(Guest Column: Peter Daley, Digital Media Analyst, Rutberg & Co)

During the one month period from July 1 through July 31, 34 private digital media companies announced $403.1 million in venture capital financings. Investments were primarily in the Advertising Infrastructure, Applications, and Content Publishers sectors. There were also 24 M&A transactions announced during the period, including Motorola’s acquisition of Broadbus, AMD’s acquisition of ATI, and Planar System’s acquisition of Clarity Visual Systems.

In this newsletter, rather than our traditional review of the previous month’s news items, we discuss the venture capital, M&A, and IPO activity in digital media over the past two quarters and compare these findings to the activity of 2005.

Venture capital activity in digital media is, by all accounts, robust. During the first six months of 2006, private digital media companies raised $2.4 billion of venture capital through 278 financings. This activity nearly matches that of the full year 2005, in which $2.6 billion was raised through 313 financings. Notably, 245 venture capital firms announced two or more digital media investments during the eighteen month period between January, 2005, and June, 2006.

The robust activity indicated by the financing totals is consistent with our conversations with entrepreneurs and investors. On an anecdotal basis, for example, we note the formation by numerous venture firms of digital media-specific strategies, practices, and portfolios over the past two years. Although raising capital is never “easy,” we believe the current environment is healthy for private digital media companies.

The M&A market remained steady in 1H06 with 181 transactions announced during the period, as compared to 183 and 185 in 1H05 and 2H05, respectively. Further, the IPO market for digital media companies remains muted. During the first half of 2006, only 6 IPOs were filed and 6 were priced in the industry, as compared to 5 filed and 19 priced in 2005. We do not find visibility toward a substantial change in the dynamics of the IPO market in the near-term. As such, we believe M&A remains the far more likely exit scenario for private equity investors.

Overall, we note that venture capital activity has increased substantially over the previous 18 months, while M&A activity has remained steady over this same period. Several venture investors in our conversations have referred to this situation as a “bubble without an exit,” indicating a concern and frustration over the high investment levels but low exit numbers. As we discuss below, we believe that this situation may be, at least partly, due to the early stage of digital media as an industry, and that there are underlying, positive indicators for future M&A activity in the industry.

Venture capital activity in digital media is, by all accounts, robust. During the first six months of 2006, private digital media companies raised $2.4 billion of venture capital through 278 financings. This activity nearly matches that of the full year 2005, in which $2.6 billion was raised through 313 financings.

On a quarterly basis, total venture capital raised during 2Q06 was $1.3 billion, representing 127% growth from the total during 2Q05.

Heading into 3Q06, venture investors appear poised to continue their strong pace. The $403 million of venture capital raised in July 2006 is on par with the $398 million monthly average over the previous six months.

The robust activity indicated by the financing totals is consistent with our conversations with entrepreneurs and investors. On an anecdotal basis, for example, we note the formation by numerous venture firms of digital media-specific strategies, practices, and portfolios over the past two years. Additionally, we hear comments from several entrepreneurs on strong interest by venture firms and on relatively attractive transaction valuations. Although raising capital is never “easy,” we believe the current environment is healthy for private digital media companies.

Size of Financings

In terms of financing size, the average size of digital media venture transactions has remained stable since 2005. During 1H06, the average financing size was $10.6 million, as compared to $9.1 million and $11.5 million during 1H05 and 2H05, respectively.

Interestingly, over this period, transactions have trended toward smaller (less than $5MM) and larger (greater than $20MM) financings. The percentage of mid-sized (between $5MM and $20MM) financings has commensurately decreased. We believe this change in distribution is driven by two factors: 1) increased venture capital for private companies in the Applications sector, which is at an early stage of development and which typically requires less total capital commitments per company than the broader digital media industry; and 2) the emergence of private companies with late stage revenue levels in several digital media sectors, such as Semiconductors, Content Service Providers & Retailers, and Advertising Infrastructure.

Most Active Sectors

The sectors with the largest total venture capital raised during 1H06 were Semiconductors, Content Service Providers & Retailers, and Advertising Infrastructure. Notable financings during the period were: $150 million by Amp’d Mobile, $49.2 million by Digi TV Plus, $48.5 million by MovieBeam, $48 million by AdKnowledge, and $46.6 million by Sling Media.

By number of financings, the Applications, Advertising Infrastructure, and Provisioning & Delivery Infrastructure sectors were the most active during 1H06. In particular, the Applications sector included 46 financings during 1H06, as compared to just 9 financings during 1H05. The significant rise in venture activity in Applications companies is driven, among other factors, by the investment theses in user-generated content and other personal media.

