I was invited to weigh in during the opening general session at the Education Technology Industry Summit in San Francisco this month, hosted by the Software & Information Industry Association. The topic: “What’s Next” in education. As a technology venture capital investor and parent of both a college student and a high school student, “What’s Next” in education is top of mind.

In the immortal words of economist Joseph Schumpeter, higher education is headed for “creative destruction,” a profound structural and economic shift in favor of employers, students and parents. The future will be grim if you run one of the 4,100 colleges or universities in the United States and are unwilling to embrace dramatic change. Especially if you run one of the 1,750 private schools that lack a top ranking from U.S. News & World Report.

Why so grim? Over the past 35 years, colleges have, in unison, jacked up their prices for tuition, room and board at a rate of about 3.5 times the rate of core inflation. They have been able to do so because of the perception of “free money” in the form of government subsidized student aid. They spent that money on fancy new buildings, expensive tenured faculty and new layers of administrators. But the merry-go-round has stopped. Student loan debt now exceeds total credit card debt. New studies are suggesting that for many graduates, a college education does not have the advertised career salary payback once believed. Echoing back to the 1976 Academy Award winning satirical film “Network,” parents and students are saying, “I’m as mad as hell and I’m not going to take this anymore.” And they aren’t.

A study released this month by the National Association of College and University Business Officers reported that enrollment fell at 175 of the 383 private colleges surveyed, with anecdotal reports showing many schools missed their enrollment targets by more than 10 percent. At the same time, the average tuition discount hit an all-time high of 45 percent. Most colleges are losing their power to overcharge for a four-year education. Meanwhile, two-year community colleges are seeing a surge in enrollment from students who figured out they could obtain a four-year degree at half the price by starting there and receiving their diploma at an accredited university. Where you receive your diploma matters most.

I believe that this is just the beginning. I would not be surprised to see several hundred private colleges merge, shrink or fail over the next decade as this unfolds.

Massively Open Online Courses (MOOCs) are driving this creative destruction. Look closely at Coursera, EdX, Udacity, American Honors (one of our companies) and 2U. MOOCs are going mainstream, and colleges will be forced to figure out how to integrate them into their curriculum. Most are shunning them – especially if they are courses from professors at other schools. But some, such as George Mason University, are embracing them. Georgia Tech announced last week a MOOC-only master’s degree in computer science — for only $7,000!

Here’s what I predict, short term:

At least 10 states will require their state universities to accept MOOCs for placement and for credit, helping taxpayers save money on education.

Many of the most talented professors will make more money teaching online than they do as a tenured professor.

Colleges and professors will begin to segregate into online content creators and online content consumers. The creators will be few. The consumers will be many.

Faculty will feel threatened, and will work to pass protectionist legislation to outlaw MOOCs for courses that can by taught in-person by tenured faculty. They may delay, but they will not stop the inevitable.

Community colleges will become a mainstream beginning of a smart and economical path for ambitious students to get a degree. Virginia community colleges are leading the way here.

In the long term:

Top colleges will offer an expanded course catalog, with fewer in-person courses, but more online courses, from both their professors as well as professors from other universities. Online courses will be complemented with active, high-touch teaching assistants.

Branded vocational programs will become mainstream. The Procter & Gamble marketing track. The Goldman Sachs finance series. The Apple user experience course package. Stanford’s Design School is setting the standard.

Except for the top 50 colleges, businesses recruiting college graduates will look through the degree from the university, and examine which courses a student took, from which professor, where and will value the course work over the degree. Online vs. in-person courses will be a distinction without a difference to employers.

Opportunities abound for entrepreneurs willing to participate in higher education’s creative destruction.

I spent last week (super-storm Sandy and the run-up to the election) in Australia, one of the world’s most fortunate countries. Australia is blessed with natural beauty, weather like California (and no hurricanes), and a huge stock of high quality natural resources to sell to hungry neighbors like China. Australia has not experienced a recession since 1990 and was lightly buffeted by the 2008 financial crisis.

