Peter Kafka has a piece up on MediaMemo reporting that Universal Music Group is pushing a plan to sell CDs at a retail price of $10 or less.  They have done some tests which show that such a move might dramatically increase sales:

In the last few months, Trans World Entertainment began testing the $9.99 price point in over 100 stores, while Wal-Mart has been telling the majors to release shorter albums at lower prices more frequently.

The Trans World test–in which most independents and every major except for the Warner Music Group participated–produced units sales increase of more than 100%, according to label executives who participated in the tests. The Trans World test helped sell the new pricing model to the Universal labels, sources say.

Yesterday I wrote about the challenge in judging market timing for big shifts like the one to music streaming services, and how in industries like music where industry insiders have an effective block on change there is only so much that startups can do to drive the timing of the shift.  This news about Universal reinforces that point.  I’m guessing that the execs at Universal will be much less willing to experiment with streaming services whilst they believe they can arrest the decline in recorded music sales by moving down the price-demand curve.  Warner’s recent statements against ad supported models may have been motivated by similar thinking.

Further, I would expect that if they get agreement from the other labels and push ahead with this strategy it will meet with initial success.  Sales would go up and the industry’s desire to embrace streaming would wane – but only for a while.  Sooner or later sales would start declining again and at that point margins would be lower and the industry would have less to lose and hence less worried about the impact of new business models.  But we would have lost some time, the startups in this space would have burned some more money, and maybe had to raise some more money, which would be bad news for their founders and investors.

Yesterday I wrote about the emerging evidence that digital is starting to pay for the music industry and Rhitu Baria commented that it is only a matter of time before the music industry allows new technologies to permeate through, and linked to a post on her blog detailing the history of change in this sector:

I sometimes wonder why we have all the noise about streaming music services and the associated revenue losses for record labels. At every stage of the music development cycle – live concerts, sheet music, gramophones, vinyl discs, magnetic tapes, CDs – there has been a huge hue and cry about the change i.e. no one will go to live shows or buy sheet music or buy tapes or buy CDs thus leading to a loss of sales for the musicians.

That’s not to say that there wasn’t an impact on sales in the traditional way of operations of the industry at each step. But the music industry as any other has moved with technological developments, been flexible and adjusted its business model, finding new ways of surviving even thriving. After all, no industry can put on blinkers to the world around them and hope to survive or better themselves.

These historical analyses of technology change are a useful reminder that new developments are often greeted with fear and scepticism, particularly if they have social ramifications – TV will destroy society by stopping us from reading books and computer games will stop kids being social are two others I remember well, and the Daily Mail’s dislike of Facebook is a more recent example (see How using Facebook could raise your risk of cancer).  These histories also a useful reminder that in the end society and companies always adapt and life always goes on, often looking a little different, and sometimes very different, but life always goes on.

Technology driven change is therefore a constant of modern society and for many observers (including a lot of VCs) it is easy to form very strong opinions about how the world will change.  In fact many VC investments are bets on a vision of the future, making it a part of my job to form these opinions (which is one of the reasons I write this blog).

For me forming the future vision is the easy bit – unfortunately we also have to bet on timing, which is much harder.

Rhitu’s point in the comment was that it is inevitable that streaming music will come to be a major part of the music landscape – and I agree with that.  It is a superior user experience than having to bother about downloading and storing files, and then being able to access them from your various devices – for me it is as simple as that.

My reply to her comment was therefore to agree it is only a matter of time before these new technologies permeate through the music industry, but to add that the question is ‘how much time?’, and ‘how many startups perish in the interim?’.  Remember the story of Imeem, the popular music streaming service that raised a lot of venture capital, did deals with the music majors and ultimately had to sell out to Myspace for $1m.  Hopefully Spotify will be more successful.

Other markets where the future was clear for a long time before it happened include mobile network operators and their evolution to being dumb pipes, and the software as a service business model for software companies.  The transition to hosting apps in the cloud and everything that means for standardised hardware and virtualisation is another that is underway right now.