Overall, as per our comments in recent newsletters, we remain bullish on investment theses related to user-generated content, casual video games, and content delivery networks, among other areas.

Most Active Investors

The investors with the greatest number of digital media investments in 1H06 were Intel Capital, Sequoia Capital, Cisco Systems, and Draper Fisher Jurvetson. Notably, 245 venture capital firms announced two or more digital media investments during the eighteen month period between January, 2005, and June, 2006. In our view, this demonstrates the broad participation and interest in the industry by venture firms.

Number of M&A Transactions

The M&A market remained steady in 1H06 with 181 transactions announced during the period, as compared to 183 and 185 in 1H05 and 2H05, respectively. Notable recent transactions involving venture-funded private companies include Microsoft’s acquisition of Massive, VeriSign’s acquisition of m-Qube, and Viacom/MTV’s acquisition of Atom Entertainment.

The North America region saw the largest number of transactions during 1H06, with 94 M&A announcements. M&A activity in the Asia region, however, increased significantly, representing 19% of transactions in 1H06, as compared to 8% in 2005.

Most Active Sectors

The 1H06 M&A transactions were primarily in the Content Service Providers & Retailers, Advertising Infrastructure, and Content Creators sectors. The Retailing Infrastructure sector experienced the sharpest rise in M&A activity, with 14 transactions announced in 1H06, as compared to 4 in 1H05. Further, the steepest decline in M&A activity occurred in the Content Publishers sector, with 19 transactions announced in 1H06, as compared to 36 in 1H05.

The IPO market for digital media companies remains muted. During the first half of 2006, only 6 IPOs were filed and 6 were priced in the industry, as compared to 5 filed and 19 priced in 2005. In our conversations with private company board members and CEOs, we find several inhibitors for IPO activity, including the generally unreceptive public markets and Sarbanes-Oxley compliance costs and risks. We do not find visibility toward a substantial change in the dynamics of the IPO market in the near-term. As such, we believe M&A remains the far more likely exit scenario for private equity investors.

Overall, we note that venture capital activity has increased substantially over the previous 18 months, while M&A activity has remained steady over this same period. Several venture investors in our conversations have referred to this situation as a “bubble without an exit,” indicating a concern and frustration over the high investment levels but low exit numbers. In our view, this situation may be, at least partly, due to the early stage of digital media as an industry. Industry drivers of broadband penetration and alternative media business models are just now emerging as visible, mass market forces, and revenues from the associated services and technologies are only recently beginning to be explored, defined, or built. Further, we find that interest on behalf of potential acquirers exists, even if only on an exploratory basis. Although it is infeasible to predict timing or to provide certainty, we believe the underlying dynamics are positive indicators for future M&A activity in the industry.

As much as I pontificate all day about online advertising, I have yet actually have much experience in SERVING ads. As a result, I’ve signed up with bunch of advertising networks and will be testing on click throughs and revenue on this blog. My goal is to figure out the efficiency vs. scale of these networks and come to some investment thesis so I can play the stock market . . . so yes, I’ve sold out by placing ads on my blog, but my appetite is bigger than measly $5 a month, I want to see if I can leverage this to even more money

For some reason, I got rejected by adsense (do I really bash Google that much? I dont think so . .. I think they are great) so I’ve started with clicksor.com . . . the ads doesnt seem very relevant to me but maybe its on a behavioral algorithm. Let see how much traction this gets and I’ll report back in about a week.

In the physical world scarcity is what leads to value.

In the digital world abundance is what leads to value.

Or atleast thats what Fred Wilson claims (follow up post)

In econ 101, they try to teach you that the demand curve slopes downwards, that as P (price) increases, (Q)demand decreases. Furthermore, the supply curve behaves the opposite way, as P (price) increases, (Q) supply or willingness of sellers to sell in quantity increases. The equilibrium price and quantity sold/bought is when the two curves meet.

“Scarcity” is an interesting concept in economics . . . because it can be either real or manipulated (cartels, monopolies). Eitherway, scarcity shifts the supply curve up wards and to the left - for whatever reason, the producer (increase in marginal cost?) decides that for the same price, it is now willing to produce LESS. . . or to sell the same amount, it would like to get paid more. Scarcity in economic terms is about the supply curve rather than about the demand curve. Because of the shift in supply curve, price goes up as the supply curve intersects the demand curve at the higher point. (note that the demand curve did nto move)

Fred’s first sentence is suppose to be a popular way of explaining this situation . . .