My Australian friends are very worried about where their economy is going, however. The government, run by two parties described as “both left of U.S. Democrats”, is building up a “nanny state”. The minimum wage is about $18 per hour, and a ham sandwich costs $20. Health care, a pension if your savings fall short, and higher education are paid by the government. Most worrisome is what Aussies call the “tall poppy” syndrome: high achievement is discouraged. Poppies that grow too high are “snipped off”, socially speaking.

My friends think (and I suspect they are right) that this happy country is at serious risk of a resource curse: if/when the resources dry up, Aussies will not be prepared to compete in world markets. High costs and entitlements will be part of the problem, but the lack of high achievers will be the greater problem; more on this below.

I went on to Hong Kong, which culturally-speaking was a breath of fresh air, despite the smog drifting down from Shenzhen. In Hong Kong the buccaneering spirit of capitalism is vibrantly alive and the high rise(r)s rise very high indeed.

I watched the election and its aftermath from Singapore, the perfect dictatorship. I was struck in particular by the candidates’ election night speeches. Romney’s speech was calm, generous, and showed a relaxed and sympathetic style in defeat that demonstrates Mitt really is a reasonable guy (I’ve known him since his 20s). Would that he could have projected such warmth on the campaign trail.

Obama put on a great show for his supporters and the country: looking every bit the winner, reminding us he is a family man, and praising his campaign team. The substance of his message was promises to take care various constituencies. I don’t doubt that these groups have needs and are deserving.

But, like the Australians, I think we are too focused on doling out the nation’s wealth to the average (wo)man, and not enough on cultivating that which makes us wealthy as a nation. The much-noted increase in income inequality is mainly driven by economic change (the information economy and globalization), which cause each of us to compete in a larger, global arena in which the winners, the truly exceptional individuals, reap the largest gains. Those with less competitive advantage have difficulty rising above the living standard of their competitors in India or China.

Our exceptional individuals bring home a disproportionate share of the bacon. Nowhere is this more clear than in the world of entrepreneurship, where the most gifted people are irreplaceable, and can build huge economic engines like Apple, Google, Intel, Microsoft, or Facebook (IPO hitch notwithstanding).

The election systematically dissed exceptional individuals that engage in business. I’m not talking about tax policy. I’m reacting to the characterization of businessmen as gamblers and exploiters, particularly Romney, who has a spotless record as a business leader, family man, charitable contributor, and leader in his church. He founded and built a great firm, Bain Capital, that has had notable success with both efficiency-enhancing buy-out investments, and job-creating venture investments, like Staples, Inc. Some of Bain’s investments failed, but many more were successful. Yes, there are some gamblers and exploiters in business, but that is the noise, not the signal.

We are starting to snip our tall poppies. And that worries me a lot, because the U.S. is not a fortunate island in a remote corner of the world with a huge resource base and 22 million people. We need to compete. To win we need to cherish and cultivate our exceptional business people, to bring forward the next generation of economic champions.

The great irony here is that Obama himself is one of the most exceptional people of the boomer generation: African-American, from a modest, single-parent home, he made his way to Columbia, Harvard Law, the Senate, and the Presidency. Without such people, the U.S. cannot prosper.

More specifically, as befits the “Golden State”, they’re roasting the golden goose.

On November 6 California passed Proposition 30, which raises tax rates to increase funding for education. California education does need funding to reverse years of cuts. The cuts resulted from prison costs and state employee pensions and benefits taking an ever-larger part of the state budget, coupled with the limits on property tax revenues created by Proposition 13 in the 1970s.

With this increase, California has the highest level of income and sales taxes in the nation: 13.3% on income and 7.5% sales tax. Adding sauce to the goose, they made the higher income taxes retroactive to Jan 1 (more). By comparison, “Taxachusetts”, where I live, has a top income tax rate of 5.3% and a sales tax rate of 6.25%. And California’s tax revenue is now highly focused on the high earners, whose incomes are volatile, and who can be mobile.

