How to Shape the Mobile Data Market

(Part 3 of "Who Will Pay for Mobile Data?")

There's a big nasty dilemma hidden at the heart of mobile computing:  No one knows how we'll pay for all that mobile data we're supposed to use in the next few years.  The question doesn't get much publicity, but it drives some of the most intense debates in mobile, including net neutrality and the wireless bandwidth "crisis."

This is the conclusion of a three-part series on the issue. In Part 1 (link), I talked about the tech industry's unlimited vision for the growth of mobile data, and why I think it won't come true because we'll run out of people willing to pay for data service

In Part 2 (link), I discussed the alternate scenario, in which everyone is willing to pay for mobile data and adoption of it continues to accelerate.  In this case, the mobile operators will need to invest urgently in increased capacity, and even with that investment we'll eventually run out of wireless bandwidth. 

The two scenarios leave mobile operators trapped between the need to expand their networks and the fear that they won't be able to pay for the expansion.  So the operators are trying to get other parties to help pay for the network.  I believe that's the real driver behind the net neutrality debate and the rhetoric about a wireless bandwidth "crisis."  Ultimately, government regulators will decide who will pay and how the mobile data network is structured, which will have a huge effect on which companies win and what we can do with the network.

In this part I'll give my take on what we should do about the situation, and I'll talk about the opportunities all of this change creates for operators, handset companies, and developers.


The look of mobile data in the future

If you only took away two messages from the first two posts in this series, these are the ones I'd want you to remember:

1. The only thing we can predict for sure about the future of mobile data is that it's unpredictable.  Maybe I'm right that it'll saturate soon; maybe Cisco's right that it'll go on growing explosively for years; maybe we'll average out to something in the middle.  The variables in play are so numerous, and so complicated, that absolutely no one can predict for sure what will happen.

In that sort of uncertain situation, I think our top priority should be to keep the mobile market as flexible as possible, so it can respond quickly and efficiently to whatever the customers decide to do.  That means we should ensure that market signals -- things like pricing and customer demand -- are as clear and unambiguous as possible, so we'll all know what the real level of demand is, and we can all respond to the same base of information.  The word "transparency" gets overused these days, but goodness gracious we need as much transparency as possible in mobile data.

2. We should plan wired and wireless data together.  We need to deal with the reality of the mobile network and market, not what we might want it to be.  And the reality is that we're not creating a separate wireless data network, we're creating a single integrated wired and wireless network.  A lot of the political rhetoric about mobile data talks about a completely cellular data future as some sort of public goal.  It's more like a public fantasy.  Every forecast I've seen from the wireless operators requires that they be able to offload a lot of traffic to the wired network.  Forget about wireless replacing wired; what we need to do is make sure they both work together well, with each focusing on what they do best.  That means wired is used whenever possible because in most cases it's cheaper and higher capacity, while wireless fills in the gaps.

We should set up a level playing field between wired and wireless so the market can sort out which traffic should go where.  Artificial political goals for the penetration of wireless, or favoring one network technology over another, are incredibly dangerous because they may lock in a market structure that turns out to be unaffordable.  In fact, because the market is so unpredictable, those sorts of goals are almost certain to be wrong.

So I get queasy when the US Federal Communications Commission, and even big companies like Google, argue that wireless data should have different regulations than wired data.  I think that increases the risk that we'll accidently bias the overall network in the wrong direction.


What we should do

As I've said before, I am not a big fan of government regulation in business, because it's usually inefficient and slow.  However, there are some situations in which you can't get the government out of the market, and I think cellular wireless is one of those cases because the public ultimately owns the airwaves in most countries.

So if we're going to have government regulation, let's do it right. 

The grand bargain.  The operators are asking for some mammoth benefits.  In the US, some of the biggest operators want to merge.  Okay, let's let them do it.  I don't think TMobile US is large enough to be viable in the long term anyway, so we need to merge it with either AT&T or Sprint.  If TMobile joins AT&T, which is the current proposal, the next merger in the US will be Verizon-Sprint; I think we have to accept that as well, for the same reason. 

The operators in the US and Europe want more spectrum allocated to them.  Again, I'd go ahead with it.  In the US, the television networks aren't using the extra spectrum, so it ought to go somewhere useful.

But in return, we should demand serious changes in the cellular data market.  I'm not talking about tweaks at the edges, I mean permanent changes in the rules of the game, designed to ensure lasting competition and a more flexible market that responds better to customer needs.

Here's what I propose:


Stop whining about the wireless "crisis" 

The first step is to change our rhetoric.  The bandwidth "crisis" is the tech industry's equivalent of the War on Terror: it's based on a genuine problem, it can never be completely solved, and it can be used to justify many actions that people might not otherwise consider.

