FCC Unbundling Revisited

It is said that in a liberal democracy the aim is equality of opportunity, while in socialism the aim is equality of outcome. Governments here and around the world have struggled with this dichotomy in developing and modernizing telecommunications regulation. The root of the dilemma is that telecommunications has in most countries become a monopoly or small oligopoly, with the government often taking a stake in these enterprises. The reasoning usually came down to a belief that telecommunications infrastructure, especially the "last mile" is a natural monopoly, and the realization that telecommunications is not only an important utility but one that is critical to society's functioning.

When the United States implemented local telephone competition in the mid-1990s, they recognized the need to tilt the playing field in favour of the new entrants, if only for a limited period of time. They correctly recognized that building a telecommunications infrastructure is extremely capital intensive, and without some legislative assistance it would be difficult for new entrants to compete with the incumbents whose capital budgets were a far smaller percentage of their budgets. As an additional spur to competition, to reduce the required capital intensity and to speed the availability of geographically-broad alternatives, the incumbents were required to unbundle local loops and other parts of their networks.

This all happened during the Clinton administration, which was willing to manage outcomes to a limited extent, with the intention that the country eventually return to a state of equal opportunity in the telecommunications industry. They put the industry on notice by building into the 1996 Telecommunications Act sunset provisions for many of these intrusive measures. Similar laws and regulations were adopted in many other developed nations, including Canada, though with lesser or greater intention in accordance with local political leanings. All this meddling is political and so it is no surprise that it was, and is, very much affected by the politics of the day. This is amplified in the US where socialism is an insult more than simply a description of an economic system.

With this history in mind, I was surprised to learn that the US is considering entering the fray once more with a modified form of unbundling to increase broadband competition. While there is little doubt that more broadband competition in the industry is helpful to consumers, this degree of government intervention is treacherous.

Certainly the current US administration is closer in sentiment to the one that spawned telecommunications reform that the most recent one. However, I think they are picking their fights carefully, choosing to focus on a few very specific issues such as health care. Intervention in the broadband market would only distract from higher priorities. I do not believe the FCC will be encouraged to mandate any further unbundling in the industry, not even the somewhat more benign form of DSL service unbundling that we have in Canada (Gateway Access Service), even though it is present in scattered locations in the US, but without the tight price and availability controls we have. There are also technology issues with unbundling -- copper loops are not seen as sufficient for the market's evolving requirements -- since it presupposes a network architecture that may not survive far into the future.

Wireless is the main disruptor here, and governments are -- correctly, I believe -- looking to these technologies to provide infrastructure-level competition in the industry, across both wired and wireless: in Canada this will take the form of new cellular providers, and in the US it will be companies like Clearwire. This would relieve them of the political risk of trying to regulate separation of physical network components from retail services, which requires permanent and intrusive oversight.

For at least the present, the likelihood of that level of intervention is small in both the US and Canada. In Canada that also means we should not expect any expansion or improvement to GAS, ever.

Gold and the Canadian Investor

If you're a Canadian investor in the gold sector, it is quite possible that your returns don't seem to be as good as the headlines would have you believe. Gold is breaking to new highs every second day, but is your portfolio benefiting?

I know that last sentence sounds like a sales pitch, however it isn't; I simply want to talk about the gold market from a Canadian perspective since it is not the same as it is for an investor in the US, which is the source for much of the media noise. One big difference is the currency. Do not be misled by the quoted price for this precious metals commodity -- or indeed for most commodities -- since they are quoted in US dollars, and that currency is faring poorly. Consider the adjacent 12-month charts: one for the commodity and the other for the loonie's exchange rate with the US dollar.

In rough numbers, gold has risen from about US$800 to US$1,150 (the quoted ETF -- GLD -- is an approximate proxy for the underlying commodity). During the same period the loonie has risen from about $0.81 to $0.95. If you invested in commodity futures or an ETF, in Canadian dollars your return is about 23%. Gold itself rose 43% against the US dollar. In other words, for every 1% rise is the US-denominated gold price, your investment returned 0.5%. That's one good reason, as a Canadian, to be wary of the hype surrounding commodity bull markets.