Assuming the Bush tax cuts expire for high earners next year, as seems likely, and adding in the new Medicare tax, the tax picture in California for a high earner is:

Incroyable! as the French say, and they should know, since the new socialist government raised their top bracket to 75%. The Economist wrote a special report on France, for which the cover picture is a bunch of baguettes bundled by a tricolor ribbon with a lit fuse hanging out, headlined “The Time Bomb At The Heart Of Europe” (link).

If you follow the Economix blog in the NY Times, as I do, to challenge my immune system I suppose, you know that various academic studies support the view that higher tax rates don’t much diminish effort by high achievers. My own experience supports this. In the 70s and 80s, U.S. federal marginal tax rates were as high as 70% (but only 50% on earned income), and that did not diminish my striving. But I was a young professional, more focused on establishing my career than building savings, and fortunately the U.S. tax regime moderated in the late 1980s. I suspect many young tech hot shots will still move to Silicon Valley to prove themselves.

And then they will take the skills and reputation they have acquired and move elsewhere. Post Prop 30 I’m hearing more and more people saying “I’m leaving California”. That could just be grousing, of course, but as I look for evidence that it’s really happening, I’m finding it. Scott McNealy (founding CEO of Sun Microsystems) is said to be starting a new company in Colorado. Facebook co-founder Eduardo Saverin moved his citizenship to Singapore to shelter his capital gains (which at current U.S. rates is ungracious, but it happened). The highly-regarded Foundry Group in Boulder is anchored by ex-Silicon Valley VCs. Others are talking about moving to Oregon, Seattle, or the Nevada side of Lake Tahoe. Many of my French business friends have left France for the U.K. or U.S.

There is no avoiding competition. If a region, like California or France, however blessed with beauty, culture, ecosystem, and climate, becomes too rapacious in its taxation and too intrusive in its regulation, people will leave, particularly successful people who are in demand many places and whose assets are more portable. It you take this too far, the economy begins to decay, as the Economist argues is happening in France. Then you have the parable of the Golden Goose.

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*Illustration by L. Leslie Brooke, from The Golden Goose Book, Frederick Warne & Co., Ltd. 1905

As I write this I am flying back from Phoenix to Washington Dulles airport via Seattle. Why you might ask?

Well, my United flight encountered what we frequent flyers call a “creeping delay.” 15 minutes after scheduled departure time, the gate agent announced to a full flight, “We have a small maintenance issue and will update you in 15 minutes. Instantly I emailed my travel agent and asked her to back me up on my connection out of Chicago. “Can’t do it” she said. “That is the last flight out. But I can book you on the 6am or 841am and get you a hotel. Which would you prefer?” The 841am, I answered, knowing I was well ahead of my fellow, mostly oblivious passengers.

I knew it was going to be real bad though when the pilot announced, 15 minutes after our scheduled departure time, “The engine is missing a 1-foot piece of fire seal. We are on the phone with maintenance in San Francisco, who is talking to the manufacturer in Europe, about a possible fix. We will have an update in another 15 minutes.”  Now I know enough about airplanes to know that this is not good.  At all.

I emailed my travel agent again. “This plane isn’t leaving Phoenix. What are my options?” In under a minute I was backed up on a 6am flight the next day back to Dulles via Denver, as well as a connection PHX-SEA-IAD, leaving in an hour, on both USAir and United. I had options. I wasn’t going to be left at the mercy of the airline.  It was only spring break 6 weeks ago when a snowstorm in Denver resulted in me and my family of 5 missing our connection.  United graciously and automatically rebooked us. On a flight 30 hours later.  My travel agent got us on a flight two hours later.  Technology failed.  People ruled.

15 minutes later the gate agent returned, told us to ‘de-plane’ (I love that word) and said they were hoping to have a spare aircraft to fly to Chicago in 4 hours – and if it all worked out it would arrive in Chicago around 1am. Now I tell all of my portfolio company CEOs that ‘Hope is not a Strategy,’ so I sure wasn’t going to wait around. I was the 3rd person off the plane, lined up at the desk for the gate agent, and told him, “I have a few backups in my reservation record. Please book me on the PHX-SEA-IAD backup.” He looked over my record, puzzled, smiled, and said “Who did this?” “My travel agent,” I replied. “Wow. She is good,” he continued.