The idea of a wireless crisis is an incredibly convenient tool for motivating government regulators.  Elected officials assume they are responsible for solving a wireless spectrum crisis, since they allocate wireless spectrum.  If it were called a "Verizon and AT&T don't want to pay for a bunch more cell towers crisis," I don't think President Obama would propose spending $50 billion on it.

This isn't just a US issue.  Anything one government does in mobile data is played back in other countries as a justification for equivalent actions there.  On a recent trip to Australia, I was surprised to hear a radio commentator complaining at length about the government's plan to supply broadband service to many Australians through landlines rather than wireless.  You can make a good argument for using landlines, since (as we discussed in part 2) they can carry a lot more data than wireless.  But the commentator was upset that Australia was failing to do "what Barack Obama is doing in the United States."

It's reasonable to ask what's so wrong with a little crisis hype and international competition.  After all, governments move far too slowly in most cases, so if a bit of alarming rhetoric makes them respond faster, isn't that a good thing?  The trouble is that we'll all have to live with the results after the "crisis" is "solved."  In that world, no matter how much spectrum we allocate to wireless data, service will continue to have slowdowns, outages and service gaps, especially in the United States, because it's more profitable for the operators to run their networks right at the edge of overload (in this sense they have the same financial incentives as airlines). 

We're lying when we tell people that the whole wireless data network could collapse.  Although service problems are a certainty, there is virtually zero risk of a full network collapse, unless the operators cause it themselves by underpricing data plans and selling more smartphones than they can support.  And we're misleading people when we say that prices will go up unless we allocate more spectrum.  Prices will eventually go up no matter how much spectrum we allocate to data, because demand for cellular data is growing faster than supply.

By overstating the risks and talking about the "crisis" as a temporary, fixable thing, we create an unrealistic public expectation for the quality and price of cellular data in the future.  That may well be advantageous for a couple of quarters or even a year, but in the long run it will erode public trust when we don't deliver the benefits we promised.  The wireless operators, especially AT&T in the US, already have big image problems.  Overpromising will make the problems worse.  To the extent that government agencies, and mobile tech companies like Apple and Google, participate in the crisis rhetoric, they risk their credibility as well.

We need to ask ourselves as an industry if we want to have the same sort of public image in five years as the airlines have today.  If not, we should be honest with people now.  For example, I think there is a convincing, legitimate case for reallocating old TV spectrum for data services.  Without it, mobile data prices will go up faster, and a lot of the features many of us want from mobile data may not be affordable.  But we should also be honest with people that cellular bandwidth overload is a chronic disease rather than a crisis, the network is not going to collapse unless we're incompetent, cellular service will not be as fast or cheap per bit as a wired, and cellular data will generally be a supplement to our wired broadband, not a replacement.


Make the cellular data market transparent

The problem with the cellular data market as it's structured today is that it often hides from users the real cost of the network they use, so they can't make well informed choices, and it's hard for us to tell which buying patterns are genuine and which ones have been created artificially.  For example, the cost of your smart phone is subsidized, so you don't realize what an expensive piece of hardware you're carrying in your pocket.  You're told that you have unlimited data, but actually if you use it too much your operator will probably reduce your data speed without telling you. 

By making cellular data seem cheaper than it is, we encourage people to use the network more, increasing the very overload that we're supposed to be fixing.  Some of the proposals for the future of mobile data would further increase the overuse of cellular data by making it seem even cheaper to users.

The structure of the mobile market also limits competition among mobile operators (especially in the US), and reduces competition between mobile phone manufacturers.

I think this systematic distortion of the market must stop.  If people could see the real cost of cellular data, they would make better-informed decisions about when and how to use it, and we wouldn't need secret back-end controls on traffic.  Meanwhile, more competition in services and phones would mean faster innovation, more consumer choice, and more efficient prices.

Here are some specific steps I think we should take:


1.  Ban covert traffic limits.  Today some wireless operators (and some wired ones as well) are quietly reducing the quality of service they deliver to some users, without telling them.  This is done through various techniques including "traffic shaping" (prioritizing or delaying certain types of data packets) and "throttling" (reducing the throughput of the network, or the speed of certain transactions).  In effect it usually means reducing the connection speed of people or apps that use the network the most.  For example, Dean Bubley recently wrote about an ISP who consistently reduced data throughput at particular times of the day (link).

There are some types of traffic management that make sense.  E-mail spam can be reduced through throttling that limits the number of e-mails that can be sent by a single account per second.  Throttling can also be used to limit malware attacks, by reducing the ability of a rogue app to flood the network with traffic.  And I think it's fine to enforce the speed you paid for in your Internet connection.  For instance, if you've paid for a 10 MBPS connection and the operator limits your throughput to 10 MBPS, I do not have a problem with that.

