presumption in favor of injunctions in patent cases, big tech companies would "stall and drown the little guy with legal fees." This is a variation on a familiar argument: Litigation normally isn't cheap; it isn't "predictable." So we should just get rid of it, right? The convoluted logic of tort reformers is now the convoluted logic of defenders of a questionable patent system.

    Patents exist to promote innovation, but lately they have begun to resemble something like a lottery --where the holder of an insignificant patent can block a larger innovation while the Patent Office in effect admits that it didn't pay much attention to the patent application in the first place and probably shouldn't have approved it. Patents are supposed to promote innovation through rewards for innovators, but the rewards are a means to an end. This distinction is getting lost in the shuffle, as entrepreneurs turn the patent system itself into a big business. The present case provides an opportunity for the Supreme Court to restore some balance.

    Are small inventors a threatened species? Small inventors can recover treble damages and attorney fees on top of compensatory damages in an infringement action. But a strong presumption in favor of injunctions is highly unusual and obviously susceptible to abuse, whether in this or in any other context. Justice Breyer zeroed in on the profit-maximizing behavior of patent trolls who have better alternatives than to negotiate licensing terms. MercExchange doesn't care about innovation (it has no interest in using its patent), it just wants to make money. I find nothing wrong with this, but it may have implications for innovation and the patent system. The courts cannot ensure that the patent system promotes innovation unless they can make necessary refinements on a case-by-case basis, and they can't do that if they are prevented from employing the equitable analysis that is always used when deciding whether to issue injunctions.

    The brief for the petitioner is here and the brief for the respondent is here.

    December 15, 2005
    Promoting innovation through employee stock ownership

    Some people think we can protect shareowners, prevent corporate malfeasance and rein in lavish compensation of corporate CEOs by requiring companies to expense the value of employee stock options. Of course, the issue is a surrogate for many of the more fundamental problems of corporate governance.

    Burton Malkiel, professor of economics at Princeton, and William Baumol, professor of economics at New York University, wrote in the Wall Street Journal in April 2002 that "there is no way to measure the 'cost' - the value of the options at the time they are granted - with reasonable precision." But bad policy is not a compliance problem for public companies, who can easily assign a value to the options they issue because shares of their stock are traded on public exchanges every day.

    What about nonpublic companies? They're supposed to guess. It's a fool's exercise that will impose compliance costs and headaches on the small start-ups who are the source of most of the nation's innovation and entrepreneurial activity. They will be forced to pay for a formal appraisal or expert opinion -- every time they award options -- and live with the threat that a bureaucrat can always second-guess the results. Naturally, these companies will reduce their risk exposure by reducing their use of employee stock options, and this will chiefly affect rank-and-file employees.

    Now these companies will have to prove to the Internal Revenue Service that employee stock options can never be less than fair market value. A notice of proposed rulemaking and notice of a public hearing were issued in October. Comments are due Jan. 3 and the public hearing is scheduled for Jan. 25. But in typical IRS fashion, compliance begins this month. The regulations implement the new section 409A of the Internal Revenue Code, enacted by Congress.

    The Republican and Democratic innovation agendas in the House both include platforms that promote employee stock ownership. The Democratic agenda, released just last month, would "Reward risk-taking and entrepreneurship by promoting broad-based stock options for rank-and-file employees." Last year, the House voted 312-111 for legislation "that would have ensured the continued ability of innovative companies to offer stock options to rank-and-file employees," according the Rep. David Dreier (R-CA).

    Its not just the rank-and-file employees who will pay if nothing is done. We live in an ever more competitive world. Countries like China and India are increasingly prepared to do whatever it takes to stimulate innovation within their borders. In this country, we are apparently prepared to allow well-meaning but myopic bureaucrats, wherever they reside, to devise regulations that they deem easiest for them to enforce. As a nation, we all benefit when one of these small start-ups succeeds and we will all lose if misguided and half-baked policies are allowed to suffocate the technology sector.

    President Bush's innovation agenda is silent on the issue. Its time for the Bush Administration to update its agenda and pay attention to what the bureaucrats are up to.

    November 16, 2005
    EU Threatens Innovation in Action Against Microsoft

    Microsoft's work group server competitors claim they can't keep up with the complexity of Microsoft's product upgrades.

    "We are, in many fields, ten years behind Microsoft. And the lag is growing with every new step Microsoft takes"

    according to Volker Lendecke of the Samba Users Group, an organization dedicated to free software that anyone can copy.

    Continue reading "EU Threatens Innovation in Action Against Microsoft" »

    October 28, 2005
    Government does not exist to protect investment expectations

    Last week George Gilder, Bret Swanson and I met with a powerful Senator who told us he is being urged to "go slow" on deregulation because it would be unfair to change the market conditions that existed when investments were made. Of course, this is a Luddite argument against any progress at all. Telephone companies invested billions before VoIP. Cable companies invested billions before IPTV. And rural telephone companies invested billions before wireless offered a cheaper way to connect remote consumers. Should government slow the deployment of alternative technologies that cost less and offer greater functionality? Not if it cares about consumers and taxpayers.