I had to board a bus to change terminals, have my ticket issued at the USAir ticket counter, and clear security, again. I made the flight with 15 minutes to spare. As I left the gate, there was a line of 100+ people waiting to be taken care of by 3 gate agents. I figure it was going to be 2 hours for the last person in line to be accommodated. Most were on the phone and none were happy. They were going to be spending the night in Phoenix, or MAYBE arriving in Chicago sometime in the wee hour of the morning.

Airline delays happen. And when they do, technology won’t solve your problem. But a human being can.

I happily pay a small booking fee to my agent for each flight she books. I call it peace-of-mind insurance.

Having a travel agent when things go wrong? Priceless!

We’ve seen a boom in U.S. angel funding of new ventures in recent years. A study performed by the University of New Hampshire Center for Venture Research (more) estimates that angels funded 66,000 companies with $22 billion (an average of  $330k per company) in 2011. That’s up from 38,000 angel investments 10 years ago.

What is happening? Here is my view:

The cost to start a company has declined dramatically. A smart phone app can be built for a few hundred thousand dollars. One of our companies built version 1.0 of a robust cloud-based shared workspace system for about $1 million.

The cost to operate has likewise declined. A couple of our companies service about a million users with operating expense of about $20,000 per month, using Amazon EC2 or similar cloud infrastructure.

It’s cheaper and easier to acquire an initial user base. The major app stores (Apple, Google, Amazon) make it simple and inexpensive to publish applications. There is a cornucopia of social marketing tools. Sophisticated search helps users find products that offer special value. And social networking companies are inherently viral: customers become salespeople.

Knowledge diffusion has accelerated. Boot camp programs like TechStars help entrepreneurs learn how to use these tools and techniques. Entrepreneur clusters like Cambridge Innovation Center (link) help entrepreneurs teach and motivate each other.

And [big "and"], there are some great, well known success stories. Instagram spent less than $7m before it was sold to Facebook for a cool [revised] $700 million. And it is truly a phenomenon with users. Zynga, Rovi (Angry Birds), 4Square, and GroupOn are other examples of companies that began with small investments and  exploded to stardom.

Considering lower barriers to starting businesses and high potential rewards, one can see why entrepreneurs and angels have jumped in. Plus, there is inherent appeal to the idea of “reinventing venture capital” and leap-frogging the old guard.

But [big "but"], once a business has a start, it’s often hard to take the next steps. Few businesses get as much growth as they need from viral marketing, especially growth among customers who will pay. Proactively acquiring customers in volume is still expensive: when a business needs to roll out its revenue strategy and drive growth, it needs to spend money on marketing and sales, so it needs to raise money. GroupOn raised over $1 billion from venture investors and spent most of it on growth: via organic customer acquisition or acquisitions.

And, while angel funded start-ups are numerous, initial venture fundings are comparatively scarce: in 2011 1,800 companies raised $8 billion in initial venture capital financings, an average of $4.4 million per company*. Venture capital funds typically invest after angels, when a business is more proven and needs bigger dollars to build out its product and scale its operations. Statistically, only about 3% of angel-launched companies will raise venture capital. So the angel boom is definitely a boon for venture capital funds which are seeing a large flow of prototype-stage investment opportunities.

Many angel-funded companies will not try to raise venture capital. Some will fail, some will become “lifestyle” businesses (providing a living for a few people, growing slowly), and some will be acquired. However, finding a buyer is difficult for companies without scaled-up revenue. Acquirers dislike buying losses, and there is a virtual herd of companies at this stage looking for exits. Hence, corporate development teams are busy, decisions are slow, and prices are often disappointing.

Venture is a cyclical business. A boom is usually followed by some type of correction. Some angels have apparently done very well (track records are seldom analyzed, but an angel I know well has an amazing record). But current market conditions argue for a high degree of caution. Building a company is a long race that’s hard to finish.