But in some cases the operators are limiting network performance to covertly restrict users, either by interfering with certain types of traffic, or by limiting the speeds of some users without telling them.  For example, the current Verizon Wireless terms of service give them the right to reduce the throughput in your "unlimited" data plan if you're in the top 5% of data users (link).  They can do this without notifying you.

This sort of hidden restriction is damaging to the market because people may sign up for a wireless plan believing they will get more service than they actually will.  They can't make a fully informed decision between wired and wireless service because they don't know how much wireless data they're really going to get.  This may misallocate resources and make the wireless network even more overloaded than it would be otherwise.

The answer to this is simple: Require operators to notify a customer when they have throttled or shaped his or her service (other than enforcing the promised speed of the connection).  I am not against throttling in general, but it should not be done without notification.  A text message would be fine.  The Internet speedometer, which I discuss below, will also help with this problem.


2. Require a data gas gauge and speedometer in smartphones.  Can you imagine buying a car that didn't have a gas gauge and speedometer?  That's essentially what we do today with smartphones.  For most smartphone users today, there is no easy way to tell how much data throughput you're getting from the network, and how close you are to any limits on your data usage.  Some operators bundle apps to do this, some have more arcane ways to check, and some send you a text if you get close to the limit.  But I think it's fair to say that most people are in the dark about their usage until they get their monthly bill, and if they do go over a limit they will have trouble figuring out why.

This is an easy problem to fix.  We should require that every smartphone have an app, accessible at the same level as the Settings app, that tells the user how close he or she is to hitting any data caps in the service plan (for example, if you are a Verizon user, how close are you to getting throttled?).  The app should also show how much data you're using at any particular time, so you can see how much throughput the network is really giving you. 

We also should modify the signal strength bars to change color depending on how much data you're consuming at any moment.  This would show you when you're using a website or app that uses huge chunks of data.  When customers see that video or Flash makes their signal bars turn red, they'll be much more cautious about using those sites on the wireless network.


3.  Decouple the phone purchase from the network.  Currently in the US and much of Europe, if you sign a contract for a data plan, you get a discount of several hundred dollars on a new phone purchased at the same time. But you have to buy the phone through the mobile operator, giving them huge control over the selection and features of the phones they sell.  Basically, users are not free to pick the phones they want; they have to take the phones their operator chooses to sell.

This operator lock-in is subject to all sorts of backroom manipulation.  Weak phone vendors are forced to comply with a huge list of tests and requirements, while for stronger vendors the rules are often waived.  I've also been told privately by some operators that they deliberately discriminate against some handset vendors because they just don't like them.

The handset vendors aren't completely clean either.  A vendor with a hot handset may restrict its availability to a single operator in order to extract concessions from them.  Can you say iPhone?

It's a wonder that some operator or handset company hasn't been sued already for restraint of trade.  With the amount of operator shelf space shrinking in the US due to mergers, I think it's only a matter of time before there's a legal detonation. 

In addition to the legal risk, these restrictions have the effect of restricting customer choice and competition, so they are bad for transparency.  It's time to open up the handset market.  To make that happen, subsidies should be separated from the purchase of a particular phone.  When someone signs up for a plan, they should get a voucher for a discount on any phone.  The voucher can be used at that time to buy a phone in the operator's store, or it can be used later to buy a phone in any other store. 

This would encourage more selection and competition in mobile phones.  It would create more direct competition between operator service plans.  And it would put the wireless and wired networks on an even footing (can you imagine a wired data provider limiting the brands of PC that you can use with your cable data connection?).

In the US, I think we should consider one other step to open up the handset market.  In most of Europe, and many other parts of the world, there is a vigorous retail market in mobile phones sold separately from an operator.  Because everyone is on the same network standard, and because all the phones use SIM cards, it is easy to buy a new phone at retail and pop your card into it.  You do lose the subsidy, but virtually all customers know they can at least switch phones if they really want to.  This leads to a much larger selection of phones, and to higher competition between operators because it's easier to choose separately the phone and service plan you want.

The US market is much less open.  Most mobile phones are sold only through operator stores, and it can be very hard to switch from one operator to another because they have different network technologies, and some of them don't even use SIM cards.  Because it's so hard to switch phones, I think most US mobile users are barely even aware of what a SIM card is, and how to find it in their phone (most of them would probably confuse it with the SD card).

To open up the handset market, the US should require that all mobile phones use SIM cards, and that they be switchable between the major operator networks.  That way someone could go into a consumer electronics store, buy the phone they want, and use it with any network.  This will have to be phased in over time, but we're already moving toward it anyway.  Verizon and AT&T are both moving to LTE, and there are very strong rumors that Sprint will do so as well.  So some day we'll have one standard cellular technology base in the US.  In the meantime, we'll have to buy dual-mode phones that use both LTE and either GSM or CDMA, depending on which operator you use.  But the chipsets for smartphones are increasingly capable of handling several different networks, so they can switch between LTE, GSM and CDMA.  I think it would be reasonable to require that future smartphones sold in the US be SIM-based and capable of operating on all three standards.  I think the real question is how quickly we could phase in that requirement; if you have thoughts on that please post a comment.