    Investment is motivated by a desire for inordinate profit. Successful investment achieves a temporary monopoly, and invites competitive entry and disruptive innovation. Nothing lasts forever. If government wants to be fair, it should neither accelerate nor decelerate this process. Government engages in industrial policy when it decides that some investments are more worthy than others.

    August 25, 2005
    Go Gottlieb

    See a former colleague of mine Scott Gottlieb getting slimed by the Seattle Times for -- gasp -- knowing something about financial markets. Scott used to write the Gilder Biotech Report and the Forbes Medical Technology Report, and he recently went back to the FDA as one of three deputy commissioners. The reporter seems to think that only people who don't like the pharmaceutical/medical technology industry should work at the FDA. Most people in government have little experience with business and financial markets, and so a Scott Gottlieb here or there is not only not going to hurt anyone but in fact provides a much needed new perspective in an institution that has trailed its foreign counterparts in approving new lifesaving medicines and procedures. We need more people from business and finance to do stints in government, not fewer. America will be healthier with Gottlieb at FDA.

    -Bret Swanson

    August 17, 2005
    Competition and customer service

    The companies delivering voice, video and data services rank low in customer satisfaction, reports the Washington Post. Customer service appears to be the primary culprit. The newspaper quotes the following expert opinion: when there is competition and consumer choice, it does get better.

    Would the cable industry alone have spent almost $100 billion in network upgrades since it was deregulated in 1996 if not to compete against the satellite and phone companies? Competition is here. Customer service may not be as important as it once was, but that's because customers today can also shop for innovative products and competitive pricing.

    Gold-plated customer service existed under regulation, when government controlled price and market entry. AT&T emphasized customer service because it was under rate-of-return regulation, which meant that is was legally entitled to pass along its costs plus earn a profit of approximately 15 percent. AT&T could increase its profit every time it found a way to justify new costs to regulators' and customer service was politically popular. Oh yes, it was easy for regulators to shift the cost to long-distance and business users. That's why it was expensive to make a long-distance call. Innovation also languished. Cell phones had been invented but not deployed. Answering machines were a status symbol.

    Deregulation, though incomplete, has provided more appropriate incentives for telecom companies to strive to offer the best technology at competitive prices along with good customer service, not spend the majority of their time trying to fool regulators.

    New Life for Narad?

    Back in 2001 I wrote about a technology company with a funny name that in a round-about way helped make the case for telecom deregulation. Narad Networks had developed sophisticated analog signal processing techniques that dramatically expanded the usable spectrum of the coaxial cables used in cable TV networks. With current analog and digital programming running from 5 to 860 MHz, Narad's network updates would open the spectrum up to 1.2 GHz, boosting by 50 percent the already considerable capacity of the cable companies' hybrid fiber coax (HFC) networks. Over this newly available spectrum, Narad could run Gigabit or even 10 Gigabit switched Ethernet trunks, enabling dedicated switched Internet services of 10, 50, 100 Mbps -- whatever -- to homes....Or to small and medium sized businesses currently served by the telephone companies.

    Although most businesses are not wired for cable TV, Narad's research showed that cable networks pass some 70 percent of the nation's several million SMBs (small and medium businesses). Short runs of coaxial cable or wireless links from telephone poles could easily connect businesses as they signed up. The cable companies already compete in the enterprise market with CLEC leased lines and dedicated fiber connections (e.g., Time Warner Telecom, Cox Business Services), but now they could easily leverage their own existing coax networks and compete with the phone companies for the SMB communications market totalling some $35 billion a year.

    Narad, however, struggled during the telecom crash, as all communications providers who didn't go bankrupt severely curtailed capital investments. The company founders, Dev Gupta and Andy Chapman, left, the company almost ran out of money several times, and management continued to turn over. Many of us lamented the surely imminent demise of this innovative company.

    Several CEOs and tens of millions in new venture funding later, however, Narad said in late July that Cablevision, New York's main cable TV provider, had successfully trialed its system and would begin offering the new broadband business services in Oyster Bay on Long Island. Narad has also had some success internationally.

    Although the cable companies are still digesting and leveraging their recent $100 billion digital upgrade and have not yet taken the plunge on Narad-like broadband upgrades, cable's potential to compete with the phone companies in the mid-range telecom services market is now clear. The phone companies want to offer video. The cable cos want to offer voice, data, and “storewidth” services. Federal, state, and local officials should be telling them: Go for it.

    -Bret Swanson

    Dotted Divider Line

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