Lessons from Google

Google reported its numbers, and by any measure it had a stellar quarter.  Revenues were up 32% and they beat Street estimates across the board.  While the dark side of success will likely be greater anti-trust scrutiny for Google, it’s better than turning in bad numbers and seeing shares fall.  But for me, two non-financial factoids dominated the earnings call. One is that Google+ seems to be taking off, but the other is the Android sweep, and that’s the one I want to focus on.

First, Android is still going strong; last month it had 10% more device activations than the month before.  The Android store had over 6 billion downloads and there are over 400 devices licensed to run Android.  For those who, like me, remember the early PC-versus-Apple wars, the similarities seem obvious.  Apple even in those early days wanted complete ecosystem control, and IBM promoted an open platform.  The result is history; IBM PCs swept the market.  But Apple is still in the PC business, and IBM isn’t.  That raises what I think is the key question for Apple.  Is the best way to succeed in the long run to develop a new market, hunker down on a niche segment of it, and then milk that segment until another market comes along?  Or is it to develop a concept that sweeps the market, share in its success, and move on?

I think that everyone realizes by now, at least reluctantly and subliminally, that Apple is going to lose dominance in the tablet space and the smartphone space, and that Google will gain it.  Apple may be the BMW brand of both these device markets, but they’ll never lead them again.  But BMW makes some nice change, and that’s not necessarily a bad thing.  The badness might come in elsewhere though.

Ultimately, tablets and smartphones are our agents in the cyber-world.  What we do, what we get, what we want, where we are, and how we spend and even think are getting wrapped around the gadgets.  You win with those agents, and you win in that much larger behavioral space.  Apple “lost” the appliance race.  Did it also lose the agent race?  Maybe not.

Steve Jobs’ big mistake isn’t that he wants a closed ecosystem, but that he wants everything to be in that ecosystem.  Making it impossible for others to clone Macs became an obsession with Steve, and that meant surrendering the option to run Apple software on other systems.  What Apple needs to do to counter Android is to license iOS.  Or maybe…?

Maybe to establish the concept of the personal agent as residing in the network, the cloud.  “Hal” was disembodied, after all.  In modern terms, we don’t necessarily see a difference between a locally hosted intelligence and a local agent of a distributed intelligence.  The iCloud might become Apple’s Camel’s Nose under the Android tent.  Make it strong.  Make it accessible to every mobile device user.  Cut Android off from the larger, more enduring, food chain.  That’s Apple’s choice.  Accept another second-tier positioning, license iOS, or make iCloud the focus.  Think on it, Steve.



VMware Pricing and Cisco UCS

In yet another price change that angers customers, VMware announced a new pricing strategy for its vSphere 5 and the new pricing could create significant increases in license costs for some customers—as much as nearly 4x.  Our model suggests that the typical user will pay less than 20% more, but it’s pretty likely that the move is a response to a gradual saturation of the virtualization opportunity base.  Companies all over tech (and elsewhere, of course) are trying to earn more revenue and if you can’t grow your user base or add features, you have to increase pricing.

It’s hard to say whether the move will have a major impact on VMware’s market share.  Yes, companies could in theory adopt Microsoft’s or Citrix’s solutions, but they could have done that from the first and elected not to.  Will the price change be enough to change their minds?  If so, then why not adopt “free” virtualization from Microsoft or from an open-source provider?

I think it’s possible that VMware is looking ahead to a shift in virtualization growth—from success in the enterprise to success in the cloud.  Cloud adoption of virtualization is a service-industry application and VMware may be rightfully unwilling to subsidize someone else’s business model by sustaining a pricing policy that encourages an explosion in the number of virtual machines per host.  One could argue that enterprises who are most likely to be hit by the changes were ones doing relatively simplistic server consolidation to address an explosion in independent server deployment that should never have happened in the first place.

Cisco, at their Cisco Live event, announced some interesting enhancements to their UCS portfolio to address data center evolution and cloud computing.  While what they did in terms of capacity changes was again valuable in an evolutionary sense, their moves lacked the big strategic sweep that would have benefitted the company’s positioning.  There are two roles a company can play in the cloud; driver of the cloud or supplier to the cloud.  Cisco offered some credentials in the latter role, but it’s the former role that needs to be filled.  Remember, someone has to drive a strategic enterprise project.  Whoever does that will likely deploy all their own gear where they have it, and let the masses scramble for the scraps.  IBM, HP, and Microsoft are driving most of the cloud, and none of them are particularly friendly to Cisco’s interest.  Two have their own data center lines, in fact.