In the physical world scarcity is what leads to value.

What technically it should say is “increase in price” rather than value because value is an amorphous term that might not be correct to use here. AND only when a existing demand curve exists.

In the digital world abundance is what leads to value

Here lies the crazy supposition with the second thesis. . . that if the supply curve shifts down and to the right due to abundance, because seller is willing to sell more at the same price, the intersection with the demand curve will actually be higher than before NOT lower! . . . thats technically not possible. . . ! according to most economic theories. . .

After I read more the example that Fred gave, I realized that Fred is using the wrong terms. . . scarcity/abundance applies to the supply curve (no duh), but the use cases he gave actually works on the DEMAND curve rather than supply curve. . .

The photobooth example and the Jonas Brother example is more about using pervasive (or “abundant”)marketing techniqeues to increase awareness & distribution and thus induce demand from consumers and thus shifting the demand curve up and to the right causing prices to go up.

This is really not that revolutionary. . . to sell shampoo you gotta make sure you get it wide distribution at everywhere your target customers are . . . and if you can give away samples to prove value and stoke demand. . . you do it even if its at a loss.

What DIGITAL goods do get you (as we know from 1999) is cheap, wide, self-replicating distribution channels with significant word of mouth that creates opportunities to increase awareness and prove value proposition. All web 2.0 has done is to increase the DEMAND curve up and to the right leveraging more effective marketing/distribution channels.

I would modify Fred’s thesis in the following ways

In the physical world scarcity is what leads to value ONLY when an existing demand exists

In the digital world abundance is what creates awareness and enables peer distribution which leads to increase in demand

Both of which are complementary, adheres to basic econmic theories, and is basic business pratices . . .

The caveat here is that given “unlimited” and easy supply of a good (not just awareness or distribution, but the actual good. . . like if downloading free mp3 is as easy as itunes, for example), you might be able to increase demand, but monetizing that demand will be hard because there are unlimited supply (ie demand and supply curves are shifting at the same time).

The way to monetize this is do what Jonas Brother is doing through upselling CD’s . . . by creating a second complementary good that does not have unlimited supply. . . . its again the classic loss leader strategy.

In March, I wrote a post lamenting the fact that web 2.0 companies are facing a huge problem crossing the chasm after capturing the “TechCrunch” early adopter crowd of a tens of thousands of users. . .

How big is this early adopter market? Let’s do some quick calculation. . . Techcrunch is a must read for the blogosphere . . . 35K RSS subscribers. . . aggressively assuming the same # of email subscribers and same # of good ole typed in traffic. . . we get to around 100K people that actually CARE about all the random startups. . . Another proxy . . . Delicious has about 300K users. . and it is by far the largest web 2.0 company. . . So at best the tech blogosphere is probably around 250K users. . . Crossing the Chasm 2.0

I would venture to guess that the chasm for web 2.0 plays is bewteen 100K to 500K users. If I was a VC’s I would not even touch a company until I see a clear trajectory to 500K users and beyond. There are way too many web 2.0 companies stuck at 20-50K users hoping to cross the chasm when their userbase hit a wall.

Both Brad Feld and Josh Kopelman echoed the same thoughts lately . . .

Brad’s Web 2.0: The First 25,000 Users Are Irrelevant. Brad went as far as me in using Techcrunch to estimate the “early adopter/trial” user base. . .

Josh Kopelman has a perfect post up today called 53,651. This is the number of RSS subscribers to Michael Arrington’s great TechCruch blog, and is exactly at the core of the “first 25,000 user” issue. Since there are 53,651 RSS subscribers of TechCrunch (at least as of 5/12/06) , if something gets reviewed there, it’s likely to get 5,000 to 10,000 users in the next 24 hours “just to try it out.” As so many traffic graphs of these “TechCrunched” products show, there is a huge spike in use for a day or two, and then it goes right back down to where things were before they were TechCrunched.

Josh’s 53,651 post also uses TechCrunch as a measuring stick . . .

As more and more entrepreneurs start building what Fred Wilson referred to as second derivative companies, I think they run a big risk of designing a product/service that is targeted at too small of an audience. Too many companies are targeting an audience of 53,651. That’s how many people subscribe to Michael Arrington’s TechCrunch blog feed. I’m a big fan of Techcrunch – and read it every day. However, the Techcrunch audience is NOT a mainstream America audience.