There is an alternative to the commodity and that is to invest in the producers: the gold miners. Consider the adjacent chart of one popular gold miners index. (Yes, while it is a US index, many of the worlds' major gold producers are Canadian and trade on exchanges in both the US and Canada, and, in general, perform similarly.)

The chart's shape is similar to that for the commodity, except look at the numbers. Over the same 12-months, the index has risen from about 23 to 51, and increase of 122% in USD and 89% in CAD. This is unsurprising since company profits typically are a multiple of the commodity. The reason is simple: if it costs a producer $500 to produce an ounce of gold, the profit is $300 when the commodity sells for $800 and $650 when the price is $1,150. That performance is why the producers outperform the commodity. Of course, and most importantly, the same reasoning works in reverse when the commodity price declines. The downside risk is in proportion to the upside opportunity!

My message is simple enough: if you are a Canadian who feels tempted to invest in gold, think carefully before investing in the commodity itself. The potential returns (and risk) are lower than investing in the producers. If you are willing to manage the risk, invest in the miners, either directly or via a fund. The advantage of a fund is that you are less exposed to operations problems that plague every miner from time to time.

Having said all the foregoing, keep in mind that this entire discussion hinges upon the price of gold continuing to track the US dollar. The strong correlation is only partly due to investors running to gold as a hedge against US public debt, which is helping to devalue their currency. This situation can change, and quickly, so act cautiously with your money.

More Bad News For Android Apps

Stories about the difficulty, and even futility, of making decent revenue from apps published on Google's Android Market are legion. I am no exception, having written most recently on the topic earlier this week. I want to draw attention to this story about Gameloft and their negative experience. Without meaning to demean the longstanding complaints of 1-man and 2-man app shops, I think it's important when even a mid-size commercial app developer -- in this case, games -- expresses the same concerns:

"We have significantly cut our investment in Android platform, just like ... many others," Gameloft finance director Alexandre de Rochefort said at an investor conference...mostly due to weaknesses of Android's application store..."Google has not been very good to entice customers to actually buy products. On Android nobody is making significant revenue," Rochefort said.

The reason for my concern is that I expect that larger, more-established companies have better and more frequent opportunities to engage with the organizations such as Google that individual developers do not. We know very well that the folks at Google Checkout and Android Market are notoriously uncommunicative and unhelpful with their customers: merchants and ISVs. I do not know if an outfit like Gameloft has better communications channels than the larger community, however my own business experience says that it is reasonable to assume that they do. If they do not, that is a further worry about the commercial maturity of these Google operations.

So when Gameloft says they can get no joy from the Android Market and are going to abandon products for the Android platform for at least the short term, I have to wonder what they know that they are not telling us. Are they getting unacceptably vague feedback from Google regarding improvements, or even a complete unwillingness to talk? Are they unimpressed with the prospects for brand-name alternatives, and especially carrier app stores?

Hope is not acceptable in a business plan. Tying a company's success to the unfulfilled promise of Checkout and Market must not be absolute: contingencies are required. I am interpretting Gameloft's message as saying that they see no suitable alternatives on which they can plan their business. That's troubling.

Asymptotic Pricing: Unattainable Cell Phone Rates

"...Recipriversexcluson: a number whose existence can only be defined as being anything other than itself." This fictional entity, which was invented by Douglas Adams, is at the heart of Bistromathics -- also an Adams' invention -- as described in the third book of his five-book trilogy: The Hitchhiker's Guide to the Galaxy. Although entirely fictional, the idea of a recipriversexcluson is not entirely useless to the better understanding of cell phone service pricing, as we will soon see.

Cell phone plans and their pricing can be terribly confusing and opaque. In this post I will not be attempting to cut through all that nonsense; it needs doing, but not here. Instead I will focus on one core portion of the pricing model: voice minute rates. That is, the actual amount you are paying per minute to use your cell phone. So let's drill down into that a bit further. To start, I will consider a simpler model that will exemplify the concept I want to explain: which is -- to coin a term -- asymptotic pricing.