I think vendors are missing something important in the enterprise space, just as they are in the service provider space.  There was a time when network technology was almost a mandate; we knew we had insufficient connectivity to support optimum employee empowerment.  Today the low productivity apples have been picked, and companies need to understand the business value behind proposed tech changes.  Ten years ago, perhaps, the trade publications would have filled this need with long-ish insightful articles on adoption and benefits.  Today, all anyone wants to publish is a snappy title on a vapid article that elicits a click-through and generates ad revenue.  Nobody is offering the buyer the guidance they need, and so they move more slowly.



Netflix and the Health of OTT Video

Netflix may be showing us something about the streaming video market with its decision to raise the prices for “combination packages” of mail and streamed video services.  The new policy is to price the two independently rather than to discount the combination, a move that raises the monthly price by about 50% and impacts nearly 60% of Netflix customers.  It’s certainly a big step, so why take it?  Because you have to, for three reasons.

The big problem with OTT video is that it’s totally dependent on having access to the content, but that it’s not likely to now or ever create the revenue stream to generate all that content on its own.  It has to license material from others.  Because any base of video will eventually pall for users unless it’s continually refreshed with new material, that licensing process is ongoing.  Because old stuff is cheap to license and new stuff typically more expensive, the need to get more material pushes the OTT player to newer and more expensive material with each refresh, and thus raises its cost.

A second problem is that the people Netflix is licensing content from are the same people it’s competing against.  TV and movie companies want you to watch their material in the traditional way, not suck it over your broadband connection.  If broadband streaming is truly supplemental in terms of use, then it’s not a threat but rather a potential incremental revenue source (hence TV Everywhere).  If cord-cutting really does become an issue, then the first response of the content producers is to make up their losses in traditional channels by charging more for material.

The third issue is Netflix’s need for growth.  Netflix has followed the classic “all-you-can-eat” Internet pricing scheme, which means it can grow revenue only by adding subscribers or by raising prices.  Competition will make even sustaining their current base more difficult over time, and that leaves only the second option.

It’s also likely that Netflix will face higher costs beyond content licensing.  The greater competition will mean more spent on marketing.  Any growth in the number of videos streamed per user will drive up its server or caching costs, and network operators are increasingly demanding some settlement for the traffic Netflix is generating.  This means that the company’s financial performance would tend to sink over time unless revenue growth was even higher, problematic for all of the reasons cited.

It’s not unlikely that Hulu’s founders are interested in selling in part because the streaming business model is problematic even if you have some of your own content to contribute.  The reason is that unless each content owner involved in Hulu charges a fair market rate for its stuff, it’s undermining its own revenue stream and hurting its own shareholders.  There can be no free ride for online video.  Which, of course, means it can’t be free.  Which, of course, means that the notion that the Internet is going to be our free pass to everything we want in the future is nonsense.  Which means we need to figure out how to make money for everyone in the food chain before we upset the whole market dynamic.

Three Steps to Rational Neutrality…and Cisco Woes

The EU is a focus of a lot of things these days, and we can now add net neutrality to the list.  The EC hearings on the issue, launched late in June, produced the predictable results—people are alarmed at the risk of loss of innovation and privacy and competitiveness, but they have no practical contributions to make.  What’s now happening is that a group of EU operators and equipment vendors are preparing their own report in response to the EU activity.  This report will conclude that the interests of the public and the aggressive 100 Mbps broadband goals set by the EC, would best be met if the operators had the latitude to explore different business models to the best-efforts peering-agreement model of the Internet today.

I have to tell you that the issue of business model is to the Internet what entitlement reform is to budget processes.  Yes, there is no question that the current peering model which doesn’t provide for settlement among ISPs or between ISPs and content sources is flawed.  In fact, it’s probably broken.  The challenge is that we’ve created a whole industry based on the broken model, and unraveling that model without scarring the players involved may not be as easy as just saying “Now’s the time”.  My view is that we need to transition to a new business model in stages.

  • Stage number one is to allow the operators to create premium services and sell them to either consumers or content providers, with the proviso that these services not degrade best-efforts Internet.  These services should include not only enhanced handling but also higher-layer services.
  • Stage number two is to establish settlement among ISPs for all such premium handling as a mandatory element in any peering agreement, but again as an independent element to best-efforts Internet.
  • Stage three is to extend settlement agreements to include best-efforts traffic, starting with situations where that traffic is delivered through premium subscription services and moving to more general applications.

If we don’t offer network operators choices to help them recover the cost of enhanced Internet usage and performance, we won’t have either.  That will not only destabilize the operators, it will hurt the network equipment space rather badly.

