Death of the "free internet"?

I've linked before to the excellent work of Izabella Kaminska at the FT's Alphaville blog. She's recently started a new series of posts she's calling Web Perestroika:

an occasional series lamenting the hypothetical eventuality of a world without a free internet* and the extraordinary implications this could have for markets and companies. A tragedy of the web commons if you will.

It is inspired both by India’s ruling to bar Facebook from subsidising internet availability with Free Basics packages (see Kadhim’s series of posts for more on that) but also Balaji Srinivasan (he of 21 Inc toaster fame), and his attempts — including a Stanford Bitcoin course — to convince the world the web should in fact be a paid-for luxury product of scarcity.

And yes, the asterisk means she does understand that The Internet is not free:

*when we say “internet” we mean it in the popular sense of the word.

She means a world without free Web content. Below the fold, some thoughts on the first two posts in the series, both from Feb 10^th.

Kaminska kicks off the series with On the hypothetical eventuality of no more free internet. She points to:

the reality that the web commons cannot be eternally supported (in terms of spam, litigation cost, fraud and other capacity/bandwidth/processing controls) by an endless resource of investors content to live off un-materialized capital gains only.

and:

the limits of monetisation strategies based on private data intrusion and the selling/reselling of data to advertisers for the purpose of moulding, shaping and predicting mass purchasing behaviours (all with the explicit aim of gouging the rich and subsidising the poor until capacity utilisation is maximised in the system).

Cross-subsidization is the key to her argument:

the web economy’s core Achiles heel: its dependence on cross-subsidisation strategies focused on overcharging premium subscribers for the sake of providing the wider “proletariat” with free services.

She runs rapidly through the booms-and-busts of tech history. Cross-subsidization works best if you are a monopolist.  Brian Arthur-style increasing returns to scale mean that someone will be the monopolist. The way to make sure you are the monopolist is to grow as fast as possible, ignoring profits (see Amazon):

For businesses that could only hope to return their cost of capital if they successfully grabbed market share from pre-digital incumbents, network effect growth meant everything. The more you invested in marketing and reach, the faster you grew. The faster you grew, the more attractive you became to patient capital investors awaiting monopoly-scale rental flows at some point in the future. And the more attractive you became to investors, the more capital you got to spend on marketing and reach, and the faster you grew — opening the door to the self perpetuating cycle of hype and mania in the period.

The period she means is the dot-com era, not today's hype- and mania-free business climate :-)

Even so, the fetish for growth over profitability took root and still continues on to today, epitomized by the open-source community and characters like Tim Berners Lee.

Kaminska clearly doesn't understand that most widely-used open-source software is, and has for decades been, written by people employed by profitable companies. The companies do this because it makes business sense for them to share costs with others, even with their competitors. But she is far from the only financial person to misunderstand open source, as is shown by Simon Phipps' takedown of Max Schireson and Dharmesh Thakker in VCs who miss the point of open source shouldn't fund it - they advocate the same cross-subsidization model for open-source software:

The authors may believe -- based on biases arising from their own careers -- that the only viable business model for a company monetizing open source software is to create artificial scarcity to ape the models of legacy corporations, but Red Hat clearly proves you don’t have to do that.

Those biases seem to arise from an outdated view of the market for open source software. Students of history know that pioneers of new markets are able to command profit margins approaching 100 percent as long as they can behave as monopolists. As their markets becomes subject to fair competition, margins fall. Expecting 90 percent margins is probably not realistic, yet the authors clearly do

Another industry with gigantic margins and cross-subsidization is academic publishing. The big publishers bundle all their journals into a "big deal" and charge each library the most it can possibly pay. Andrew Odlyzko's fascinating 2013 paper Open Access, library and publisher competition, and the evolution of general commerce (PDF) points out that Harvard pays nearly 5 times as much as the University of Montana for the same product. The most extreme example is the:

HINARI Programme set up by WHO together with major publishers, enables low- and middle- income countries to gain access to one of the world's largest collections of biomedical and health literature. Up to 15,000 journals (in 30 different languages), up to 47,000 e-books, up to 100 other information resources are now available to health institutions in more than 100 countries, areas and territories benefiting many thousands of health workers and researchers, and in turn, contributing to improve world health.

Andrew's paper anticipated Kaminska's argument:

these “Big Deals” appear to point the way to the future of the whole economy, where progress is characterized by declining privacy, increasing price discrimination, increasing opaqueness in pricing, increasing reliance on low-paid or unpaid work of others for profits, and business models that depend on customer inertia.

Kaminska uses Google as the example monopolist:

One of the most successful ventures in that regard is Google — a poster-child for the new digital technostructure — subsidising communications, entertainment and social services for the great unwashed (us) with revenues raised from advertising, business contracts, premium charges for things like data storage, as well as the general collection and resale of personal data.