In the past -- and perhaps at the present, but I don't actually know -- Chapter's book stores offered a discount card. How it worked is that for $25 you get 10% off on all your book purchases. The term was one year (if I recollect correctly). To many book lovers that may at first blush seem like a good deal. The first time I was offered this card by the cashier it did momentarily peak my interest. However a few moments thought was enough for me to find the flaw in the offer, so I smiled knowingly and politely declined. Let's look at how it works, with the aid of a graph.

You pay $25 up front, so you are immediately in a losing position. To dig yourself out of this hole you must buy books, lots of books. How much? Well, to break even you must purchase $250 worth of books (before sales taxes) since 10% of $250 is $25. That is, you pay $225 for the books plus $25 for the discount card, which equals the undiscounted total of $250. Of course, beyond that you do begin to see real savings. As an aside we should note that for Chapter's there is a marketing advantage in that you are motivated to buy lots of books, perhaps more than you otherwise would. If you do, they win, and if you don't, they also win. Win-win for them and lose-sorta win for you.

Regardless of how much you spend on books the one total discount you will never see is 10%. You can get arbitrarily close to that number by buying ever more books, but even if you buy all the books in existence, and even all those that existed in the past and that will exist in the future, you will never save 10%. That is because the initial outlay of $25 doomed you as surely as the poor horse whose rider dangles a carrot in front of its nose to make it run faster; the horse will not get the carrot no matter how fast and far it gallops.

In mathematics that 10% figure is an asymptote: a number that can only be reached by a limiting function, in this case with the limit taken to infinity. (There is a pale similarity to the earlier Hitchhiker's reference.) With this simple example in hand we are now ready to tackle cell phone voice minutes pricing.

Forget about data, SMS, vertical services, premium phones and other add-ons to your cell phone plan; it's only voice minutes we care about here and now. Even so, the graph (below) is more complex than the discount card example. In this hypothetical though typical pricing plan we see that the basic plan costs $30 (you can add in other fees and taxes if you wish to make it more realistic) for 150 minutes of air time. Again, we're keeping it simple, so no free weekends and so on; we'll stick with minutes that are chargable.

If you give any thought at all to the price when you are considering signing the contract, it is very likely that the one figure you will calculate is your expected price per minute by dividing the monthly fee by the number of minutes. In the present case that is $30 divided by 150 minutes, which yields $0.20/minute. However, as you can see in the graph, that value is only attained if you use precisely 150 minutes. If your usage is any other amount you will pay more. If you use less, you might pay substantially more per minute. (I've assumed a typical value of $0.35/minute for every minute you use beyond the 150 limit.) This is a bit like coin flipping: flip a fair coin 1,000 times and the likelihood of getting exactly 500 each of heads and tails is much lower than you might guess. At least if you do the flipping experiment many times the average will tend toward 500, but this is not the case with cell phones since you are relying on your (poor) ability to estimate how much you will use your phone:

Three-part tariffs optimally exploit overconfident consumers because overconfident consumers both underestimate the likelihood of very high usage, and the need to pay high overage charges, and underestimate the likelihood of very low usage, and the likelihood of not getting a refund for included “free” minutes.

The first thing to realize is that the first estimate of the per-minute price is an unrealizable optimum. Second, unlike the book card case, the $0.20 rate is not an asymptote since you can (if you're very careful) actually get that rate. However (third point), there is an asymptote in the graph, except it's not where you might have expected it to appear. The asymptote, like in the book card case, is also a limit for minutes taken to infinity. The asymptote is at $0.35, which is the overage rate.

If you think about it, that makes perfect sense. With unbounded use of your phone -- which is still very finite, coming in at 44,640 minutes in a 31-day month -- you will pay as much as $15,601.50, or $0.349495967/minute. That's pretty close to $0.35 though not equal. This limit is approached when minutes of use (MOU) is much, much greater than the 150 minutes in the basic plan.

Well, that's it. You now understand cell phone pricing just a little bit better than before. Just don't bring any of this up at parties or you will shortly find yourself with no conversational partners.

Making Android Pay

Earlier this year I decided that for our small venture we would not publish anything other than free apps on the Android Market. Initially this was because of the woes of Google Checkout, but the trouble has gone far beyond that, and can no longer be attributed to Google's growing pains. It's a shame since there is a lot of potential with the built-in Android Market app on pretty much all Android phones: now over 3M out in the wild, and slated to grow to over 10M a year from now.