Cisco, premier provider of network equipment, is the subject of escalating rumors about job cuts, the latest being that the total could run to ten thousand jobs.  What seems to be happening is that Cisco is considering a range of options, some of which include the sale of or spin-off of some of its businesses, notably the Scientific Atlanta property.  The most radical cuts would seem to come from exercising one of these choices.  However, it does seem likely that the company will actually cut over 4 thousand jobs.

There is no company in the industry that embodies what I believe to be the “intransigence of incumbency” than Cisco.  Networking has undergone revolutionary changes, changes that Cisco products helped to bring about.  Despite this, Cisco has gone forward with a marketing, strategic, and product approach that has presumed the most simplistic of all possible futures—the one that’s nothing more than a bigger form of the present.  With arguably the best intellectual property portfolio in the industry, the stuff that carriers would kill to be able to deploy effectively, Cisco has failed to show those very carriers what effective deployment would involve.  “Buy a router today because traffic demands are growing exponentially!” says the sales guy.  Hey, I’m tired of hearing about exponential growth, and so are the buyers.  Traffic doesn’t mandate investment, return on investment does.


Video-Chat Wars

As some things change, others stay the same.  That’s about how I see things fresh from two weeks in Brazil, a place on which I’ll also comment here.  We’re seeing changes in the networking business space as Google vies anew with Facebook and Twitter, and yet the moves raise the same issues we’ve faced all along.  In the economic world, it almost seems like Groundhog Day.

Google+ is definitely a revolution, a step toward social networking as many believe it should have been all along.  Because it avoids most of the privacy problems that seem inherent to Facebook’s simple model of “friends”, it could potentially be used more effectively without putting its members at risk.  Because it’s built around communication, it would establish Google not only as a social network leader but also as a player in the web-based communications space that will eventually displace the old PSTN we’ve come to know.  And behind it all looms the old Google/Microsoft face-off, this time regarding the Microsoft acquisition of Skype.

Make no mistake, Google wanted to counter the Skype deal probably as much or more as it wanted to be a social networking player.  Skype, in Microsoft’s hands, could become a powerful force to integrate Microsoft cloud software into people’s lives.  Skype could also be the foundation for social communities, of course, and having Microsoft in a position to exploit Skype at its leisure wouldn’t serve Google’s interests.

The fact that Facebook went running to Skype for a deal is interesting too.  They can’t now expect to buy the company after all, and they’ve admitted that they have either never thought of the communication-based social network (unlikely) or that they can’t toss money and time at creating one to counter Google’s move.  Facebook’s weakness, as I’ve pointed out, is its off-market trading and correspondingly high valuation.  They can’t afford to keep going to the well for more capital and they can’t be perceived as losing ground—though they are.

All of this comes at a time when the Street is newly aware of the eroding credibility of carrier capital budget planning.  To quote Credit Suisse, “We expect the ongoing disconnect between revenue growth and bandwidth economics to drive an ongoing shift in carrier capex to specific projects focused on revenue generation or cost savings”.  Network spending focused on cost is an open invitation to Huawei, and spending on revenue generation is clearly not going to focus on creating more of the low-value bits that have put carriers in the disconnect to begin with.  This is the issue that raised our concerns about Alcatel-Lucent’s FP3 chip announcement.  The world doesn’t need a way to push more bits until we can figure out how to make bits pay, and right now everything happening in the industry is disintermediating the operator more.  Alcatel-Lucent, we’d note, continues to champion IMS as the basis for mobile broadband “services” when the Google/Facebook brouhaha makes it clear that it’s going to be tough to make even IMS voice work effectively against OTT P2P competition.

With bit-pushing going out of fashion, Cisco seems unable to break out of the bit-and-box marketing mold and is instead looking to cut costs by cutting headcount.  The company’s reported early-out package expired in late June and there’s no official word of how many people took advantage of it, but we did hear that there were still as many as three thousand more jobs on review for elimination.  That could push the total cuts above the 4,000 that were rumored.  Cisco’s intransigence with respect to the service layer is creating an opportunity for its competitors, who could not only gain market share on Cisco’s fall from grace but also gain an early lead in the service layer.  So far, though, nobody is stepping up with a good story, and we’d not be surprised to see any improved positioning saved for early September, timed to the carrier strategic technology planning cycle that will end around November first.

On the economic front, the question of whether Greece can avoid a technical default seems almost answered in the negative, but at the same time eclipsed by what Italian sources say is a speculator-driven attack on Italy’s debt.  This is the issue that the EU needed to avoid; the house-of-cards attack on weaker countries generated because speculators believe that the strong (notably Germany) won’t accept a rescue package that keeps players out of default.  A default would trigger credit-default-swap payments, and CDSs are the instruments of speculators.