Nick Dynice

This post is my submission to the TechDirt Insight Community. It was one of the top three winning submissions for this challenge case.

The challenge:
The Digital Entertainment industry can be characterized by the creation, distribution and monetization of digital content and devices intended to entertain end users through media consumption. Examples of players in the industry are device manufacturers (Apple, Nokia), distribution networks (CBS, XM Satellite), network access providers (Comcast, AT&T), content producers (Electronic Arts, NBC Universal), web based content aggregators (Yahoo, Google, MySpace) & multi-business tech/media conglomerates (Sony, Microsoft).

Given the rapid pace of innovation and shifting power dynamics to date, what are the major trends that will shape the industry over the next 3-7 years? How would you respond to these trends if you were the CEO of any of the above firms? Specifically discuss the economic impact of each trend and show how it would affect the market valuations of the relevant companies.

My insight:

Introduction
In this insight, entertainment will be referred to as media, since they are closely related. Due to the vasts amounts of media available, information consumption has become a form of entertainment. Each player in the media world is dealing with these five points, and the future requires that they carefully consider each of these points when developing strategies in their respective areas.

1. Declining Attention Share of Each Legacy Content Mediums
2. Legal Landgrabs
3. Bundling/We Can Do it Better/Not Invented Here Mentality
4. Free and Open Platforms
5. Edge Monetization

Declining Attention Share of Each Legacy Content Mediums
The new digital landscape offers ever increasing options for consumers attention. This means that consumers will spend less time consuming traditional mediums, and this could result in declining market/attention share in these mediums [1]. Companies should be both careful not to fault them, complain about them, and then do nothing innovative in response to these externalities. They should prepare to innovate and grow offerings in new areas or accept a downsizing of their market share. Here to compete with television, radio, CDs, movies, books, newspapers, the phone, outdoor activities [2], and socializing in person are:

* Internet community interaction
* Online learning and research
* Internet TV and video sharing sites
* VOIP
* mobile phone applications and games
* social networking web apps
* creating peer content (user generated content)
* video games
* online news consumption and interaction
* satellite radio, Internet radio, and podcasts

Almost all of the old pastimes have a staring point and and ending point, but almost all of the new pastimes can go on infinitely. This is partly because they have deeper engagement built-in. The smart CEO will recognize this shift and learn to adapt to it and go to where the consumer attention goes. For content that does have an ending, users will want to make recommendations to friends when the experience is a good one. Rights-holders, distribution networks, and the content producers, and device manufactures should allow this to become second nature to these users.

Caveat
The Long Tail [3] of with the help of the Internet allows more users to find content that is increasingly relevant to themselves. While a traditional content medium such as a book might be competing with video games, the long tail of content allows users to find books that are worth more attention than new mediums such as video games.

Legal Landgrabs
The shifting digital landscape has allowed for new interpretations of existing law. There are also a lot of sue-happy incumbent market leaders. Given these two factors, unless there are some major reforms in patent, copyright, and trademark litigation, some CEOs are going to let (or maybe be forced to by uniformed shareholder) their lawyers litigate whenever the law allows. Lawyers are not marketing strategists. Since legal strong-arming is perceived as being more important than any strategic marketing values (such as the legal case to protect trademarks), many incumbents will continue to shoot themselves in the foot by suing customers and sending cease-and-desists letters to innovators. The spirit of protecting intellectual property has been hijacked and is being used to protect obsolete business models and any vague threat of IP infringement (in some cases, one is used to protect the other). Many content publishers are ignoring fair use, going after consumers, and causing ill will in the marketplace. The smart CEO will recognize the difference between fair use and the attempt of a third party to resell or profit outright from content. Legal departments should learn to ignore what I will call incidental monetization. This is when a third party happens to make money from a content provider while still allowing the content provider to keep their own business model intact, while also not being in the same core business as the third party. An example of this is Google AdSense. Ads might show up next to a high ranking search result, but the business model of the company that occupies the top search result is not fundamentally affected by the ad’s placement. Another example is the use of copy written music in a consumer’s YouTube video. In these situations there is no licensing deal for the consumer to enter into in the first place, and the video will not serve as a substitute for purchasing music (some will even argue that it is free promotion for the music [4]). The video is not purporting to be posted by the artists or label, so the rights holders fundamental business model is not jeopardized by the consumers use of the music. A great practitioner of this is George Lucas. Lucas allows Star Wars fan sites and even remixing of his content [5] to exists since they do not fundamentally interfere with his licensing of the Star Wars franchise to commercial licensees. The fan site’s authors are usually not trying to sell fake Star Wars merchandise or pirate Star Wars movies (both of which would interfere with Lucas’s two core business), just wanting to celebrate the Star Wars culture.