Google is putting precious few resources into Android Market and Checkout. You can count the countries from which developers can publish paid apps on the fingers of both your hands and still have one finger to spare. Improvements to Market and the Market app have been even slower in coming. I have to believe this is deliberate. It seems that, true to its knitting, Google is not keen on direct sales, preferring instead to distribute innovative and interesting technology and making their money on ad revenue. They won't spend, say, $5M to improve and extend Market (although probably even more for Checkout), but they will spend $750M to purchase AdMob.

Money is not the problem. The pace of improvements is glacial and the problems are widely known and discussed -- often with great vehemence. Rather than hope for better, I project forward from their known performance and reach my conclusion: the Android Market may never pay for the bulk of app developers. Even their most recent Android Market Developer Distribution Agreement only further emphasizes their disinterest in enabling paid apps. That is their right.

Despite this lament it has never been true that publishing mobile apps is the road to riches: precious few win at that game and I had no illusions. For me the attraction was product placement since every Android user has the opportunity to see and acquire our companies products with the built-in Market app, which is a cheap way (for us!) to build the core of a sustainable market. Every other method is either more expensive or attracts fewer eyeballs.

Carrier billing is a step in the right direction, but insufficient by itself: it addresses the limitations of Checkout but not Market. Carrier "channels" on Market seem to me to be more of a ghetto than a platform from which to get noticed. Verizon has made some progress -- well before introducing Droid -- with their own app store, and they may be further encouraged by early Droid sales. While this strategy will cause fragmentation and increase developer costs, it could relegate the Android Market to only being a pool for free apps. That will still be of immense value to Google and most developers, just not the path to commercialization for ISVs that are treating their businesses as more than a hobby. It is interesting, though a bit worrisome, that the enabling corporations in the field are not yet clear on how to proceed.

Carrier stores are perhaps the best hope for Android app developers. I am beginning to suspect that the Android Market carrier channels are no more than a short-term fix that will be replaced in 2010 with true carrier-sponsored app stores, and their own built-in market apps. I have indications from private sources that at least a few North American wireless carriers are moving in this direction. Exactly what these stores will look like and whether they will be better than Google's offering for app producers and consumers, I unfortunately do not know.

Which gets me back to my own sales strategy. Our view now is to use the Android Market as one way to generate awareness within the target market -- everyone with an Android phone -- and attempt to leverage that with sales through other channels. The legalities of the agreements that every developer is bound to by publishing to the Android Market must be carefully navigated but are not insurmountable. The freemium model can still work on the path we propose to follow.

Still No VC

This is a regrettably long-running story: there is no venture capital money around, and especially not in Ottawa. There is some hope that the situation will change, but that is only a hope, not reality as yet. Knowing all this, it was with some interest that I read this article about the effect Nortel has had on the Ottawa high-tech industry. What Pat DiPietro had to say in that article is very much on point even if it is nothing we don't already know.

First, there is a dearth of seasoned technology executives in Ottawa. This is true, and has been true for a long time. This is not to say we don't have them, it's just that their numbers are disproportionately small in comparison to the engineering talent. As Pat says, much of the blame must be laid at Nortel's doorstop. Bell-Northern Research was constructed on the AT&T Bell Labs model where the technology and research organization was kept separate from the business units. For anyone who has not experienced it directly, this must seem a perplexing concept. After all, how can it possibly make sense for the product builders to be disconnected from the product marketers and sellers? It is ineffective except in the now-extinct monopolistic telecommunications industry structure. It had its good points, but speed, efficiency and relevance were not among them. In Nortel's case, since the vast bulk of the business talent was not in Ottawa we now don't have enough of it to spread around.