4. Enable toll-free apps and websites.  As I discussed in Part 1, we need the data equivalent of a toll-free phone call, in which a website or mobile app company would pay for the data traffic generated by a particular app or site.  This requires changes to the operators' billing infrastructure, but I think it will be essential for enabling the growth of mobile data.  It should be an extremely high priority for the operators, and it's in the interest of web and app companies to get together with the operators to define standards for these charges, so they'll be easy for developers to work with.  I suspect there's an important role government regulators can play in helping to encourage these negotiations.


5. Do not allow the operators, or the web companies, to discriminate against one-another.  I agonized over this one a lot.  The operators would like to be able to charge web companies extra if they want reliable delivery of data (for example, in a time-sensitive app like video streaming), or if they want a guarantee of a certain level of throughput.  I understand why they want to do this, because it would help pay for their infrastructure, and I do not think it is inherently evil.  But I think it would cause too much collateral damage to the mobile market.  In fact, I think it would put us on a road toward wrecking mobile data.

The first problem is that hidden back-end charges like this are essentially an invisible subsidy for cellular data.  A user won't know the real cost of the data he or she is using, and this could end up increasing traffic on the cellular network artificially, contributing to data overload.

There are also big practical problems with implementing charges for quality of service.  As Dean Bubley has pointed out repeatedly (link), there are huge drawbacks to this sort of approach.  To give one example, there is no way to guarantee quality of service when you don't know how overloaded a particular cell site will be.  If one high-priority video session comes in, does the operator shut down five other "regular" data sessions to make way for the high-priority one?  In that case, the "regular" customers are not getting the service they paid for, and they won't even know it.  They'll just think something is wrong with the web app they're using.

I agree with Dean that there's no way to make a system like this work predictably and fairly.  Better to just charge users for the data they consume, let them know how much that costs, and allow them to adjust their own usage patterns.

The other reason we should ban quality of service fees is because in some cases they could produce in a destructive power struggle between operators and websites, with users caught in the middle.  US cable television is a nightmare example of what not to do. 

In cable television, it's common for network operators and content companies (the cable channels) to pay each other for services.  For example, Home Shopping Network reportedly pays cable TV companies to be included in your service package, because they know they'll make more money if they're seen in more homes.  They are, effectively, subsidizing your cable television service. 

On the other hand, many of the most popular channels charge the cable companies a fee for the privilege of carrying them.  For example, ESPN (the leading US sports network) reportedly charges cable companies about $4 per month per household; other popular channels are in the 5-20 cent per month range. 

The same sorts of things could happen in the mobile web if the operators could charge websites for service.  For instance, what if Facebook started offering video streaming as part of its services?  If the mobile operators tried to charge Facebook for its network usage, what is to stop Facebook from turning around and demanding a fee from the operators for allowing them to carry Facebook? 

Unless we're very careful, we could end up with a situation in mobile similar to the one in cable TV, where users get caught in disputes between the network operators and the content creators.  Some of those arguments in the US have been incredibly ugly, with users tied into long-term contracts for cable service but unable to access the channels they thought they paid for.  And remember, in cable we get these messes even though we have only have about a hundred channels to negotiate.  On the web, you have literally millions of them.

The operators should not kid themselves that they would win in this sort of showdown.  If Facebook cut off its traffic to Sprint's servers, what would happen?  Would users abandon Facebook because it's not on the Sprint network -- or would they switch off of Sprint because it doesn't have Facebook?  I think we all know the answer to that: there would be crowds holding pitchforks and torches outside the Sprint stores.  The websites have far stronger brands and far more user loyalty than the operators.  So it's unlikely that the operators will really be able to coerce money out of the most successful websites.

In practice, I think the operators would be able to get fees only from small startups that don't have brand awareness with users.  That becomes a barrier to entry for those companies, which historically have been the source of most online innovation.  To give a real-world example of what that could do to the web, look again at cable television programming: A small number of networks dominate the selection of channels, resulting in slow innovation and reduced choice.  There is very low turnover in these channels. 

If the web worked like cable TV does, we'd all still be using AOL for e-mail.

I've talked with people at small startup cable channels, and they are incredibly bitter about the barriers they face getting placement on cable systems.  They're actually counting on the web to let them bypass the cable operators.

I think the only way to make the mobile market work efficiently is to make the payment mechanisms as clear and visible as possible.  Make users pay for the data they use, and allow web and app companies to make their sites and apps toll-free if they want to, but don't start creating hidden layers of fees and subsidies.  That will just distort the market and expose operators to retaliation.  My operator friends, this is a war you cannot win -- so don't start the battle.