Bundling/We Can Do it Better/Not Invented Here Mentality
Companies may or may not be experts in value added service, or they may have an understanding of where they need to be looking in the coming year, however, in the face of these massive changes, it comes down to a company really knowing what business it is in. It also needs to keep a laser-like focus in being as good as it can in its respective area. This will mean forgoing opportunities to have a value added component that is not in its corporate DNA. One example is telecommunication companies (network access providers) who also attempt to become content originators or license deals with preferred content originators. They attempt to bundle services via these licensing deals with a third party not because of meritocracy and quality, but because of politics or financial incentives. This is part of the Net Neutrality debate. Companies that focus on nothing but great content will do a much better job at delivering value to the consumer, whereas, network providers that guarantee Network Neutrality will make customers feel better about their service provider. It will be hard for network access providers to ignore such perceived opportunities in their attempt to create more short term value for shareholders. If they will consider increasing value over a 10 year plan instead of a 6 to 12 month plan, they will see that giving consumers the highest speed access to the most destinations on the web will be profitable in the long term. What it comes down to is the desire for inventors to reap rewards in the short term, the instant gratification mentality. This is perhaps another argument for tighter regulation or privatization of these networks.

In Google’s recent bid for the 700MHz spectrum, they asked the FCC to make it possible to dynamically allocate the spectrum. It is apparent that they have learned that openness and creating the ability to place a real-time market value on commodities is the key to profitability, efficiency value and consumer value. Companies that have not learned this first hand are probably too lazy to innovate due to their position as part of an oligopoly. They are opposed to such changes. Companies like these deserve to be routed out of the market. The smart CEO will lean from Google’s success in creating a real-time marketplace for keywords (Google AdSense/AdWords) and adopt similar strategies and guiding principles. If this is allowed to happen, a thousand innovative mobile service providers can bloom, just as they did in the web 2.0 application space. It is not as if incumbents have lost value or market share. They have actually gained value by acquiring start-ups. This is the same lesson the motion picture industry learned after they finally stopped fighting the VHS format and used it to gain even more business and create value to consumers by selling movies on tape. Incumbents are risk averse, and start-ups take risks as a key strategy. Or as they say, when you’re young, you innovate, when you are old you litigate. And, as they also say, history repeats itself. No one said that being the smart CEO will not be painful in the short term, but long-term benefits are at the end of the dark tunnel.

Free and Open Platforms
The end of business development deals [6], exclusive licensing deals, and service level contracts in the digital content and entertainment space should be very near. The web platform has demonstrated that openness allows more rapid innovation, which allows for experimentation and sifts out marketplace winners.

Platforms do have a caveat. This happens when a company’s strategy is in either the platform or in the content for the platform and the company provides both and one is a loss leader. Of course, the problems can ensue when the market ends up favoring the loss leader. If it appears that one is either being given away for free or is able to be replicated for very little cost, the strategy is in trouble. Oftentimes, this results in legal strong-arming which always hurts consumer value and spills over into hurting market valuation. This can be seen digitally managing printer ink cartridge providers so that only the printer manufacturer’s ink can be used, selling them at a profit and the printer at a loss, only to later have a third party come in and reverse engineer the ink cartridges. This can be seen in locking customers into mobile phone plans when the phone is given away for free, and then creating ill will when the customer wants to terminate early or cannot switch to a different phone not supported by that carrier the customer is in a contract with. Perhaps the most famous instance of this can be see in Apple’s iTunes Music Store selling DRMed AAC music files that can only be played on Apple’s iPod, only to have the DRM removed by software such as jHymn [hymn-project.org]. (While writing this, Apple began offering DRM-free music purchases at $0.99 per track). This clearly illustrates what an RIAA member’s head of litigation has recently admitted in Capitol v. Thomas [7], when using the law to protect a business strategy in the face of open platforms, litigation is a bad financial investment.