Given that TechCrunch is growing significantly, notice that they added 20K new subscribers since March, the good news is that atleast the growth of the web 2.0 crowd is not slowing down. . . but in the end, I rather ride on a train that is bigger and faster growing ala MySpace . . . (think Paypal on eBay, YouTube on MySpace, Slide on Myspace) . .

So whats the point of the post? Its to feed my ego and claim that great minds think a like and I deserve to be in the companies of Josh and Brad . . . . . . I wish

“Defeating Feature Fatigue,” Harvard Business Review is the first academic research I’ve came across that tried to quantify the negative impact of feature creep while attempting to manage trade-offs from reduced sales. To put it in another angle, in the world of iPod, “less is more” is fastly becoming the new mantra (deservedly so) but as with everything, moderation is always the happy medium.

To get the right mix of capability and usability in a product, managers need much more guidance than the general advice that “less is more.” On the basis of our results, we developed an analytical model to help managers balance the sales benefits of adding features against the customer equity costs of feature fatigue. The model steers decision makers away from the extremes—too few features to capture initial sales or too many features to ensure ease of use—and toward a middle ground that maximizes the net present value of the typical customer’s profit stream. The model also demonstrates that the optimal number of features depends on a company’s objectives.

Furthermore, the study cautions that buyer loves to BUY features but hates to USE features. As a result, a feature rich product might generate huge marketshare gains initially from first time buyers, it might not recieve word of mouth support because these buyers ended up with feature fatique (eventhough they bought the product for the features in the first place).

One way or another, managers must correct for the misleading information that many market-research techniques deliver. As noted, our findings call into question the predictive power of attribute-based models for determining the optimal number of features. If companies conduct market research by asking consumers to evaluate products without using them, too much weight will be given to capability, and the result will likely be products with too many features. Instead, designing research that gives consumers an opportunity to use actual products or prototypes may increase the importance of usability so that its relevance in choice approaches its relevance in use.

Another interesting nugget is that packing features into a product is actually the anti-thesis of segment based marketing and product design. Find your target market, design a product for the market with the feature set that these users will LOVE to use, and no more . . . packing in everything ensures that your product is good enough for everyone, but never the best for a particular user.

Particularly in cases where a company has packed one model with many features to address market heterogeneity, consumer satisfaction might be greatly enhanced by tailoring products with limited sets of capabilities for various segments.

Perhaps device convergence is a pipe dream after all . . . or atleast in the current incarnation . . .

Gary Flake recently announced the founding of MSFT Live Labs. I found his manifesto (via Richard McManus) for Live Labs to be an interesting departure to most “labs” or “skunkworx” groups within large corporatopns.

Philosophy & Strategy Ostensibly, the charter of Live Labs suggests a dilemma: How can we simultaneously be small and agile but also influential enough to have a meaningful impact? Indeed, this is a dilemma that all organizations face as they grow and mature. Our answer is embarrassingly simple: We are a perpetual startup within Microsoft, which carries three important implications.

First, we will deliberately not do many things that are already well-established within Microsoft. Instead we will seek to connect complements or to fill existing voids, so as to maximize impact for effort. Our bias will be to focus at intersections: between science and engineering, tactical and strategic, users and businesses, vertical and horizontal, short-term and long-term, internal and external, but above all - between problems and solutions. Like a startup, we seek to create entirely new value by making new combinations.

Second, all of our teams will be small, but with sufficient resources to make a modest level of success something that is completely within their own control (which implies minimizing some dependencies).

Third, when appropriate, we will opportunistically partner with other Microsoft groups to amplify their efforts as well as our own. We aspire to being positive agents of change across the company, helping to break down barriers, and expediting innovations - but on a scale that can only be realized by multiple teams with Microsoft working in concert.

Most labs takes the “northeast” approach to innovation . . . riskier, more disruptive innovation, and longer time horizon than typical product develpoment/management innovation process. As a result, the lab/skunkwork unit is usually as far away from core products & business as possible (without losing context/vision) in order to be able to innovate independently without the baggage of corporate scared cows. Distance from the mothership, in many ways, is hugely desired for both political and innovation sake.

Gary, however, is using a more strategic approach to innovation. . . 1) identify stakeholders, technology, strategies, and products, 2) Map all variables within a vector space (geek speak) 3) identify “whitespaces” 4) create solutions to fill in whitespace 5) add value by creating synergies.

For anyone that have taken an MBA course on innovation and read Innovator’s Dilemma, this is hugely sacriligious. For those that adhere to the Michael Porter’s idea of “strategy = trade-offs on the efficient frontier” this is also very disconcerting. Academics do not believe someone should be able to pull this off. To be able to innovate significantly while PARTNERING with existing legacy business units is close to impossible. Many have tried and gotten dragged back to the daily grind of politics, meeting earning estimates, and managing cannibalization.