All of which begs the question of how to judge the timing.

Most of these markets tip pretty quickly when they go, especially the ones that are interesting for startups.  So judging the timing is about spotting the tipping point, and knowing the extent to which you can make it happen sooner.  With hindsight tipping points are periods when massive demand was created (Ben Horowitz today defined winning a new market as 1,000 enterprise customers or 50 million consumers) – so judging timing is all about understanding the obstacles to creating that demand and the extent to which you can get over them.

In the music industry the chief obstacle to (legally) creating demand has been getting a service to market.  The problem has been that the startups need co-operation from the players with the most to lose (the record labels).  The result – slow innovation.  The key to judging timing in this market is understanding the point at which the writing is so obviously on the wall for the old model that industry veterans can only look forward AND when their legacy revenues are declining sufficiently fast that there is a financial imperative for them to face up to reality.  Unfortunately that is a very hard call to make.  The two things that startups can do are a) generate consumer pressure for change by building popular services, which Spotify has done well, and b) look for win-win solutions with the old guard – but the biggest driver of industry acceptance of change comes from within.

Similarly, in the mobile industry the services that would turn operators into dumb pipes have to run over those same operators networks, giving them a control point which they have used to hold back the future while they continued their (in my opinion) futile search for an alternative business model.  It took the consumer power of Apple and the iPhone to really make a change here.  In this market there was next to nothing startups could do to help speed operators towards their destiny.  The key to judging timing was spotting the catalytic effect of the iPhone before anyone else.

In contrast, back in the 1990s Yahoo! was more easily able to quickly beat AOL and realise their vision of an inevitably open internet because users on ISPs other than AOL could easily switch to their better portal service.

This post is already overlong so I will end here with a quick summary – which is to look for the value chain blockers that slow down the transition to an inevitable future and not to underestimate how long they can take to overcome.  Often it is years and years.

Daniel Ek, founder of Spotify, was interviewed at SXSW today.  There is a full write up on VentureBeat which is well worth a read if you are interested in this space, but the standout nugget for me is captured in the following quotes from Ek.  They capture the industries main challenge, the evidence it is starting to overcome the challenge, and the article of faith that underpins many free-cheap music services.

The industry is looking at new revenue opportunities and are generally positive on them. But nothing in digital has really been able to counter the decline in traditional revenue sources. [The challenge]

……..

If you also look at Sweden, between 15 and 18 percent Swedish population actually uses Spotify. The music industry revenues are up there. Legal music revenues are up. Everything is up. It’s only a few percentage points but it’s up. [The evidence of progress]

……..

I really believe that if music could be legally available on any device that you wanted… I think the music industry would be radically bigger than what it is today, [The article of faith]

It is dangerous to read too much into an extract from an interview at a conference, particularly when the interviewee has a vested interest, but if legal music revenues in Sweden continue to rise that will be of huge significance.  In supporting news elsewhere in the interview Ek said that the UK is showing signs of being similar.

Last week in a post about Apple and Android mobile OS market share I wrote that:

Something deep inside me that I am starting to think may not be entirely rational prefers open to closed, so I’m pleased by the early signs of Android’s success.

and James Penman commented:

Hi Nic,
You normally choose your words very carefully so I’m fascinated by the clause: ‘Something deep inside me that I am starting to think may not be entirely rational prefers open to closed’. Would love to read a blog post unpacking that as it suggests a change, or the beginnings of change, in outlook presumably driven by experience?

I’ve been mulling this question over in my mind since then and I think the reason I’m starting to question my preference for open over closed is that (as with so many things) when you get into it the whole debate is too complex and nuanced to simply come down on one side or the other.

I think my dislike of closed comes from watching big companies operate closed systems to promote their own interests to the detriment of innovation and startups.  Mobile operators loom large in my mind here – the way they controlled the content that could be accessed via the phone on their networks and tried to take a big slice of any revenues held back mobile innovation for years.  IBM and Microsoft have at times played similar games too, and now Apple is doing the same thing with their App Store application approval process.