*Source: NVCA 2012 Yearbook.

Today, we have a bloom of Angel investing with round sizes routinely north of $1 million, there are micro-VCs doing seed investments, single firms have different funds for different stages, there are several multi-stage firms with very large funds, a massive contraction of the number of active venture firms, while hedge funds, corporations and family offices are doing direct investments across a spectrum of stages.  Add crowd funding and secondary market liquidity to the mix and we have what appears to be a venture finance hairball.   There is no longer a “typical” venture fund.

Then there are the companies themselves.  Where once seed and Series A capital was primarily used to create a technology barrier to entry, with all the powerful software tools available now, those technology barriers of old look more like speed bumps.  So seed companies are expected to gain real customer traction, and Series A often looks like what used to be Series B, particularly in companies that touch the consumer.  Even how we define “traction” has evolved to include many measures beyond revenue.  So there is no “typical” early stage company any more either.

So what is Series A today?  My working definition is that Series A is a financing round, from any source, that exceeds $3 million in size, and has a post money under $15 million.  No longer can we point to the firm that led the round or the customer traction or stage of product development to define Series A.  Which is fine with me.

The old world was easy to understand, but too confining and exclusive.  Startup capital was something available to a few risk taking MIT or Stanford grads.  Today we have crowd funding, and starting a company is available to anyone who can hustle, get some engineering done, and find a big problem to solve.  A potential job creation engine like no other we have ever encountered.

Which leads me to a public policy digression.  We need to redefine what we mean by a “college degree” just the way we have redefined what we mean by “Series A”. The real goal of US economic policy should not be to make “a college degree” available to everyone.  This implies paternalistic employers looking to hire legions of generic college graduates to be “knowledge workers.”  Very retro thinking.

Rather than a generic college degree, policy should strive to make a “rewarding career” available to everyone.  Which, in a global economy, means we should make starting a business, or contributing to a young growing business, a possibility for everyone.  I propose an “entrepreneurial path” with both significantly lower debt accumulation so graduates can take lower/no pay, and a new cadre of compulsory coursework that includes work experience so they can hit the ground running.  And not just tech startups – Restaurants, landscaping companies, hotels, all of these vital enterprises require a grasp of accounting, finance, sales, computer skills, internships – things most students graduate without.  Startups are the creative expression of economic ideas.  Teams who start a business are practicing artists, and giving these artists the education, tools and capital they need to be productive founders or startup employees is what will sustain economic growth.

One of my partners reminds us that, to be a success, a company must not only sell successfully to its immediate customers (“sell-to”), but also enable the customer to sell successfully to his/her end customers (“sell-through”), not just once, but repeatedly. Too often we (as venture investors) see businesses that have revenue traction selling to immediate customers. But, that success proves illusory when the end-customer does not buy, or if s/he buys, there is no stream of repeat business. As a result, the business spends more and more on sales and marketing, but ultimately fails to scale.

This might seem like an esoteric problem, but in our experience it happens often. Right now there is a major example coming out of the daily deal companies.

PrivCo (a private equity newsletter) reported last week a 94% write-down of the valuation of Living Social, from $5.7 billion to $325 million. The devaluation resulted from both operating losses and write-down of the value of acquired companies. It came to light because it contributed materially to the quarterly loss reported by Amazon, which owns 29% of Living Social. PrivCo’s conclusion: “LivingSocial’s Business Model Is Unsustainable, Co. Must Raise Massively Dilutive Add’l Outside Funding, Or Undergo Immediate Layoffs and Cost Restructuring, Or Both ASAP To Survive Another Year”.

GroupOn has also hit headwinds, as evidenced by sharp decline in its share price post-IPO.

I don’t claim to be an expert on daily deals companies, but I know a couple of things:

1)  A large part of their expenditure goes on acquiring customers, either directly via sales/marketing, or indirectly by acquiring similar companies whose principal asset is their customer base.