BUT if you really think about it . . . this is the ONLY way to innovate relevantly. Too many innovation groups end up creating solutions to non-existant problems (nano blah?) OR solutions mis-understood by the mothership (Xerox’s anything in the 70’s). This is a very brave approach to innovation. . . to ensure relevancy while leaping toward step function changes . . . I wonder if this can work. . . I’m sure there are a few projects that does fit the definition . . . better ad serving algorithms, better presonalization, recommendation . . . anything that focuses on optimization of an existing business or product function could all possibly work . . . the key question than is: in the long run will these advantages remain “strategic” and sustainable. . . or algorithmic superiority will go the way of TQM - price of entry but not “strategic” as defined by Porter and eventually get competed away . . .

Do you think Total Quality Management was strategic when it was developed?

Not strategic in the sense that I use the word strategic.

“Strategic” is a word that gets used promiscuously—some people use it to mean anything important. Total quality management was a very important development, and provided an enormous advantage for Japanese companies initially. It is one of the reasons why they were able to produce products with such few defects. U.S. companies used to pride themselves on having good repair networks. Japanese companies came out with products that didn’t need to be repaired.

Total Quality thinking really was a breakthrough, but it is what I call operational effectiveness. It is a “best practice,” or something that every company should do.

“Strategy” is a term I reserve for choices—things a company does to set itself apart from others. So a strategic choice would be, “What customers does the company choose to serve?” A company that is not strategic serves whatever customer appears, or whatever need presents itself.

This notion of operational effectiveness vs. strategic positioning, is, I believe, fundamental to thinking about management. Companies must distinguish these two very different agendas, which present different organizational challenges.

One of the oldest business phenomenon is the continued atomization of the value chain from one integrated entity into loosely coupled federation of value added participants. Outsourcing of non-core business processes is one example.

The same thing is starting to happen on the internet especially to the so called “Walled Gardens.” It might seem from what I am about to write that I think these walled gardens are screwed, I actually would argue for the opposite (unlike most people). That for a subset of walled garden internet companies that have created many-to-many relationships between its participants; the future is still quite bright.

First generation Attention Aggregators are search engines that have developed significant edge competencies that enabled them to quickly and effortlessly aggregate value (be it content, services, products, or anything else) from the “edge” of the internet and the so called walled gardens to create comprehensiveness and increasing economies of scale. These edge companies (whatever the next incarnation might be) are here to stay and have carved out a valuable slice of the value chain as the ultimate arbiter of relevancy, interestingness, not to mention comprehensiveness. Their role in the internet economy is attention aggregation (where I go to look for stuff first) and traffic switching (tell me where do I go next). This is an incredibly important function and deservedly so they will and is extracting value for providing this service.

Too many people belittle the importance of what I called Presence Aggregators . . . they believe value will flow to the edge and the long-tail will eventually help Attention Aggregators extract all the value. I disagree, Presence Aggregators, in a very simple sense, are “websites” that Attention Aggregators sent traffic to. More specifically Presence Aggregators are the “containers” of value (again - content, services, or products). It is a “symbiotic relationship.” Whether the so called Presence Aggregators are walled gardens or not is really a semantics discussion.

The difference between MySpace (what most would call Walled Garden?) versus TypePad is almost minimal . . sub domain vs. sub directory vs. own domain name. . . RSS enabled vs. not . . . . customizability . . . etc . . . My point is that there are functional differences but not structural ones where a subset of walled garden companies could become more open via improvements to the software/site/business model. Yes, I do agree that one sided Presence Aggregators (such as cnn.com) are in for a round of value destruction and the transition will be much harder. But those that have created many-to-many relationships will have an easier time (relatively) managing the encroachment of Attention Aggregators.

Traditionally true walled gardens have acted both as Attention Aggregators and Presence Aggregators . . . aggregating value, traffic, and users in one swoop hoping to keep all the pieces together in an infinite loop. Those days are over. Walled Gardens must make the transition to being value containers instead. . . Presence Aggregators must focus their attention on aggregating the long-tail be it facebook, myspace, wordpress.com, or even a web hosting company. Attention Aggregators, by definition can not and should not get into the business of aggregation through “ownership”. . . they need to continue to improve on their edge value extraction/indexing competencies. Gather.com has gotten a lot of crap lately for being a “walled garden” . . . I don’t think that is what they are trying to do . . . (there are functional issues with the site for sure. . . but being a walled garden is not one of them). GoogleBase is Google’s strategy towards long tail presence aggregation. . . which is NOT dependent on (but complementary to) their search business.