Second, we seem not to have people with the needed skills. While it is true that a talented engineer can quickly come up to speed on new technologies, it is less so as the engineer ages. The most productive and creative engineers are young. This is of course not always true, just true enough that it is a valid generalization. A good engineering team should combine the energies of the young guided by seasoned professionals, thus most profitably exploiting the best of both groups. The old Nortel hands are often not found in these senior roles. Many have left the industry, taken on junior roles in government or elsewhere, or are otherwise uninvolved for a diversity of reasons. This is a subject all its own which I won't get into here. The result is that we do have a pool of telecommunications software and hardware professionals in town, but telecom infrastructure products are not where the buzz is these days. The younger folks who are well-versed in the new technologies and customer-facing services are somewhat adrift in their various "hobbyist" start-ups without either funding or experienced leaders. There is too often a large gulf between the young and the old in this town.

Third, we sell too soon, and thus fail to maximize the value from our limited pool of small, successful companies. I think that Pat is off base on this point. For one thing, the reason many start-ups in Ottawa sell too early is that the VCs won't or can't make follow-on investments (a recent example is Third Brigade selling itself to Trend Micro). The money is usually needed if growth is to be stimulated rather than allowed to proceed organically while generating modest profits. Pat can look in the nearest mirror to spot the problem. Apart from the lack of VC money, I am not convinced that the rate of acquisitions is too high; it is a normal sequence of events. It is also to be expected that the acquirers are American since they have the companies with the size and incentive to do these deals. I believe the real problem is that we are not creating enough new, well-financed start-ups to replace those that are acquired. It probably takes 5 of these for every acquired company for the technology industry to thrive; the talent gradually moves into new companies, using money from the acquisitions to grow the local technology industry. Unfunded start-ups don't count in this scheme; these orphans are often little more than lottery tickets.

Ultimately it is money that is the fuel that will light the fire of entrepreneurship in Ottawa. If it stays away too long the talent we do have will drift away. If that does happen it will not soon return.

Windows 7: Meh

I have long ago stopped paying attention to Windows releases from Microsoft. While it's true that every version does add new functionality, almost none of it is so striking that it's worth more than brief attention. Windows 7 is no different, no matter what short-term impact it might have on the PC market.

For me, Windows is simply there; I need it to make my PCs function. That's all. The only time I notice it is when it breaks or makes it difficult for me to do something that is urgent. Those are negative points, not positives. There are many positives in its continuously-improving features, it's just that those features are of the type: well of course they did this, and, what took them so long. This covers everything from uPnP and auto-update to driver availability and TCP/IP support.

None of it makes an impression on users since this is at best nothing more than keeping up with Apple and Linux, or trying to keep user hostility under control due to failures, poor usability and high cost. Few users love Windows; they simply need it in their daily lives. Most don't switch to Mac or Linux since it isn't worth the bother, learning curve, or perhaps the non-availability of the applications to which they are accustomed or need.

Pretty icons and translucent surfaces are very pretty but are not selling points. Most of the applications that are familiar to users -- Office, Internet Explorer, Outlook, etc. -- are not part of Windows, and are only noteworthy in the context of Windows since many of these are not available on other platforms. Competitors don't restrict themselves in this way since such a policy only reduces their potential market. For Microsoft, the only advantage, although it is an important one, is that once these applications are loaded up with your address books, archived emails, bookmarks and so forth, make switching costs high. In marketing speak this is known as stickiness.

Of course, that is why competing products make it easy to import user data and documents from Microsoft applications. Microsoft has fought this in the past with hidden APIs and non-disclosed data formats. This secrecy has declined remarkably over the years as Microsoft has battled anti-trust charges in the US and Europe.

When I purchase my next PC I will be buying Windows 7 as well. It's included in the price and it's already installed. That is simplicity itself. The thing is, if it were to instead come with XP or Vista I would be equally happy. For Microsoft this is a problem that in the long run is certain to bite them.

Choosing the Right Price

Markets go up, and they go down. Or to be more precise, individual stocks, commodities, other financial instruments and collections thereof (indices, ETFs, mutual funds) go up and down. Rarely do prices sit at one level for any length of time, whether the duration is measured in minutes or years. This raises the all-important question when one is looking at a real-time quote: is this the right price? What we mean by this is, is there some rational, evidence-based justification for this price, or is the market simply wrong?