I also dislike content and consumer device companies pushing closed DRM’d systems which offer a worse consumer experience because they hope to lock you into their platforms.  The Kindle is the latest device to get my goat in this regard.

Finally, the open source revolution has been a boon to everyone.

The shift in my thinking comes from a growing appreciation of the power of closed systems to drive game changing innovation.  Two big examples – it took the iPhone to break the mobile operators control over wireless networks, and it was AOL’s closed system that got the web moving for many people in the 1990s.

Similarly I have been experimenting with the FitBit this year and I have liked what their proprietary hardware and closed web service has allowed me to do (the devices keep breaking though…).

Thinking further forward Apple have just hired a ‘Senior Prototype Engineer’ to work on wearable clothing.  This guy (Richard DeVaul) has previously wrote a dissertation on Memory Glasses – a heads up display that provides memory support.  DeVaul describes the results of his work:

The short version is that I can improve your performance on a memory recall task by a factor of about 63% without distracting you, in fact without you being aware that I’m doing anything at all. Even more interesting is that giving you wrong information subliminally doesn’t seem to mess you up.

I want some of those!  And I’m also reasonably convinced I’m likely to see them sooner as part of a closed and proprietary system.

To generalise, the obvious conclusion to all this is that closed is appropriate early on in the evolution of a market and open is better later on.  Maybe the reason the debate evokes so much passion is the moment of transition is painful for individuals who are asked to ditch their loyalty to the closed systems of which they were early adopters and embrace the messy chaos of open systems which offer the promise of greater richness but maybe less utility out of the box.

Debates about privacy are often polarised between those of the Scott McNeally “you have no privacy, get over it” school of thought and those who feel deeply uncomfortable with this notion. 

I have been in the former camp because it seems to me that people are increasingly sharing private information and getting benefit from doing so, and that (appropriately annonymised) the data has commercial value whose (appropriately sensitve) exploitation can bring value to everyone.  The way advertisers can now narrowly target on Facebook is a good example – it is good for Facebook and by extension its users and it is good for the advertisers who can now reach their customers more cost effectively.

The counter argument is usually a sense of deep unease about how the data might get used and the point that once the genie is out of the bottle you can’t get it back in and bad things might happen.

danah boyd’s speech to SXSW on Saturday helped me understand this counter argument much better.

For those that don’t know danah does a lot of primary research talking to people about how they use social media so when she says “Privacy Is Not Dead. People of all ages care deeply about privacy” I take notice.  Particularly when it is sandwiched between an admonishment of privileged straight white male technology execs who think differently (that’s me) and an assertion that privacy may have a different meaning to my current understanding.

According to danah, privacy is about having control over information flows and understanding the social setting in order to behave appropriately and avoid embarrassment.  When either of these things are challenged they scream privacy foul.  Reading between the lines of danah’s talk slightly it seems to me that the first thought is about avoiding embarrassment and the desire for control might stem from a desire to be able to fix things later should a difficult situation emerge.

The key to your consumers feeling good about your privacy policy is therefore trust – trust that they understand how your site works from a social perspective and that you won’t change the rules on them in ways that might create problems.

Three quick illustrations of privacy FAILs illustrate the points, the first two from danah’s talk and a third from the UK market:

• Google Buzz – Google introduced a service into gmail that took data from a private system (email) and by default made it public thereby changing the rules and creating potentially embarrassing situations
• Facebook Newsfeeds – we have gotten over this now, but when Facebook first started putting status updates into Newsfeeds it created an uproar – because they had changed the rules of the site to make updates much more public which shifted the context and changed the social game (my point isn’t that this was a bad move – we have gotten to like Feeds now)
• Phorm – this UK company planned to sell a software service to ISPs that would allow them to target ads based on surfing history, people were outraged at the lack of control this implied and the business struggled to make progress

The web and in particular the social media sites within it are of course evolving extremely rapidly which I think explains why privacy is such a hot topic.  If feeling good about privacy requires an understanding of the social setting it is easy to see why people are nervous.