The smart CEO will monetize on the platform or the content that is free for any qualified new entrant to experiment in, and will not be too heavily involved in both the platform and the media. They will only try to monetize with either one or the other. They should also try to diversify their offerings in either the platforms or the content. An example is in open web standards and open source software. They are free to use and free of licensing agreements. Since no one owns them, no one business is at risk if they are suddenly abandoned. The organizations that use them can change when necessary. Organizations can monetize by adding value to the platform or content that was not already available to the consumer. For example, RockYou.com’s MySpace widget strategy was costing them a lot of money with no return. It was not until they were able to diversify with Facebook’s free and open F8 platform that they were able to make revue by charging advertising clients and delivering ads.

Edge Monetization
Again, this means figuring out what business a company is really in, surveying the new landscape, and figuring out where they fit best. This shift could be from 1)selling to consumers to 2)selling to businesses, or vice versa. It might be a shift from selling your core product to giving it away and monetizing at the edge. An example of this strategy is a move from selling digital media to selling experiences or packaged goods, or vice versa. This could be a shift from total control of your brand to totally letting go of control of your brand. A good exercise in this is the flip test. If you sell one type of item and give away another, what would your company need to do to survive if you had to flip your strategy around? The smart CEO will force its executives into this exercise, and then surprise them by implementing the strategy as a way to keep the company nimble. This should not always be done in a defensive manner, but in a cooperative fashion. Again, this may put the lawyers on alert, but the smart CEO must know when to keep the lawyers on a leash.

Edge monetization can also be done by giving away something that the company traditionally charged for, and putting advertising in it (which, for better or for worse, is a staple of the web 2.0 strategy). Advertising is becoming an attention war with customers, and it is the war mentality that is the mistake. Marketing is evolving in a way that is more relevant and contextual for your consumers. As Seth Godin points out in his book Permission Marketing, if you can ask for permission to market to your prospective customers, you create relevance and eliminate annoyance. I give Google permission to show me ads in the sidebar (and they are contextual) and in exchange I get to browse and go to the most relevant search results.

Conclusion
Since devices will always have a production cost to them because they are a hard good, there will usually not be too much innovation in how they are monetized unless they are loss leaders. These devices should be free of lock-in by content providers, service providers, and accessory providers (unless there are real quality control issues, not fake ones to support dead business models and lazy oligopolies). Content producers and distribution networks should not be concerned with control of their content since the smart ones will have an edge strategy, and it will not matter how many places or devices their content ends up along the incidental monetization chain. They will also need to keep in mind that consumers have a wide variety of choices when it comes to media consumption, and they should be happy about the attention they do get, no matter how they get it. Network providers need not be concerned with the content they carry as long as they are laser-focused on delivering consumer value, sometimes forgoing short term financial incentives via bundling. Web based content aggregators, especially those that have succeeded in the web 2.0 space, have these lessons built into their strategy so they usually do not go astray (with the exception of “also-rans” such as Microsoft). Multi-business tech/media conglomerates usually have so many conflicting constitutes to please that they are better off breaking their companies up into independent subsidiaries with dedicated resources. They will have a hard time existing in the new digital landscape unless they put a lot of effort into following the strategies of the smart CEO listed above.

I am not going to try to predict what might happen in the next 3 to 7 years in this space. It seems futile since there are too many variables. What is clear is that the successful strategies used by remarkable companies today are from lessons learned as recently as twenty years ago and as early as the beginning of written communication. The most nibble survive. Openness allows for more rapid innovation. Long term strategies beat short term strategies. And the market has rewards for those who have these qualities.

All of this comes down to these two points. First, the smart CEO creates value for the customer at almost every step, but also grows shareholder value over a longer period of time. And second, in Clayton Christensen’s series of books, The Innovators Dilemma, The Innovators Solution, and Seeing What’s Next [8], Christensen argues that it is hard for incumbents to change direction and see new opportunities when they place too much trust in the tactics and strategies that made them successful in the past. Fresh, outside perspectives are necessary, so it is a good thing that you have tapped the Techdirt Insight Community.

References
[1] The Media Possibilities Are Infinite, But People’s Time Isn’t
[2] Pets Just Can’t Compete With Video Games When It Comes To Kids’ Attention
[3] The Long Tail
[4] EFF Sues Universal Music For Getting Home Video Of Kid Dancing Pulled From
[5] People Will Create Stuff For Free? Impossible!
[6] Business Development 2.0
[7] RIAA anti-P2P campaign a real money pit, according to testimony
[8] The Innovator’s Battle Plan