Power Grid Neutrality

by on July 19, 2006

I just got a copy of my friend Tim Carney’s The Big Ripoff: How Big Business and Big Government Steal Your Money I’ve only had time to thumb through it so far, but I thought I’d mention a fascinating chapter on the Enron debacle.

Tim explains how the California power crisis was largely due to the “deregulation” of electricity that Enron lobbied for. I put deregulation in scare quotes because although the regulatory changes introduced in 1998 did increase competition in some aspects of the electricity market, this was far from a free market. Indeed, as Carney documents, Enron lobbied for rules that would rig the market in its favor: the price of power it sold into the California market was unregulated, but the transmission networks which carried that power had an “open access” regime in which prices for the use of the power grid were set by the government. California also prohibited the utilities from generating electricity themselves, forcing the utility companies to buy their power from middlemen like Enron.

Of course, we know the rest of the story: with retail prices tightly controlled and wholesale prices unregulated, wholesale prices spiked and utilities began bleeding red ink. Enron made a bundle, and California got rolling blackouts.

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Against Platform Monopolies: Platform Protectionism

by on July 18, 2006

Earlier today I described the concept of network effects and analogized it to gains from trade. I suggested that public policy should encourage open systems in order to maximize the gains to interoperability.

But there’s an obvious objection to this line of argument, which is hinted at in the IEEE article I referenced yesterday:

Surely it would require a singularly obtuse management, to say nothing of stunningly inefficient financial markets, to fail to seize this obvious opportunity to double total network value by simply combining the two.

In other words, if there are gains to interoperability, it’s in the interests of the firms themselves to make their platforms interoperable in order to increase their value. Firms, therefore, have the necessary incentive to maximize the value of their platforms with or without a platform monopoly.

The problem with this response is that it ignores the question of who captures the gains to interoperability. In a closed platform controlled by a single firm, most of the surplus flows to the platform owner, who is able to raise prices to capture the increased value. Apple is currently reaping the financial rewards from sitting atop a closed platform as it grows to dominate its market. On the other hand, in an open platform, competition pushes down prices. As a result, most of the surplus flows to the consumer. Given that price-fixing agreements are difficult to enforce (not to mention illegal), companies may rationally opt to keep their platforms separate.

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Microsoft XBOX Live & Net Neutrality

by on July 18, 2006 · 6 comments

I’m consistently amazed with Microsoft’s XBOX 360 and XBOX Live Network, and not just because of the games I can play on it but because of everything else I can do.

I was reminded of that tonight when I got on the XBOX Live Marketplace to look for a new “NCAA Football 2007” game demo from EA Sports that I wanted to download and check out before buying the game. When I got to XBOX Live, however, the first thing I was greeted by was a notice about the latest “Artist of the Month.” So, I gave that a listen.

Then, my wife came into the room and said something about getting a babysitter sometime soon so we could go see a new movie. But she wasn’t sure what she wanted to see, so I pulled up the movie and TV previews page on XBOX Live and downloaded clips from “Superman Returns,” XMEN 3,” “A Scanner Darkly,” and several other movie clips… all in glorious 720p high-def with stunning digital surround sound. (Indeed, downloading all these high-def clips via XBOX encourages me to just wait for home release of the flix because they look much better on my home projector than they do at the theater!)

A short while after that, my kids came into the room so I decided to pull up something for them. I downloaded some clips from Pixar’s new movie “Cars” and then also downloaded a free version of the arcade classic “Frogger” for my daughter to try out. Here was a game that I pumped countless quarters into as a kid back in 1981, and now my daughter was sitting with me playing it for free 25 years later. On the sofa in our basement. With a wireless controller. On an 8-foot wide projection screen. My how times change!

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Against Platform Monopolies: Network Effects

by on July 18, 2006

Yesterday I presented an argument that’s sometimes heard for granting companies that create technological platforms monopoly rights in those platforms. Today I’m going to start to explore what’s wrong with that argument. Today, I’ll discuss network effects, the idea that as new users are added to a network, its value grows faster than the number of users.

My claim is that the more people who use a technological platform, the more valuable that platform will be per user. One classic statement of this idea is Metcalfe’s law, which is summarized well in this article:

Metcalfe was ideally situated to watch and analyze the growth of networks and their profitability. In the 1970s, first in his Harvard Ph.D. thesis and then at the legendary Xerox Palo Alto Research Center, Metcalfe developed the Ethernet protocol, which has come to dominate telecommunications networks. In the 1980s, he went on to found the highly successful networking company 3Com Corp., in Marlborough, Mass. In 1990 he became the publisher of the trade periodical InfoWorld and an influential high-tech columnist. More recently, he has been a venture capitalist.