The final point I want to bring out from danah’s talk is the notion that privacy isn’t binary.  Offline there are a myriad of privacy status’s between nobody knows and published in a newspaper and online services need to recognise the complexity of how people think about information sharing.  The Facebook newsfeed example makes this point nicely – they made information that was already publicly available more visible and people were upset, in the way they might be if information from a handwritten note that was passed round the class was copied onto the blackboard.

From the perspective of a startup if privacy might be an issue for your users this analysis tells suggests to me you need a clear set of principles about how and why information will be shared and to inspire trust by having integrity as a core value and not springing surprises on people.  Be aware also that as your site grows the rules of information sharing are likely to change and creating a shift in the privacy ‘environment’ that will need managing.

• Twitter Weekly Updates for 2010-03-07 http://goo.gl/fb/kCxB #
• Old media needs to embrace change http://goo.gl/fb/OKvj #
• Just joined the Venture Capital community to keep track of the best experts. Join me here: http://mrtweet.com/c/venture_capital?v=jt #
• @paulsweeney thanks Paul. I will think about that. in reply to PaulSweeney #
• "Paradoxically, the enduring competitive advantages in a global economy lie increasingly in local things…" http://tumblr.com/xdv76vit5 #
• Choose a banker who understands your story http://goo.gl/fb/isRh #
• Most platforms start as applications http://goo.gl/fb/J96y #
• Real time search results not that useful? http://tr.im/RiSZ #
• The UK passes law allowing blocking of fileshare websites – protecting creatives is good, but this is risky http://tr.im/RiTP #
• Geeking out this afternoon at a Serious Games Institute seminar on artificial intelligence in gaming #
• @jonathanmendez maybe not much fallout?!? in reply to jonathanmendez #
• Amazon 1-click patent re-confirmed. To me this is about protecting business, not innovation: http://tr.im/Rqwa #
• US mobile market share – Android growing faster than Apple http://goo.gl/fb/3a6v #

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comScore reports from Jan in the US just out show that whilst Apple still has momentum it is still emphatically not top dog.  Taking overall mobile (i.e. not just smartphones) they are not even in the top 5:

Then when it comes to smart phones Google has added 4.3 points of market share to Apple’s 1.7 points in the three months ending Jan 2010 compared when with the previous three months.  That is much faster growth off a smaller base and bodes extremely well for Android, particularly given the number of new devices they have got coming.  It’s also noteworthy that RIM is still way out in front and also gained more share than Apple during the period.

Something deep inside me that I am starting to think may not be entirely rational prefers open to closed, so I’m pleased by the early signs of Android’s success.  That said, it would be nicer still if Google wasn’t behind it.

Creating a platform business is the dream of many entrepreneurs and their VCs – and it is easy to understand why.  Successful platforms have huge scale and customer lock in and, to an extent at least, if you own a platform you can sit back and watch the dollars roll in as other companies build their businesses on top of yours.

So I’ve been thinking about how successful platforms come to be, and it seems to me that most of them start off as applications.

I’m writing this post today having just read about Facebook’s latest step towards being a platform business imminent launch of a share location feature which will work both on site and via an API.  As we all know they started as a profile surfing application business and then communication service via messaging and news feeds.  Then when they had sufficient volume of users to be attractive to third parties they became a platform as well, first with their applications API, then with Facebook Connect and now with location.

The Google story has similarities.  They started as a web search application and once they had a sufficient volume of traffic to attract third parties they became an advertising platform.  This began with Adwords on their own site, and then when they had a sufficient volume of advertisers to attract third party publishers they added the Adsense product.  It probably isn’t an exaggeration to say that their other products since have been funded from the profits generated by these two.

Two more quick examples.  Twitter always had platform ambitions but it was the success of the microblogging service which convinced developers to build Twitter clients and other apps based on the service.  And then on the business side – Salesforce started as a SaaS CRM application and used their success and scale to launch the Force.com platform.