2)  Several of our portfolio companies have used daily deals. They report that “doing a GroupOn” produces a good flow of new customers (sell-through), but few of those customers come back again (little repeat).

GroupOn’s model is: the merchant offers a product/service at a deep discount to the normal price (like 50%) through GroupOn, and GroupOn keeps half the revenue, so the net revenue is about 25% of normal price. This contributes no profit on the first visit unless the marginal cost is very small or the discounted product pulls through other profitable sales.

Daily deals appeal to small business owners, who are often not data-driven and analytical. They see the welcome increase in people coming through the door, and are less aware of the profit they make from these customers. This probably was a major basis of the initial success of the daily deal companies: they create traffic and bring in new customers.

But small business owners are smart, and soon they become aware of the profit in daily deals, from the first sale and over time. Some entrepreneurs say daily deals deliver profitable customers for them, but many that I know believe they do not. These small business owners move on, and the daily deal companies must acquire new customers who want to try daily deals. Judging by Living Social’s numbers, maintaining revenue growth is becoming increasingly expensive.

The lesson for entrepreneurs and investors alike is simple: pay attention to your customer’s economics, and make sure your product is paying off for them. If it does, they will buy again. If not, you need to fix the problem. Sell-to, sell-through, and repeat!

The Android 4.1 (Jelly Bean) upgrade appeared on my phone yesterday. I had no idea when I might see it: it was pushed by some carriers to some phones three months ago, but must Android users won’t see it for a long time. There was no roll-out plan and not much of an announcement.

It’s a terrific update. Jelly Bean boosts usability with a smoother and more responsive interface, a much-smarter keyboard, and an improved camera. Notable new features include an interactive notification screen (where Android has always been ahead of iOS), cool self-arrangement of icons and widgets, NFC beaming of info between nearby devices, and the very advanced “Card” feature which serves up personalized, context-relevant information as the user goes through his/her day.

But, only Android aficionados even know what’s in Jelly Bean.* There’s little attempt to market the value, probably because the Android update process is so haphazard.

So Google is getting little value from a significant product enhancement. Most Android devices won’t get this update anytime soon (Nexus phones, which I have, are typically far ahead). Why? I don’t actually know, although I think it has to do with the fact that Google permits the carriers to control the update process, and updates do not seem to be a priority for carriers, or perhaps carriers intentionally suppress updates so that customers must get new phones with 2-year contracts to access new Android features.

The bigger issue is: Google does not present the user with a unified view of the value offered by its mobile devices and cloud services (the “Android ecosystem”). Each product seems to be fighting its own war. An example: iCloud does a poor job of sharing photos with selected groups of family and friends. Since MobileMe got axed, the main answer has been Facebook.** Google has long had good functionality here: pictures taken on an Android phone upload automatically to Google+, which has simple, robust tools for sharing photos with pre-defined groups of family and friends. But, Google+ is busy making war on Facebook. No one is telling the Android user about this valuable feature advantage. Contrast this to how well Apple presents an integrated view of how iOS 6, iCould, and MacOS work together to create value for users.

For Android tablets, access to Google Mobile Services (“GMS”) and the and related applications (e.g., Google Maps and Google Play) is a similar gap (or chasm). Google made access to GMS difficult for other than a small group of tablet OEMs; this has impeded the success of many aspiring Android tablet OEMs and encouraged Amazon to create an alternative ecosystem centered on Kindle Fire, which is now the largest-selling Android tablet. Ouch!

And, although Android Market (now part of Google Play) has ~parity with the Apple App Store in the number of apps available, revenues from Android app sales are a small fraction of those from iOS apps. This Achilles heel of the Android ecosystem (it drives app developers to invest more in iOS apps) has been visible for several years. I don’t see a big effort to rectify it.

Google’s strategy of focus on producing an attractive smartphone that OEM and carriers partners could sell against Apple has delivered market share: 66% of smartphone units in 1H 2012 versus 20% for Apple***. It has worked less well in tablets, perhaps because cloud services (e.g., media access) matter much more for tablets and carrier distribution clout matters much less. So Google is now leading with a Google Nexus branded tablet, and its web site features integration with Google Play; more news soon.