The foundation of his eponymous law is the observation that in a communications network with n members, each can make (n–1) connections with other participants. If all those connections are equally valuable–and this is the big “if” as far as we are concerned–the total value of the network is proportional to n(n–1), that is, roughly, n 2. So if, for example, a network has 10 members, there are 90 different possible connections that one member can make to another. If the network doubles in size, to 20, the number of connections doesn’t merely double, to 180, it grows to 380–it roughly quadruples, in other words.

The article argues that n2 is probably too high, which I think is probably true. But what nobody disputes is that network effects exist: that a network or platform with 2 million users is going to be more than twice as valuable as an Internet with a million. Or to put it another way, two networks with a million users each will be worth less than a single network with 2 million users. This has the obvious implication that, all else being equal, public policy should encourage the creation of a small number of comprehensive networks as opposed to many small, fragmented networks.

Of course, all else isn’t necessarily equal, and I’ll deal with some of the complications in future posts. But for now I want to offer an analogy that I think helps to flesh out why network effects exist and how they work. I alluded to it a couple of weeks ago: there are close parallels between the argument for interoperability between networks and the classical case for free trade between nations. Just as there are gains to trade when people from different countries can exchange goods and services, so are there gains to interoperability when the users of different networks are able to freely exchange information.

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MovieLink Baby Steps

by on July 17, 2006 · 2 comments

Ars is reporting that Movielink has inked a deal with Sonic Solutions (makers of the Roxio burning software) to allow its users to burn downloaded movies to DVD.

Supposedly, the burning will be scrambled with DRM, but I haven’t been able to find technical details on how that’s supposed to work. My understanding is that the reason commercial DVDs can’t be duplicated is that the encryption keys are normally stored on a part of the disk that ordinary consumer burners can’t write. It’s not clear to me how you make a burned disk that can’t be duplicated.

In any event, I think Ars’s take on the subject is spot on:

The focus on DRM is starting to look downright silly. The Wall Street Journal reports that “many studios worry consumers will find new ways to pirate their products with downloadable DVDs, even though Sonic says the discs will be secure.” But it’s not as if normal DVDs are unrippable, and there’s no shortage of other illegal ways to gain access to the latest and greatest from Hollywood, if your dedication to Jolly Roger is strong enough…

You’d think that the movie industry would take a cue from its musical cousin, where anybody can rip MP3s from most any CD in her collection, and people still buy songs through iTMS and its brethren. Not to mention the relatively easy access to illegal downloads. WSJ says that “getting the movies onto DVDs would help boost the online movie-sales business, which, despite years of effort, hasn’t taken off.” Make that “despite years of half-hearted and self-defeating effort,” and we’re good on that.

Memo to Hollywood: The people who are plunking down their hard-earned money for your products are not your enemy. You should be focusing on making your products more convenient for your paying customers, not worrying about whether you’ve thrown up enough roadblocks to their enjoying the product they’ve purchased.

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Kangaroo Court in Brussels

by on July 17, 2006 · 8 comments

Last week, European Commission (EC) regulators fined Microsoft 280.5 million euros (US$356 million), adding to the 497 million euros ($630.7 million) the company has already been forced to pay.

Noncompliance with a mandate to disclose technology documents is the official reason for the fine, yet the deadline for such compliance has not yet passed. This bizarre situation should serve as a warning to anyone thinking of doing business in Europe, and it should make the Europeans seriously question the legitimacy of their so-called “competition” policy.

In March 2004, the EC ruled that in addition to paying the record 497 million euro fine, Microsoft had to sell a copy of Windows without Media Player software and hand over the specifics of its Windows server technology to rivals. Both these mandates were meant to correct Microsoft’s supposedly harmful market power.

Of course, that supposition is highly suspicious, and the directives are currently under appeal at the European Court of First Instance. Take, for example, the idea of offering consumers a product with less functionality.

Read more here.

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EFF Blasts NSA Spying “Compromise”

by on July 17, 2006 · 2 comments

The Electronic Frontier Foundation is blasting Sen Specter’s “compromise” legislation on the Bush administration’s NSA spying program:

While the final bill is not public, a draft of the bill obtained by the Electronic Frontier Foundation (EFF) is a sham compromise that would cut off meaningful legal review–sweeping current legal challenges out of the traditional court system and failing to require court review or congressional oversight of any future surveillance programs.

“This so-called compromise bill is not a concession from the White House–it’s a rubber stamp for any future spying program dreamed up by the executive,” said EFF Staff Attorney Kevin Bankston. “In essence, this bill threatens to make court oversight of electronic surveillance voluntary rather than mandatory.”

Although the bill creates a process for the executive branch to seek court review of its secret surveillance programs, it doesn’t actually require the government to do so. The bill would, however, require that any lawsuit challenging the legality of any classified surveillance program–including EFF’s class-action suit against AT&T–be transferred, at the government’s request, to the FISA Court of Review, a secret court with no procedures for hearing argument from anyone but the government.