To formalize this settlement, government regulators should ban both operators discriminating against websites or types of traffic, and websites withholding their content from a particular operator or network.


6.  Encourage open WiFi.  As I mentioned above, we're not creating a standalone cellular network, we're creating an integrated wired and wireless network.  WiFi has a critical role to play in that network, and we should make it even more central.  Here's a question for you:  How often have you tried to find an available WiFi network, and seen no networks at all in range?  I can't speak for other countries, but it almost never happens to me in any populated part of the US.  But how many times have you tried to sign onto WiFi and found only locked access points?  That happens to me all the time. 

We already have a very dense, well-populated wireless front end to the data network in most places that matter, but we can't use it fully because most of the access points are locked down.

There are good reasons for the lockdown.  If you leave your WiFi router open, it can be hacked (actually, it can also be hacked if you keep it locked, but that's a topic for a different post).  Also, in the US if someone downloads child pornography or does something else illegal on the Internet, the law often goes after the router owner because that's the only person they can find.  You can read some horror stories here.

But getting those connections opened up would have huge benefits for the public, because it would take some of the pressure off cellular wireless.  Rather than telling people to close off their connections, we should be encouraging them to leave them open.  Regulators could help this in a couple of ways:

--First, we should require that the next generation of WiFi routers have a pass-through feature enabling public access to the Internet without giving access to the user's home network.  Traffic from the user's private connection should have priority over the public one, and if public usage is excessive the user should be able to throttle it.

--Second, the law should be changed to protect people whose open wireless connections are abused without their permission.


Opportunities

So that's how I think the future of mobile data will look: unpredictable growth, always skating the line between overloaded and overpriced, and with a huge variety of users, almost all of them with some sort of limits on their data service, and many with budget plans that encourage very careful use of data.  For the health of everyone involved in the market, I hope we'll also get regulations that make the market more transparent, and more open to new players.

It's a different mobile data world than many analysts have been predicting, but that's not necessarily a bad thing.  Often the best business opportunities happen when conditions change unpredictably.  I think this is one of those times.  So I'd like to conclude by recapping the big opportunities as I see them...

For handset vendors, I think the most interesting new opportunity will be the smartphone designed for people with limited data budgets.  How do you entice people into gradually using more data?  This is an opportunity to do a fundamental rethinking of the smartphone user experience.  Since different people will probably respond to different data features, I think it will also be an opportunity for smartphone vendors to stake out their own market segments, helping to insulate them from the intense commodity price pressure we're likely to see in generic smartphones as the market fills up.
   
Try to think like an automobile vendor in 1950.  Do you want to compete with everyone else in midsize sedans, or would you like to dominate a smaller segment like station wagons or sports cars?

To target a segment, you'll need to hire people who know how to design integrated hardware-software systems rather than just devices, and you'll need to learn to partner closely with app and web companies as peers (rather than the serf-overlord relationships you're used to having).

In the last couple of days I've been contacted privately by some people who predict even more revolutionary moves by the handset companies, most notably the idea of selling a phone at retail bundled with airtime that you've bought from an operator.  In other words, the phone comes with its own network service.  That's what Amazon did with Kindle, and there's nothing in principle to prevent a handset company from doing the same thing. 

I think there would be a lot of implementation challenges, most notably keeping access to that third party network if it starts to run out of capacity.  But it would be intriguing to see what someone like Apple would do with this.

For operators, I think it's important to pick your battles.  Although covert traffic-shaping and charging websites for service is very seductive, in the long term that will lead you into intense conflicts that you're not likely to win.  It would also create more incentives for the handset companies to set up their own virtual networks, which really would transform your networks into dumb pipes.

I think it's better to focus on new business models that are a win for both you and your business partners.  The most appealing of these to me is toll-free data.  That would be intriguing to a lot of web and mobile app companies, allowing you to build cooperative alliances with them.  And it's a whole new revenue stream that might become very large over time.

For web and app developers, the emerging segmentation of mobile data makes the idea of "enticement" even more important than it is today.  How do you give people some software for free and then entice them into paying for add-ons or other apps?  Already most of the mobile app developers I talk to are thinking along those lines, and obviously that business model is very well established on the web.  But as smartphones reach down to more price-sensitive people who are less enthusiastic about data, there will be intense demand for apps and websites that can entice them into starting to pay for bits of mobile data. 

These "data on-ramp" apps are not always intuitively obvious, and will probably differ by country (for example, mobile horoscopes were a major driver of beginning data use in parts of Asia).  The companies that can find the on-ramps will be incredibly valuable to investors, handset companies, and operators.


What do you think?

That's my take on the situation. What do you agree and disagree with?  What else would you add to the picture?  How does it differ in your country?  And most importantly, what do you think the opportunities are?  Please post a comment and share your ideas.