What’s lost is the opportunity to market a high-value ecosystem to the user. Google’s great cloud services, many of which integrate with Android, are not presented in a unified value proposition that is tuned to appeal to mobile users. In fact, I wonder if they have thought enough about what matters to the mobile user (or, as Jobs would frame it, what will matter to the mobile user when Google shows it to them). What is the Google counterpart to iCloud as a marketing concept? I can’t find it.

Strong focus on marketing the Android ecosystem will put the right emphasis on solving key problems, like the mess in the Android update process. More important, it will strengthen every part of the Android ecosystem and create more opportunity for every player in it, to Google’s great benefit.

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*  There is a nice website if you look for it: http://www.android.com/whatsnew/.

**And, I for one, do not want to use Facebook for my family pictures, as I am unsure who will be looking at pix of my grandchildren next time Facebook makes an obscure change to its byzantine privacy policies. The Shared Photo Streams feature of iOS 6/MacOS 10.8 may address this gap; the required updates to iPhoto have been pushing this week, and I’ve not yet tested how well it works.

***IDC data quoted in The Economist, 9/15/12, p.61.

Some customers and pundits have reacted negatively to new smartphone pricing plans that take away unlimited data, either explicitly or by “throttling” intensive users (e.g.: Fox News coverage). There’s a meme here that says unlimited data is an aspect of “Internet freedom”. This confuses two ideas: carriers discriminating against certain applications or application providers (which would be a “bad thing”, IMHO), and carriers simply charging for the quantity of data they deliver.

Verizon has new plans that make payment for extra data usage very explicit: users buy monthly data usage buckets in 1-2 gigabyte (GB) increments, and this data charge is a large part of the bill. I think this new approach makes a lot of sense and promotes healthy growth of the mobile ecosystem. Devotees of the unlimited data plan, get real: there is no such thing as a free lunch.

To be clear, I am not commenting on the average level of price for wireless service; rather, I’m focusing on how much different users pay based on how they use the network. When I switched to the new Verizon plan my price went down slightly; I’m a medium-heavy user. I have read that for users at the ends of the spectrum (very light users and very heavy data users) the price goes up.

Wireless carriers spend primarily in two areas: network coverage/capacity, and customer acquisition. Voice makes a small demand on network capacity relative to data and texting makes almost none, so increasingly coverage/capacity is all about data. And, there are two things that consumers value most: network quality and new devices.

Past pricing schemes were out of sync with this value system. Data plans were often unlimited at first, and consumers paid high prices for buckets and overages on voice minutes and texts. This distorted the market: AT&T attracted a lot of iPhone users who used a lot of data, but failed to upgrade its network to carry the traffic. I suspect that the fact that users could increase data usage without paying more contributed to AT&T’s reluctance to invest in capacity: there was little return on the investment.

And, data usage is highly skewed: a small group of very intensive data users tie up the network and degrade service for moderate users, who paid the same price. The arrival of high-quality mobile video turbo-charges this: one high-def  TV show is most of a gigabyte, while smartphone users who are voice and text-oriented (like me) are unlikely to consume more than 2-3 GB/month.

Unlimited data plans made sense at the beginning of the smart phone era. Consumers did not know how much they would use data and value it. Putting a cap on the charge made them more comfortable trying a data-intensive smart phone. However, consumers are well attuned to the value of wireless data today.

Verizon’s new plan charges for the things in which Verizon has to invest to grow its business: data usage and customer acquisition. (A major part of the cost of acquiring customers is the subsidy for new phones, about $300 for a high-end smart phone). Logically, the new Verizon scheme does not charge for the parts of the service that are cheap to provide: texts, voice minutes, and tethering. Carrier text services are under attack by free texting services offered by Apple, Blackberry, and various Internet-based providers (free because the bandwidth needed to enable texting is minimal). By making texting free, Verizon may hope to keep the texting on its system and use it to bind its customers more tightly, at minimal cost.