This is one of those times I wish at least one house of Congress were in Democratic hands. These issues need some actual public debate, not a closed-door compromise followed by Congressional white-washing. I bet Sen. Leahy wouldn’t be treating the White House with kid gloves.

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Against Platform Monopolies: Introduction

by on July 16, 2006 · 14 comments

Lately, there’s been quite a bit of discussion on TLF and elsewhere about the merits of giving companies legal rights to control access to the technological devices they control. The central thesis of my DMCA paper was that the DMCA was an ineffective piracy deterrent, but that it did create unnecessary platform monopolies. I wrote that paper assuming that it would be obvious that platform monopolies are a bad thing.

That assumption proved false. A number of smart people have since made the argument that this feature of the DMCA isn’t so much a bug as a feature–that it’s a good thing to give Apple control over the iPod-iTunes platform, to give Microsoft control over the XBox platform, etc. One of the smartest of my former colleagues at Cato made such an argument to me when I was in DC, and in recent months Randy Picker has had a series of posts laying out the case for such platform monopolies (or platform property rights, depending on your perspective).

Back in October, Picker made the analogy between the iPod/iTunes synergy and the classic “razors and blades” marketing strategy where Gillette underprices its razors and makes the money up by charging premium prices for razor blades. A few weeks ago, Picker expanded on that argument in a response to Ed Felten’s post on the effort to install unauthorized third-party hardware on the XBox. I also weighed in on that discussion.

I think this is the most intellectually serious defense of the DMCA I’ve seen. If giving companies exclusive rights to the platforms they create is good economics, then the fact that the DMCA creates such platform monopolies ought not to concern us. I’ve been meaning for some time to write an article or paper analyzing this argument in detail, but it’s becoming clear to me that I’m not going to have time to do so in the near future. So instead, I’m going to take a page out of Ed Felten’s playbook and offer my (possibly disjointed) thoughts on the subject in a series of blog posts, which I may or may not turn into something more formal in the future.

I should warn you at the outset that this discussion is likely to be a bit fragmentary and meandering, as I’m still working out some of the details of my argument. I’m going to spend a couple of posts laying some conceptual and historical groundwork–discussing the important concept of network effects and describing some of the history of innovation and platform creation in the computer industry. With those preliminaries out of the way, I’ll hopefully get to the meat of the argument later this week or early next week.

Below the fold, I kick things off by summarizing the argument for platform property rights and dispensing with an oft-heard but faulty argument against them.

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Broadband Bad News is Good News . . . but it’s Bad News

by on July 16, 2006

Headlines are meant to draw readers in, and this one did me: Broadband’s Double-Digit Growth Coming to an End.

Something’s gone wrong with broadband! Quick! To the BroadbandMobile!

In the next instant, I realized that something had actually gone right. You see, double-digit change in percentage-based figures can’t keep going forever. In fact, it can’t last more than about ten time-periods. (Because then you’d have 110% of something, which only makes sense in rock ‘n’ roll, where the loudest speakers go to 11.)

Adoption of broadband is slowing as people who want it have already got it and people who don’t want it persist in not having it. (Bizarrely to people who live every minute of every day online, some people live no minute of every day online – ever. That is perfectly acceptable.)

There is undoubtedly a tiny margin of poor people who can’t afford broadband. But “can’t afford” is subjective. Many prioritize things other than broadband to buy with their limited resources (which is fine – remember, sans broadband is an acceptable way to live).

But the news report says this is all bad news:

One of the goals of US public policy when it comes to broadband is to ensure all US residents have access to broadband. President Bush said in 2004 that he wanted universal access to broadband in 2007, an achievement that appears unlikely at this point.

But, but . . . if people who want it are getting it, and people who don’t are not, isn’t that universal access to broadband? Apparently not. Affordability has been added to the metric, moving the goal posts so that federal subsidies for telecommunications seem important once again. Our news report continues:

The Democrats think it’s a great idea too–one plank in their platform for the 2006 mid-term elections is universal access. The telecom law rewrite which may or may not emerge from Congress this year intends to further that goal by funding broadband in areas currently unserved via the Universal Service Fund.

That’s the Universal Service Fund about which Daniel Berninger asks: What have we gotten for our $50 billion dollars?

In the end, this report amounts to an argument that satiation is a basis for subsidy. Huh.

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Authorization = Identification or Alternatives + Authentication

by on July 14, 2006

As promised in his welcome write-up of my book, Tim Lee has also picked a nit with it. Unsurprisingly, he homed in on an issue that others are likely to find difficult: terminology.

In researching the book, I found no end to the variety of uses given to words like “identification,” “authorization,” and especially “authentication.” I generally avoided the latter because it is so confusing.

So why don’t I review, and perhaps improve on, my treatment of terms in the book. I think Tim has gotten some of his thinking wrong in his comment. Because he does so after reading my book, the error is mine. I did not convey my thinking well enough to fully explain or persuade on the first shot.

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