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Cord Blomquist

Why buy when you can regulate for free?

WARNING: The PFF Aspen Summitt served to both educate and inspire me, so expect a flurry of blog posts over the next few days.

While reviewing my notes during my 24 hour trek back to DC (most of which involved sitting in the Denver airport) I realized that Eric Schmidt said a lot of interesting things despite my intitial impression that his speech was rather devoid of content. Unfortunately for Dr. Schmidt, most of my conclusions are rather critical.

During the middle of his remarks, Schmidt pointed out that our web-powered world changes conventional thinking about business models and industry integration. In the past, Schmidt observed, vertical integration–buying up assets like, mines, railroads, and mills–cut costs by allowing one company to take a good from raw material to finished consumer good, without the transaction costs of swapping ownership throughout the process.


The wired world is different, he argued, because standards and interoperability make cross-company integration easier. That is to say that so long as we have standards and make things talk to each other, we can have several independent companies acting at all different steps in the process of delivering digital goods and services.

This is an interesting point, and one that I believe that hold some truth, but is this just a guise for a net neutrality argument? Non-neutral nets give network owners the chance to vertically integrate, tying application directly to network architecture features, for example. Is saying that this type of vertical integration is outmoded really true?

Open platforms are a good idea in most cases, but open business models that allow ISPs to experiment with integrated add-on services are also a fine idea. I’m also open to the idea of exclusivity arrangements that allow more revenue to be brought into the net company, allowing it to expand and grow faster. Schmidt might feel differently.

One thing is for certain, Schmidt and Google love horizontal integration, as is evidenced by their constantly expanding buffet of services. Google has purchased countless start-ups to further expand their offerings, as have MSN, Yahoo, and other online service firms. Should the logic of vertical integration be challenged at a time when horizontal integration is on a tear?

Vertical integration is costly and difficult to do well. Paying companies farther down stream is also costly. Regulation, however, is free, or at least the lobbying dollars are cheap compared to the discounts that can be forced from competitors. However, if Schmidt pushes for regulation of vertical integration he may be cheating himself out of future acquisition deals, no matter the direction.

August 24, 2007 | Comments |

  • Open platforms are a good idea in most cases, but open business models that allow ISPs to experiment with integrated add-on services are also a fine idea. I’m also open to the idea of exclusivity arrangements that allow more revenue to be brought into the net company, allowing it to expand and grow faster. Schmidt might feel differently.


    Cord, I think it's important to distinguish between vertically-integrated business models and proprietary architectures. Vertically-integrated business models obviously can work very well--look at Apple for a sterling example--but some of the best vertically-integrated companies nevertheless construct their products atop open standards. Here too, Apple is the poster child: the story of the last decade has been Apple's gradual abandonment of home-grown or niche standards and protocols in favor of industry-standard ones: Appletalk to USB, PowerPC to x86, Mac OS 9 to *BSD, Appletalk printing to CUPS, and I could go on.

    No one disputes that companies can create a lot of value for consumers by selling consumers an integrated widget that includes a lot of different components designed to work well together. The question is whether consumers benefit when a company designs the interfaces between those components using a proprietary standard when open alternatives are available. Generally speaking, I think the answer to that is "no."

    Now that isn't to say that proprietary interfaces can't be very lucrative for the company that creates them. And there may be cases where a company won't be able to turn a profit unless he's able to capture some of the rents that come with controlling a popular proprietary interface. Obviously, consumers don't benefit if a product never gets created at all, so I don't think the government should prohibit companies from creating proprietary interfaces.

    However, I think it's important to keep in mind that the primary reason proprietary architectures are profitable is that they allow companies to limit competition and charge consumers higher prices. Therefore, from the consumer's perspective, proprietary architectures will almost always be at best a necessary evil. They might benefit consumers indirectly by allowing companies to finance the development of products they wouldn't otherwise be able to finance, but the proprietary-ness in and of itself is almost never beneficial to the consumer.
  • Tim, what about the distinction between prohibiting companies from creating proprietary interfaces and choosing not to use the power of the state to enforce proprietary interfaces? Should tax dollars go toward enforcing the No Refilling Toner Cartridges Act, or the Only Get the Oil Changed at the Dealership Act?
  • Don, that's an excellent point. I think the state should be neutral on the subject of proprietary interfaces, neither prohibiting them or giving them the force of law.
  • Tim, as I have commented here before, there needs to be one exception: where government-owned technology and citizen-owned technology are on opposite sides of the interface (as in the case of "you must file legal documents in this format"). In that case, government decisions to adopt proprietary interfaces create an unaccountable mandate on the citizens.
  • Don, that's a great point and I completely agree that government should stick to widely used standars. What examples are there of governments adopting an obscure format? The FCC allows comment filing in Word, PDF, and, as I recall, a handful of other formats, which are pretty common. Do some localities require filings to be submitted in Lotus Wordpro or .XYW?
  • Don, I agree that citizens should never have to purchase a particular software product in order to interact with their government. On the other hand, I don't think it's inherently objectionable for a local government to standardize on a proprietary format for their internal reporting documents. Government employees aren't entitled to use the software of their choice on the job. Where it gets tricky is defining the line between "internal" and "external." For example, can local governments require government contractors to use a proprietary format for reports? On the one hand, a contractor is more like an employee than a taxpayer so we might define it as "internal." On the other hand, such a mandate amounts to an implicit, and hard-to-defend subsidy for the manufacturer of the software in question. If a large government body requires all of its contractors to standardize on Product X, the government is arguably putting its thumb on the scale in favor of that product.

    Also I just noticed that in my first comment I said "Appletalk to USB," when of course it was ADB to USB.
  • It's all about what we call "switch costs".

    For a long time the tech industry has tried to avoid compatibility in order to lock users into their technology. IBM did it (think both mainframe era and the IBM PC), Microsoft sure does it (monopolistic behavior), Cisco does it sometimes (EIGRP), the "last mile" service providers do it (try running your own cable line and it gets cost-prohibitive really quick). Sometimes, the technology is cheaper because of the tight vertical integration, other times it's more expensive because the vendor knows that you can't afford the switch costs.

    It also makes sense because as a vendor/contractor, you'll amortize the initial standup costs to average out over a period of time--say, a year. If your customers leave prior to that year, then you lose money on the whole deal.

    The only people who want compatibility are users who like low switch costs and vendors who sell infrastructure that has to plug into everything else. Yes, that's the majority of the populace.
  • Cord, the biggest lock-in risks so far seem to be "e-government" initiatives in Turkey and Chile. I don't understand them well enough yet, but watch the LinuxWorld.com site for more info. The easiest example to understand was the FCC ULS, which was MSIE-only for a while. I think they've fixed it by now. I also hear about Linux users having to boot a non-Linux OS to complete some paperwork required for getting some security clearance, but I don't have the details on that.

    Tim, what if the documents being created are subject to FOIA? It seems like almost any government document might in principle have to be shared with some citizen, and it's a limit on the government's accountability to put a EULA restriction on the citizen's ability to use the document.

  • Don, the government agency could convert the documents to PDFs before giving them to the FOIA requester, could it not?
  • Tim, if you're a CFO giving spreadsheets to the auditors appointed by the board, you could convert them to PDFs first, too. But the auditors wouldn't like that, and the board would make you turn over the documents in a useful form.
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