Mike Masnick points to a story about the latest front in the federal government’s obsessive crusade against online gambling: advertising companies. Apparently, creating an ad for an offshore gambling web site could lead federal fraud and racketeering charges. Because they conspired “to develop a scheme to defraud gamblers in the United States by inviting, inducing and persuading them to place bets.” The ads apparently “falsely stated that internet gambling on sporting events and contests was ‘legal and licensed.'”
I think it’s a safe bet that the feds haven’t arrested any of the American gamblers who supposedly broke the law by using BetOnSports. And it’s an even safer bet that most of them feel don’t feel “defrauded” by the ads. Unfortunately, the use of fraud and racketeering charges to punish actions that aren’t otherwise illegal is a growing trend.
As Mike says, don’t the feds have better things to do with their time? I thought there was a war on terrorism going on–maybe these officials can help out with that.
On Monday I laid out the case for platform monopolies: that they provide firms with incentives to create new products by allowing them to recoup their fixed costs. Yesterday I had two posts arguing that closed platforms can harm consumers by preventing gains to interoperability.
The question is, Is a platform monopoly an effective way to promote the creation of new devices? And is this benefit sufficient to outweigh the opportunity costs of reduced interoperability?
In considering these questions, it’s vital to distinguish between creating a device and creating a platform. Obviously, we want to create incentives for firms to produce more and better devices. But we
don’t necessarily want firms to create new platforms. In fact, we only want firms to create new platforms to the extent necessary to enhance the functionality of new devices. If an existing platform will do the job as well, we should prefer the firm to use it, both because that saves the costs of developing the new platform, and because it permits gains to interoperability with compatible devices.
To illustrate this point, I want to offer a brief history of one of the world’s most successful platforms, the x86 computer chip architecture. I’ve discussed Intel’s x86 chip architecture (which powers almost all modern PCs) before as an example of beneficial reverse engineering. What I didn’t talk about explicitly was the role of network effects on the fortunes of the x86 architecture.
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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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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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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 n
2 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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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.
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.
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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Bill Herman has another long and thoughtful rejoinder to my critique of Herman’s original response to Felten’s paper, as well as the responses of Ed Felten and Brad Templeton. I’m honored to be lumped into the same category with those guys!
Herman does a thorough and fair-minded job of summarizing my concerns, so I don’t have a whole lot to add. As he says, I think the dangers of regulation outweigh the dangers of possible discrimination. He thinks the reverse. So let me just comment on the issue that I think is the crux of the matter:
If (a) telcos and cable cos are impossible to regulate, or (b) the FCC is fundamentally corrupt and/or incompetent, then we have bigger problems on our hands the net neutrality, and we certainly should not passively accept this state of affairs. But if this is the case, then there’s nothing we can do, but there’s nothing we can do to make it worse.
Oh, but we can make it worse. The important point is that right now, the FCC has absolutely no authority over the vast majority of the Internet. It has no authority over the backbone. It has no authority over the high-speed pipes that Google and Microsoft use to get on the Internet. It has no authority over high-speed dedicated lines used by medium-sized businesses. It has no authority over the WiFi connections in hotel rooms and coffee shops. Most importantly, if a serious competitor to the Bells and the cable companies come along, the FCC would have no authority over it.
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Every week, I look at a software patent that’s been in the news. You can see previous installments in the series here. This week I’m going to look at this patent, “System and method for protecting a computer and a network from hostile downloadables,” which I believe forms the basis for this lawsuit against Secure Computing.
In a nutshell, what Finjan patented was the digital equivalent of a bouncer. A bouncer stands at the entrance to a club, examines each prospective patron, checks his name and ID against a list of names (either the guest list of people to let in or a blacklist) and then admit the ones who meet the requirements. Replace “bouncer” with “server” and replace “patron” with “downloadable program,” and you’ve pretty much summed up Finjan’s patent. Finjan describes a system that allows a systems administrator to establish rules describing what kinds of executable programs are allowed on client computers, and Finjan’s software enforces the policy.
There’s literally nothing more to this patent. Don’t believe me? Take a look at the patent itself. Tell me the “Summary of the Invention” isn’t a jargon-laden description of what a bar bouncer does. Even by the low standards of your typical software patent, this is a bad patent.
The Technology Liberation Front is the tech policy blog dedicated to keeping politicians' hands off the 'net and everything else related to technology.