Will Attention Aggregators eventually dominate the entire internet landscape? I don’t believe so . . . a lot of people believe so by pointing to Google’s incredible growth, margin, & size . . . I would attribute that to Google’s virtual monopoly in search. Given fragmentation of Attention Aggregators (say in a particular vertical), their ability to extract value from Presence Aggregators will decrease as well. I look at the hard good distribution business as an example (imperfect example because hard goods distribution lacks edge competencies, and exponential economies of scale). Aggregation is great but it is also a commodity (anyone can index websites or buy products) . . . it is through merchandizing and branding (same function as relevancy and interestingness!!!!) that aggregators scale and grow . . . Thus if a distributor has a virtual monopoly (Walmart) the value creators or containers (P&G) will be in an much inferior negotiating position. . . but that could easily flip (such as movie studios vs. movie theater chains) based on simple capacity and fragmentation dynamics.

In the end, the value of walled gardens WILL diminish no doubt because an additional industry has risen to dis-intermediate it from its end users. That, however, doesnt mean all walled gardens are screwed. Those that focus on aggregating the long-tail, providing valuable service to value creators, and (very important) encourage framentation of attentiona aggregators in their space will be able to hold on to most of their value.

Unfortunately, technology is one of the most insular industries in the world. While “old world” executives jumps from one industry to another . . . CPG, to media to industrial products (GE-trained managers are the perfect examples), very few technology executives ever leaves the industry once they enter. Even old-world executives who got recruited to the tech world (such as Terry Semel, Meg Whitman) rarely go back. (the money is too good, and the work too exciting ?! ) Even worse, many of us have spent most of our business careers in the industry without ever tasting what it is like to work at a “build-to-last” company like P&G.

These so called geeks turned entrepreneurs/executives (I’m one) tend to truly lack context for making complex business decisions. We tend to think that we are breaking new grounds but in truth, we are really just re-inventing the wheel. This is one of the main reasons I decided to leave the comfy confines of the valley and head eastward for business school. . . to get a little perspective, context, and some history lessons.

Nothing is more clear these days as I read blog after blog arguing about some new business model or partnership using some new fanagled meme to explain away one business decision against another. Sure there are many nuances that only someone knee deep in the industry will understand . . . but fundamentally, the industry is not so different from what existed before that we deserve to re-write the rules of business. (remember what happened last time when we did so? where did the new economy go? Dot-Bomb?).

So there has been incredible amount of noise lately about profit motives, margins, and market powers of content creators versus content publisher. Specifically Google & AOL ’s blockbuster deal as well as lots of startups & bloggers arguing over revenue share model to content creators from content publishers (is it fair? is it communism? is it necessary?). The value chain for content in the internet world is really not so different than media . . . the line is not so clear who is really the content creator and who is the content publisher. . . AND there are so many value added layer in the middle (producer, executive producer, talent agents, distriubtors, theators etc) that mashups are really not a cool new invention born out of the colletive genius minds of the web 2.0 crowd. So yes, other people do get the complexity of the two-dot-oh world.

For better or for worse, search engines has become the defacto channel for distributing internet content. Even more so than cable/satellite TV providers in the broadcasting world. Google is by far the largest and most powerful search engine, and Comcast is the same in the broadcasting world (ever wondered why Comcast wanted a piece of Google?). As Michael Porter will tell you, the power interactions (and direction of revenue flow!) between two partners within a value chain is highly dependent on industry concentration and the market share of the particular players. Because Comcast owns such a powerful position in the TV industry it can extract “tolls” from commodity content creators to have access to its subscriber base. ESPN on the other hand, because it owns highly desirable content, can negotiate with Comcast significantly more aggressive. We tend to forget that when AOL first started, it was PAYING for content to be made avaiable to its subscribers, BUT as AOL grew larger and larger the table turned, and AOL ended up getting PAID to make content available to its user base. (BTW AOL lost most of its gateway strangling hold to google . . . but its still important enough for Google to want to work with)

The same powerplay has been in play for almost a hundred years . . . I dont see why we are arguing over AOL/Google OR over whether content creators (in the peer economy) deserve to be paid or not. There is no right answer it all depends on who you are. . .

AOL needs Google to act as a distribution channel for its content/services. Google OneBox seems to be the most effective/premium placement for search inclusion. Google, on the other hand, needs AOL to distribute its advertising content/network. The powerplay and eventual “deal” comes down to what other alternatives each other have and what they are willing to offer.