The Truth about the Wireless Bandwidth "Crisis"

(Part 2 of "Who Will Pay for Mobile Data?")

There's a big nasty dilemma hidden at the heart of mobile computing: No one knows how we'll pay for all that mobile data we're supposed to use in the next few years. The question doesn't get much publicity, but it drives some of the most intense debates in mobile, including net neutrality and the wireless bandwidth "crisis."

This is the second of a three-part series on the issue. In Part 1 (link), I talked about the tech industry's unlimited vision for the growth of mobile data, and why I think it won't come true because we'll run out of people willing to pay at the current rates for data service

In this part, I will talk about the alternate scenario, in which most people are willing to pay for mobile data and adoption of it continues to accelerate. In this case, the mobile operators will need to invest urgently in increased capacity, and even with that investment I think we'll eventually run out of cellular bandwidth.

This means the operators face two conflicting possible futures. In one, growth is about to slow down and they don't need to invest in a bigger network. In the other, they need to invest urgently in additional network capacity. For telecom execs, it's a bet-your-career choice with no clear winner. So, naturally, they are trying to get someone else to pay for the investment. That's the real cause of the rhetoric about a wireless "crisis," and it's driving much of the net neutrality debate.

To understand why this is happening, let's start with a look at the physics and economics of a cellular data network...


Mobile data doesn't scale like fixed-line broadband

When mobile operators in the US and Europe first built out their 3G networks, they miscalculated what people would do with them. They expected that new, relatively low-bandwidth mobile services like a simplified version of the Internet (called WAP) and picture messaging (MMS) would be the dominant source of data traffic on the network, and they structured it accordingly. But those new data services failed to take off, and the operators were left with a ton of excess capacity. Desperate to generate any revenue from their new networks, they offered fire-sale data plans for the newly-emerging smartphones. It didn't matter if the operator made a good profit off a smartphone data plan -- with the network already built and sitting idle, any data revenue was better than none at all.

So the operators in many regions gave us low-cost or unlimited data plans. Those plans set customer expectations for how they should use mobile data and what it would cost in the future.

Overcapacity continued on most mobile networks until the launch of the iPhone in 2007. We tend to forget about it today, but the iPhone was the first smartphone to make PC-style browsing practical and attractive for most smartphone users. The result was an explosion of mobile browsing, and almost overnight mobile data networks supporting the iPhone started to go from overcapacity to overload.

The reason for the overload was simple -- people in the developed world learned to browse first on their PCs, most of which have high-speed wired connections to the Internet. Bandwidth on these connections isn't infinite, but it's large enough that activities like file sharing and watching videos are mainstream.

When people started doing PC-style browsing with their smartphones, they brought their PC browsing habits with them. Unfortunately, the cellular wireless networks don't have nearly the same data capacity as the wired networks. So mainstream browsing behavior on a PC turns out to be excessive browsing on a smartphone, especially if you use a lot of YouTube.

Even if you're not a big video user, the normal sorts of messaging and web traffic created by a PC can overload a wireless network. A typical PC has a more or less continuous connection to the web, so instant messages and web app updates can ping back and forth constantly. But to conserve battery life and stretch network resources, a smartphone doesn't talk to a cellular network continuously; it basically says hello to the network, sends a message or a bit of data, and then says goodbye. Each little message and each app ping creates its own set of hellos and goodbyes. Send too many and they can overwhelm an operator's servers. Web apps send too many.

The operators, of course, can add additional wireless capacity to cope with the increased traffic, and they have been doing so. Cisco estimates that the total capacity of the world's wireless networks will increase by about 10x from 2010 to 2015. But these additions eventually run into physics problems. There's only so much information you can squeeze into a certain amount of wireless spectrum. At some point the cellular infrastructure overloads, and as an operator you have some ugly choices:

--You can add a lot more cell towers, reducing the size of each radio cell and therefore increasing the number of devices you can support. Unfortunately, this is extremely expensive -- not just to build the towers themselves, but for the fiber optic cables connecting them, the servers to manage them, and for the lobbying you must do to overcome political opposition to additional towers.

--You can offload data traffic to local wired connections. The operators are already pushing this hard, via WiFi. Some are also encouraging the installation of femtocells in individual homes and businesses. (A femtocell is basically a micro cell tower in a box the size of a wifi router. It gives you cellular service inside a building or business, using wired broadband to communicate back to the cellular network.) But that too is expensive: at around $200 a pop (link), it would cost about $13 billion to attach a femtocell to every one of the 67 million consumer broadband lines in the US. Plus there's the support cost for installing them, and the expense to put millions more cells in businesses, and the cost to buy the back-end servers necessary to support them. Nevertheless, some very smart people watching the mobile data market believe that femtocells are essential to the future of mobile data (link). Cisco estimates that offloading of some sort will handle about 20% of mobile traffic by 2015, and up to 40% in some countries.