That's a great question, and probably the best possible question. Is there an answer? More importantly, if there is an answer, is it knowable? Having that knowledge is a near certain path to untold wealth; all you need to do is determine what the right price is and place your money where the price correction -- which you are sure must occur, sooner or later -- will yield profits. Of course it isn't that easy, and even the very best get into heated arguments over what is the right price.

Here we have Rogers and Roubini arguing, among other things, about whether the current price of oil is right or wrong? We have Rogers saying that the most recent dip in the price was the market getting the price wrong, therefore the 47% rise off the bottom is not only not unexpected, but may yet indicate that the market is still undervaluing the commodity. On the other side, Roubini says that since the economy is still in distress, the previous low price is closer to being right, therefore the recent 47% rise is unsustainable and we should expect a correction.

Who is right? Is the price of oil too high, too low, or just about right? I certainly don't claim to know. If you really care about the fundamental arguments about pricing, these sorts of discussions are very pertinent: you need to know which of these guys is right. Since (as is commonly understood) the market is a future discounting mechanism, the current price is an indication of the future returns of the current economic trends, typically about 6 months out. If you believe that, and since oil is in an uptrend, you must believe that the market is saying we are gradually pulling out of the recession. Of course if you think the economy really stinks, you should believe the market is being stupid, so you should go short on the commodity or the producers and you'll be that much richer in 2010.

If you ignore the fundamentals and only look at the chart for guidance -- this is called technical analysis -- it is enough to know that there is an uptrend. Yes, it has to end sooner or later, but what you should do is go long now, then cash out when the trend turns against you. You too, if you get it right, will be richer in several months.

The one nice thing I do like about technical analysis is that you don't need to know if the price is right. It's enough to know that other market participants believe that the price is too low -- which is what is driving buying and the trend to higher prices -- and go along for ride while that belief dominates. It is however crucial that, once taking this approach, you do not subsequently become a believer. When the market turns, sell. With that discipline you are most likely to profit, and you can do it without knowing whether the price is right or wrong. Leave that for the pundits.

H1N1 Scare, Politics and Vaccine Fears

The progression in the H1N1 pandemic story has fascinated me. We went from panic to complaisance, then back to a more earnest form of panic: huge line-ups to get the vaccine. Much to my amazement, through all of this our various governments, federal and provincial, have stuck to their guns and performed quite well. The Liberals' recently attempted to cast the federal government in a negative light in this matter -- presumably hoping to profit from some understandable frustrations in how the vaccination program is unfolding -- is merely one more failed attempt on their part to latch onto an issue, any issue, that will elevate their and their leader's public standing.

It seemed that while H1N1 was only killing the elderly and the sickly, public sentiment became little more than a collective shrug once the flu-season ended in the spring. In that light, and the typically moderate symptoms suffered by almost all that have been infected, the continuing pressure from the government on the pharmaceutical industry to prepare for a mass vaccination program had the appearance of gross incompetence, and needlessly expense. When the unfortunate deaths of otherwise healthy children occurred recently, the potential seriousness of the threat became very real for most of us.

H1N1 is not killing a disproportionately higher number of people than other strains of the virus, yet there is the danger that it could. Since it more aggressively attacks the respiratory system and is highly contagious, there is an opportunity for a deadly mutation to turn the pandemic into at least a minor catastrophe. Or, it might not.

Either way, the risk of taking the vaccine is lower than the risk of not taking it. Even if you do wish to take the risk with your own health, there is the matter of whether you want to risk the health of others with whom you come in contact if and when you do become infected (rough predictions say 25% to 35% of us will eventually get infected, though not all will get sick).

However, rather than repeat what is said better elsewhere, what I want to say is that the point about supposed vaccine risks is becoming moot. When children started dying, the public mood changed. Now the trend is pro-vaccination. It seems that while we had the luxury of time to sit back and pontificate without expertise, avoiding the vaccine was a valid form of personal expression. Now it isn't. H1N1 kills in modest numbers among the healthy and affluent, kills more among the poor and sick, and could mutate to kill indiscriminately. That knowledge may now be enough to quell the evidence-free tirades against vaccination. I hope this trend will seep into other conversations about the supposed risks of vaccinations for other diseases. It should.