These monopolists have the problem of dealing with a flood of cash. In the good old days, after investing in the business and lavishing some on the executives, they returned it to the shareholders as dividends. No longer. There is so much cash that they can't decide what to do with all of it, so much cash ends up sitting in banks overseas. In effect, it is flowing out of the productive economy. As for the rest:

But it is the Google executives, not the increasingly de-ranked common shareholders, who ultimately decide which services get to be subsidised and which won’t (bye, bye RSS reader). It’s also the whims of Google executives which decide how surpluses are reinvested or which moonshots get to be funded and which don’t.

Google’s campus evokes exactly the same over-investment in a single privileged community as the old company towns. There’s even the sense of executives thinking they know how to invest their profits better than employees, shareholders, the government, or the public at large.

The monopolists are banking their cash overseas because if they bought it onshore, or worse distributed it to shareholders, a lot of it would be taxed and thus end up in the hands of a competing monopolist:

And while it’s fair to say the government represents the ultimate cross-subsidising monopolist of all — taxing the rich, to invest in the common good — there is one major difference in its paternalist nature: our representative governments are supposed to let us have some input into what management decides to tax and what it subsidises.

Google has a fix for the problem that "our representative governments are supposed to let us have some input". Robert Epstein's The new mind control (and his EE380 talk The Search Engine Manipulation Effect (SEME) and Its Unparalleled Power To Influence How We Think, available on YouTube) describes research showing how individually targeted manipulation of search result ordering can radically affect people's political behavior:

I see clear signs that Google is backing Hillary Clinton. In April 2015, Clinton hired Stephanie Hannon away from Google to be her chief technology officer and, a few months ago, Eric Schmidt, chairman of the holding company that controls Google, set up a semi-secret company – The Groundwork – for the specific purpose of putting Clinton in office. ... We now estimate that Hannon’s old friends have the power to drive between 2.6 and 10.4 million votes to Clinton on election day with no one knowing that this is occurring and without leaving a paper trail.

As we see in academic publishing and may other areas, monopolists tend to  grow their top line by increasing prices faster than inflation, because they already have all the customers they're ever going to have. This leads Kaminska to ask:

what happens to the internet economy if and when digital systems for the masses (from free email and social media to youtube) can no longer be cross-subsidised with ads, data or the gouging of the rich because even the the rich, the advertisers or the surveillance entities can’t afford these prices? Or, alternatively, because there’s no disguising the fact that the underlying structures of the internet were less efficient than the incumbent structures they replaced?

Her answer is that, to increase their bottom line, the monopolists would exclude the poor:

One thing’s for sure, a neutral net might be a helluva lot more expensive than we ever expected, and if that’s the case, things might not come down to a choice between neutral web content or skewed web content (like Facebook’s intrusive interpretation of your personal behaviours), but to the contrary, between web engagement or no web engagement at all.

The value for the monopolist is reduced by reducing the size of their customer base, but increased by improving its demographics (making the average customer richer). So this is a plausible response.

Kaminska's second post On unicorn imperialism was inspired by a notorious but rapidly deleted tweet from Marc Andreessen about Free Basic. It explores the historical analogies of this way of allocating resources:

We further outlined how it was the unicorn’s subjective interpretation of who it was fair to gouge, who it was fair to exploit and who it was fair to subsidise, which not only turned them into the command economies they supposedly loved to hate, but in particular into the technocratic planned systems of the Soviet imperialist Union.

The Soviet Union analogy came from a post Kaminska had written five days earlier, Digital money, negative rates as Gosplan 2.0:

Which ties in with why banks are much better sharing economy platforms than tech firms could ever hope to be. When functioning properly they assign spare capital into the formation of even more productive capital. They are able to do this because of the privileged upcoming consumption information they obtain from us depositing fungible social redemption coupons (money) in their care, and our access requirements to them (i.e. whether we want current account, time-deposit or investment terms).

Technology conglomerates (from Tesco to Google) on the other hand tend to use the information they collect to subjectively interpret or presume our consumption patterns on qualitative grounds so as to stretch existing output amongst more people, rather than to encourage its growth. This in turn leads to the popularisation of cross-subsidisation models in the market, the loss of price signals and the unintended support of uneconomic ventures on the hope that one day, perhaps — by driving out all “at cost” competition — they’ll be the last man standing, with rights to monopoly rents.

See academic publishers and Farhad Manjoos "frightful five", Apple, Amazon, Facebook, Google, and Microsoft:

By just about every measure worth collecting, these five American consumer technology companies are getting larger, more entrenched in their own sectors, more powerful in new sectors and better insulated against surprising competition from upstarts.

Though competition between the five remains fierce — and each year, a few of them seem up and a few down — it’s becoming harder to picture how any one of them, let alone two or three, may cede their growing clout in every aspect of American business and society.

See also Justin Fox's take on this in How Tech's Undisruptables Got That Way, and Ben Thompson's The Reality Of Missing Out:

More broadly, the winner-take-all dynamics described by Aggregation Theory have inspired a powerful sense of FOMO (the Fear of Missing Out) amongst investors resulting in a host of unicorns intent on owning their respective industries; I think the recent chill in valuations and fundraising are about coming to terms with the fact that a lot of those unicorns are in the same boat as Facebook and Google’s advertising competitors: they have already missed out to the dominant player in their field (or, that their field was never viable to begin with).