--You can buy more spectrum, but there are huge licensing costs associated with that, not to mention the cost of retrofitting your cell towers for the new frequencies and replacing all of the phones in the installed base.

Unfortunately, even if you make all of the changes above, there are some very convincing arguments that it won't be enough, quickly enough, to head off a capacity crunch if current trends continue. The growth rate of smartphones, tablets, and wireless notebooks will swamp the cellular infrastructure no matter what. Folks in the mobile industry have taken to calling this the "Moore's Law vs. Shannon's Law" problem, with Moore's Law representing the exponential growth of computing power, and Shannon's Law the fundamental limits on how much data you can push over a particular chunk of spectrum. Reinforcing the Shannon bandwidth limits is the fact that some other critical elements in the mobile data infrastructure can't keep up with Moore's Law. The number of cell sites can't increase exponentially, and handset battery capacity is barely growing at all. A crunch is inevitable at some point.

So the people who tell you that cellular wireless will replace wired broadband just don't understand the physics involved. An outstanding summary of the situation was written by Martyn Roetter, a telecom consultant (link).

Here's the key paragraph:

"Until and unless the current laws of physics are invalidated in ways that remove current limits on spectrum capacity such as are embodied in Shannon’s Law, the future will see: (a) The vast majority of broadband traffic (as distinct from numbers of broadband subscriptions) continuing to be carried (delivered and transmitted) over fixed access networks; and (b) Demands for broadband traffic from wireless or mobile subscribers outstrip the capacity of all the bandwidth available for radio access networks to handle it, even with the use of the new spectrum that can be allocated and the deployment of more spectrally efficient technologies... Bandwidth within one optical fiber is vastly greater than all the bandwidth that might theoretically be made available for mobile communications, even if every megahertz were to be refarmed for mobile services. A single mode fiber has a bandwidth of as much as 100,000 GHz, or 100 terahertz, whereas total valuable spectrum for mobile communications provides bandwidth of no more than at most 3 GHz."

Got it? What he's saying is that wired broadband traffic can continue to grow exponentially, which will create demand for mobilizing that traffic through cellular wireless -- which the cellular networks can't handle.

If data traffic continues to grow at its current pace, we're headed for a situation in which the cellular networks will be overloaded no matter what we do.


Rock, meet hard place

So we have two possible scenarios for the future of mobile data. In the segmented scenario I discussed in part 1, we run out of customers willing to pay for mobile data plans, and the growth of mobile data slows down. In the consensus scenario, customer demand continues to increase, and we run out of cellular network capacity.

These conflicting scenarios are terrifying to the mobile operators because there's no way to tell for sure which one will happen. If you knew for sure that demand was going to continue to grow, you'd invest heavily in capacity, and also start raising data prices to restrain the growth in demand to something you can actually deliver. But if demand is about to stop growing, investing in capacity and raising prices is exactly the wrong thing to do. You'll end up with excess capacity, and the price hikes will make demand stop growing even faster.

This table summarizes the dilemma (click on it to see a larger version):



An economist would tell you that this will all sort itself out in the long term, and I'm sure it will in 20 years or so. But in the meantime, in the real world, the operators have to invest in infrastructure years before the demand arrives. If you're an executive at a major operator, it is almost impossible to get the forecast right. That means you will probably either overbuild the network, wasting billions of dollars and putting your career at risk; or you will underbuild, losing share to competitors and putting your career at risk.

You can't win. It's like one of those Star Trek episodes where Captain Kirk destroys the rogue computer by putting it in a logical loop (link). If you watch closely at tech conferences, you can see the smoke seeping out of the ears of telecom execs.

Faced with this dilemma, those telecom execs naturally are trying to find a third option: Get someone else to pay for mobile data. There are a couple of options:


Option 1: Have the government pay for mobile data

I doubt that most governments would pay to make wireless data completely free for everyone, but I was surprised when I found out how much governments are already paying for mobile. For example, the US government subsidizes mobile phone service for millions of unemployed people (because it helps with their job searches; they need phone numbers so employers can all to offer them jobs). I could easily imagine that benefit being extended to include mobile data, on the assumption that poor people need access to job boards (how we'll avoid paying for their YouTube and Kongregate usage I don't know).

Governments are also being lobbied to give special regulatory treatment to wireless data. The rhetoric around a "wireless spectrum crisis" is being used to influence governments. The focus of this lobbying in the US is on taking spectrum away from the TV networks and supplying it to the mobile operators. Effectively that is a financial subsidy for the operators -- if the government forces the transfer the operators will have to pay less, and will get the spectrum faster, than if they were to purchase it on the open market.