The same case for startups . . . if you are a new cable TV provider, you dont have the bargaining power of Comcast so you need to pay up the wazoo to get ESPN. . . (plus other larger problems) . . . if you are a new distribution channel for internet content (such as a new search engine or a new content aggregator) the only way you are going to get proprietary/differentiated content (like AOL in the early days) is to provide some sort of value to content creators (and cash is one way to add value). . . Google can give away eyeballs/traffic/subscriber as a “value proposition”, startups can’t so they end up have to use cash instead . . . sometimes its just that simple. . . good ole Porter’s Five Forces.

Content is a dirty business. . . . more specifically content that has commercial/transactional value. (ie not entertainment and informational content.) I had a taste of the business a few years back at my B2B startup working to get industrial catalogs onto the site. After digging around the industry and meeting with different companies, I quickly realized it was an extremely incestious circle of people that cycle from company to company in an endless merry go round. The hardest part is that every player in this particular industry accuses of each other of various form of copyright infringement and it is next to impossible to figure out the real story. The reason is that the law is extremely fuzzy on the actual ownership the content. For example, if 10 manufacturers hands-off their product specification to a content normalization firm (who is commissioned to do the job by some other company) who really owns the content after all the work was done? Is it the manufacturers who created the content in the first place? the company that hired the content cleansing firm? Or the content normalization firm because their value add is so significant to warrant more than just derivative work rights? Or is it public domain? (how can anyone own the fact that a certain grade of steel piping only come in 6 standard form factors?) Can the content normalization firm resale that content even though it was under some sort of consulting contract? How can anyone prove that the firm “repurposed” the content rather than “started from scratch” if it was caught reselling the content to another company? Does it really matter if the process is manual or done via software or a combination of two? Even if the law is clear, it is next to impossible to prove any type of illegal practices. All it really take is to burn a CD-ROM and walk it out the door. And in fact, I quickly discovered (unfortunately not early enough) that most of these players are really recycling the same content.

I also quickly discovered that even more important than the content itself, the so called schemas - aka semantics, aka meta data, aka attributes - that are the most important “IP’s” in the industry. Once you know how products should be characterized (or how experts in the field define their products) , the job of matching and normalizing content to that schema is significantly easier if not trivial. Furthermore these schemas are what drives the discoverability of your search engine and create true comparability between products. Having a system that is both structured but responsive to change (for example if Apple releases a new 1000G iPod Nano today, I better have those attributes defined ASAP or the discoverability of ipod will suffer) is a competitive advantage. So the harder, more important question is . . . Is the ownership rights of content seperate from that of semantics? Or is it bundled? Is schema or semantic even “ownable”?

So why the long set up? by now you probably figured it out. . . instead of walking out the door with a CD-ROM what if I created a RSS feed and happened to send it to GoogleBase? What happens there? Is someone violating some sort of copyright law? Maybe not the content itself but how about the schema? What if I owned the content but someone else build the semantics around the data? Can I export it and give it to someone else? Can that someone (GoogleBase) use it to their own benefit without notifying me? What if instead of CD-ROM full of data, the data actually reside on web pages? And THAT is the issue we are facing today . . .

Today, vertical search engines are normalizing semantics around the content that that do not own (similar to content normalization firms of yester-years). Certain times these vertical search engines are feeding the content directly into GoogleBase; other times, Google is simply indexing the content through the search engine. In both cases Google is taking not just the content but the schema and repurposing it for their search engine. Do the vertical search engines care? Do the content owners? Who owns the content? who owns the schema? Does anyone have the right to stop Google? I dont have the answers . . . maybe someone does. . . .

In the not too distant future (6 month?) , once they gain critical mass and the bell curve reaches steady state, Google will have a pretty good idea what are the attributes of most of the transactional products and services (any “physical” or “metaphysical” objects really) on the web without lifting a finger by the virtue of their folksonomy based name:value pair attribute engine. At which time, they will be able to extract semantics out of webpages they crawl without the help of vertical search engines or expansive manual design. When it happens, Google will be able to launch a thousand vertical search engines with a switch . . . scary thoughts for vertical search engines which invested numerous man hours in designing their attribute rules and believes it to be their barrier to entry . . .

This is GoogleBase, content is just a means to an end . . . and the end is so called schemas, semantics, metadatas, and attributes. . . this is what I come to realize . . . that content is simply too perishable to be valuable but this other stuff with funny names . . . this is worth more than gold . . . this is the ticket to owning the semantic web . . .