And Verizon lets you share your data bucket among devices: you pay for what you use, and you get to use what you paid for. This creates an incentive to move all of your family devices to Verizon.

Rational pricing is a sign of maturity in the wireless business: revenue is aligned with value perceived by consumers and cost borne by carriers. As usage grows it generates funds to build more capacity. And carriers are not offering competitors opportunities, like cheap texting, to pull away their customers.

[By the way, I am not a Verizon fan boy, if there even is such a thing. Just ask about software upgrades to Verizon Android phones, and I will go right to the dark side …]

Apple invented the smart phone. It has been building iOS and its ecosystem since the iPhone launched in 2007. iOS made Apple the world’s most valuable company. Steve Jobs was a genius, and Jony Ives and the other wizards of Cupertino carry on the magic. Surely iOS is the best smart phone OS, and surely that matters a lot to Apple’s success. At least I thought so, until I looked at the data.

Consider the chart above which analyzes the importance of the smart phone OS in the purchase process. This data comes from a large survey (n = 25,000) of smart phone buyers conducted by CivicScience.com.

The data says that ~50% of iOS and Android fans consider the OS to be very important, and fans of Blackberries and other smart phones think it is less important. Blackberry is widely viewed as a weak OS, and iOS is widely viewed as very good. It makes sense that Blackberry fans think the OS less important, and iOS fans think it is more important. What’s fascinating is that Android fans put even more importance on the OS. To me this says that people who buy Android phones like the Android OS as much or more than Apple users like iOS.

The second chart compares the importance of the OS relative to other attributes of the smart phone. My takes from this data:

1.  The OS is not the dominant factor in choice of phone family. “Functionality” (i.e., hardware capability, form factor, and the non-OS features of the phone) and price are the biggest factors, even for Apple buyers.

2.  iOS buyers are least price-sensitive, Android buyers more so, and Blackberry and Windows buyers are most. This makes sense: Apple is definitely the premium product.

3.  Carrier availability is a factor: iOS buyers care about it somewhat less, which makes sense today, given that iPhone is widely, but not universally, available. Android buyers care about it a bit more, but it’s not a big difference, which runs against the received wisdom that Android wins on the basis of breadth of distribution.

4.  Last, a surprise to me: hardware brand (“manufacturer”) is a big factor, distinct from the OS. Apple buyers place strong importance on the Apple brand, and Android buyers place very little importance on hardware brand. This tells me that the main Android hardware manufacturers (Samsung, HTC, Moto, and LG) have done a poor job creating brand equity. They have to use price appeal and distribution breadth to overcome this. The biggest weakness of Android is the hardware manufacturers’ brands, not the OS.

Of course, Android retains a strong market share lead: 48.6% U.S. market share in January, 2012, versus Apple’s 29.5%, a nice 2.3 point rebound for Android from the fall of 2011 when Apple’s iPhone 4S launch increased its market share. Taken as a whole, the Android formula is a winner.

What thoughts does this spark? Here are a couple:

1.  There’s an opportunity for a major consumer electronics company to gain a lot of ground on Apple by making its hardware and brand fully competitive, and leveraging the already-quite-competitive Android OS. Samsung is the obvious candidate. Can they do to Apple what they did to Sony in the video market?

2.  Apple is dominant in the tablet market (more), despite Google’s determined investment in tablet-ready Android (v4.x, “Ice Cream Sandwich”). I hypothesize the OS is less of a differentiator here, too, and hardware brand and value are more important. And the content ecosystem is big for tablets, too: phones make much of their own content (talk, text), but tablets consume commercial media. The lesson from phones for Android tablets is: don’t go head to head with the Apple brand with high-priced tablets, as Google did at first. Instead, focus on very good hardware at a lower price, build up the content ecosystem, and make it available to these lower priced tablets. Then, when a hardware brand emerges that can challenge Apple, Google can engage at the top of the market. Is this part of the strategy for the Moto acquisition? It will be interesting to watch.