There are counter examples, of which Ning is the best I can think of right now, but these are riskier ventures requiring much more investment before proof of value can be generated.  I suspect the application first route to platform development is a new one enabled by the internet.  On previous platforms aggregating huge volumes of users and cross selling them to new services were both much harder.

UPDATE: in more of the same Google are now leveraging the traffic on Google apps, gmail and google calendar to launch Google Apps Marketplace.

I’m fresh out of a pitch from a group of bankers we thinking of appointing at one of our portfolio companies and on my way home I was working through our selection criteria.  In this case at least I think it comes down to three things (other than fees):

1. The story – do the bankers understand why this company is valuable above and beyond the cash flows
2. Access – have they had recent regular contact with senior people at your target buyers
3. Fit – is there a good fit between the target size of your deal and the bankers you are thinking of working with

All three of these are important, and if any one was missing I would seriously think about working with someone else, but I list them in this order because I think the story is the most important.  Good venture capital is all about selling companies for big revenue multiples and that requires big stories – you need to be able to explain why your company is important to the acquirer and most of the time that won’t be because of the immediate financial contribution.  The most prolific aquirers are Cisco, Google, HP, Microsoft, IBM and Oracle and very few startups have the scale to make a difference to their financial statements at the point of acquisition.

Some common stories:

• ‘revenue pull through’ – i.e. post acquisition every dollar of sales from the acquired business will pull through say $50 of sales from the acquirers other products.  That way your $20m revenue will make a $1bn impact.
• ‘account control’ – for companies with large suites of products filling a gap with an acquisition enables them to keep competitors out of their clients business.  This was the logic AOL had when they acquired buy.at.
• Finally, another common story is that acquiring a company will allow the acquirer to enter an strategically important market.  This can be a hard sell when the startup is still small.

Different potential buyers will have different strategies and different reasons why they might be interested in making an acquisition.  A good banker will appreciate that and craft different stories for different suitors.

To close, it is worth reminding ourselves that these ‘stories’ need to be real.  A far fetched ‘I have the cure for cancer’ story will get initial interest and meetings but will come undone during due diligence.

There was a good article on Techcrunch on Saturday covering an interview Erick Schonfeld had with Marc Andreessen.  In a reference to explorers landing in Mexico and burning their boats so looking forward was their only option the post was titled: Andreessen’s Advice To Old Media: “Burn The Boats”.

He makes an excellent contrast between the way technology companies embrace change whilst old media companies fight it.

On technology companies embracing change:

The one thing technology companies do really well is deal with constant disruption. “Microsoft is going through this right now,” he points out, “Ballmer is not complaining about it.” He’s tackling it head on. So did Intel when Andy Grove gutted it to shift from memory chips to microprocessors.

On old media fighting change:

Andreessen asked me if TechCrunch is working on an iPad app or planning on putting up a paywall. I gave him a blank stare. He laughed and noted that none of the newer Web publications (he’s an investor in the Business Insider) are either. “”All the new companies are not spending a nanosecond on the iPad or thinking of ways to charge for content. The older companies, that is all they are thinking about.”

And if you are wondering about the impact of the iPad, read this:

[Andreessen] points out …. No matter how many iPads the Apple sells, the Web will always be the bigger market. “There are 2 billion people on the Web,” he says. “The iPad will be a huge success if it sells 5 million units.”

Old media’s excitement about the iPad is symptomatic of an industry in existential crisis.  The smart thing in every company is to go where the customers are, i.e. the open web, rather than where your business model might work better, yet that isn’t their approach.  Until/unless the old guard learns to embrace change and think about what the consumer wants rather than how they can preserve their businesses they continue to lose out to new media businesses like Techcrunch.

Note – this is not a post about free vs paid content, an argument which I think is more finely balanced that comes across in Andreessen’s TC interview.  Right now my view is that it is difficult to come down emphatically on either side of this debate and I expect to see both more companies making free content pay as a business model and more companies innovating and successfully persuading consumers to pay.