I must be crazy or stupid, I have no idea what George Colony of Forrester is talking about. . . Now given that he is the CEO of Forrester, I must be completely dense since I find his latest Quick Take, a little light on content and heavy on self created buzzword.

Most of us use two types of computer software: 1) programs like Microsoft Word or Oracle Financials, and 2) Web files — like a corporate intranet or Amazon. You can perform many tasks with programs because they are executable; they contain millions of lines of computer code that enable you to underline words, calculate profit and loss, check spelling, etc. You pay for programs — ostensibly to defray the high cost of writing all of those lines of computer code.
In comparison, the Web files we use are like documents. When you click on a link for a site, the server at that site sends you pages of information. Web files are mostly static — they can’t do much compared with programs. Their limited functions (buy buttons, search) don’t execute on your computer — the server that you are connected to does most of the work.

Eh. . . ever heard of Ajax? Or even better, hotmail? Static website are so 1994. Whether a program executes on your desk top or not is extremely irrelevant. Client Server, mainframe, mini-computer applications are not completely executed on the client side either, that doesn’t make them “dumb” or “static” With all the talk of Google bringing openoffice to the web and MSFT re-architecting MSoffice for the web browser, I’m really not sure where George is going with the “web cant compete with desktop apps in functionality” argument.

Forrester has predicted that Web pages will get replaced by programs — we call this executable Internet (X Internet). In the future, when you click on your bank’s site, servers will download a program to your computer, not static pages. Once that program is installed, you will be able to “converse” with your bank, run financial models, analyze your net worth — do much more than you could have with old Web pages.

. . . this is getting ridiculous . . . I’m betting all these “conversation” are going to be done right on the webpage using AJAX. Actually I think my Ameritrade account does this pretty well and I’m pretty sure I’m not downloading anything.

Google is also leading a pricing revolution. Google’s programs are free, funded through advertising and syndication. This is a prescient move. I foresee a world in which even enterprise applications like financials, ERP, and supply chain software will be advertising-funded.

SAP serving up ads? What would Johnson & Johnson’s CIO think. . . better yet, Jeff Nolan might have a cow just about now. . .

What It Means No. 1: Large corporations should get Google executable Internet programs onto their corporate desktops. Google Desktop Search, Google Toolbar, and Google Maps will drive productivity. In addition, this move gets corporate IT ready for a world in which free executables will begin to proliferate. IT staffs will learn to incorporate Google’s programs and application programming interfaces into corporate Web experiences.

I’m at a lost for words. . .

What It Means No. 4: The coming of executable Internet fundamentally changes the software and Internet landscape. Microsoft is an obvious loser. The closed, centralized architectures of Oracle and SAP will get a bunch of new salesforce.com-type challengers over the next five years. Amazon, AOL, eBay, and Yahoo! will be stuck with old Web-style experiences — not as easy, fast, and customizable as the executable Internet experience. That is why Google may be so dangerous for its Internet brethren — it knows programming and they don’t.

If George is right, that downloadable thick client apps are going to take over the world, I think Microsoft more than Google is going to have a kick ass time, as that’s what they’ve advocated for the last 3 years. BTW saleforce.com is not a thick client, it’s a “static” web file. Also, Google Maps is not a X-internet downloadable app, its AJAX or AJAX-like more technically correct. Google knows programming? That I agree. . . other companies like Amazon, Yahoo, and eBay don’t? huh? Sure we don’t have as many PHD’s as google but we still got plenty of genius CS types running around the company. . .

So here’s Google’s playbook: 1) have the best search; 2) have more of the world to search than anyone else through the digitization of university libraries, earth images, maps, etc.; 3) attract the most advertising and syndication; enabling the company to 4) give all of its software away for free; which enables it to 5) change the rules and economics of the software business and define the future through its pioneering work in X Internet.

Ok. . . I’m being a little facetious, and didn’t mean to take George lightly. I do agree with his final analysis that Google is changing the economics of the software business and that it is much much more than a search company. Maybe what he menat by X Internet is really web 2.0+Ajax . . . that would make more sense . . . but why doesnt he just say so instead of inventing another word. . . and why does he think Google has the exclusive expertise on Ajax? has he tried out Yahoo Mail 2.0 yet? . . . strange . . .

(I’m sure someone will flame me for this post. . . so go for it )

BTW, other people’s analysis here (apparent I’m the only one that had an allergic reaction to the article)

Benson’s Blotter
Infectious Greed