Here's how the lobbying works. This is an excerpt from an e-mail sent to me recently by a PR firm working for a group called the Internet Innovation Alliance:

"IIA's Blog: The Spectrum Clock is Ticking
Writing for Forbes, Lawrence J. Spiwak, President of the Phoenix Center for Advanced Legal and Economic Public Policy Studies, warns Congress that more spectrum needs to be freed up for mobile broadband and it needs to be freed up soon: Like it or not, the clock is ticking on spectrum exhaustion, both for consumers and our public safety professionals. Unless we want a market characterized by higher prices, failed data sessions, dropped calls and stifled innovation, policymakers need to implement a cohesive spectrum policy with a large degree of urgency."

At first glance, that reads like a standard plea from a bunch of web companies worried about the mobile network getting overloaded. But the backstory is that both IIA and the Phoenix Center are reportedly funded by the mobile operators (link, link). So this isn't an independent assessment of the situation, it's the operators sending us a message. And the message is: "Give us more bandwidth or we'll trash your phone service." I think that's a bit disingenuous -- unless the operators seriously mismanage their networks, we won't end up with both bad service and higher prices. But they're right that without more spectrum we'll definitely get one or the other.


Option 2: Make web companies pay for mobile data

Several of the leading operators in Europe recently argued that big tech companies like Apple and Google should be forced to pay to use the wireless networks. Although they don't put it this way, they're asking the big Internet companies to subsidize mobile data plans for users (link).

The CEO of Telefonica said the web companies "use Telefonica’s networks for free, which is good news for them and a tragedy for us. That can’t continue."

Here's the CEO of France Telecom (link):

"The real risk of everything is collapse. Nobody utters this loudly enough, but the real issue for the world is a collapse of the network or some local collapses. We are the people with pipes. We are supposed to invest heavily in pipes in order to bring the capacity which is necessary to sustain the explosion of consumption and usage and data traffic in our networks. At the same time, the people that create this traffic…are not really incentivized to manage properly, globally, the traffic. There is an unbalance in the overall system, which in our view is a major problem. It is totally impossible to absorb such an explosion in traffic without first, clearly investing massively in spectrum and equipment, and second, without introducing some new pricing approaches."

This is the heart of the whole debate about net neutrality. I believe it's not really about mobile operators trying to give an advantage to their own services, it's mostly about the operators trying to open up a second revenue stream because they're afraid they can't get enough revenue from users to support future growth.

For the operators, charging web companies a fee seems intensely attractive because the fee could be scaled to the amount of traffic they generate (unlike the flat-rate data plans that users prefer), forcing the web companies to use bandwidth more efficiently. It also would let operators increase their revenue without directly reducing user demand. Basically, the web companies would subsidize a shift from wired to wireless computing.


The third option

I can see why the operators are pushing on both of these options. They're in a difficult situation, and it would be very helpful to them if somebody bailed them out (link). I might be trying the same things if I worked for an operator. But there is a third option for managing cellular data overload, and it deserves to get a lot more attention:

Raise prices.

In almost every other industry in the world, you're responsible for charging enough money to support your business. Yes, sometimes you have to make investments before you know how much demand there will be, and yes, sometimes that creates a lot of risk for your company. But that's why they pay you the big bucks, Mr. or Ms. CEO.

I don't understand how we as a society came to the conclusion that wireless data should be different. Is there some religious commandment that people must be allowed to stream Netflix on the subway? Or maybe those big Cisco growth forecasts have led us to think that endless growth of mobile data is a ravenous beast that will cause immense suffering if it's not fed more bandwidth.

Baloney. If the network is overloaded, raise your prices until you either get enough money to expand the network, or you force people to use less data. If you want network bandwidth used more efficiently, show users the cost of the data they use and they'll demand more efficient apps and devices on their own.

I bet a price increase from $50 a month to $80 a month for mobile data would end the bandwidth crisis overnight.

Not only is higher pricing the simplest way to manage network overload, it's going to happen no matter what we do. Even if we give the operators all the bandwidth from the TV networks, and get the web companies to subsidize wireless service, all that will do is delay the crunch for a few years. More traffic will switch from fixed-line to wireless until once again the network saturates and prices go up. It is inevitable.


What it means

When we plan for the future of mobile, we need to be realistic, and a little bit humble, about what we can change and what we can't. We need to learn to live with the things we can't change, and focus on doing a good job of managing the things we can.

Here's my list of the things I think we can't change about mobile data because they are driven by economics and physics:

--Most data traffic will be wireless only for the last 100 feet (30 meters) that it travels from your device to the nearest hotspot (whether it's WiFi, femtocell, or something else). So we need to be careful about our terminology. Most data could well be technically "wireless" in the sense that it passes through WiFi at the end, but that is a meaningless distinction for the purposes of this article; most of it won't pass through the cellular data network.
--Most of us will continue to have some sort of broadband cable connecting to our homes and offices, or to a point very close by (like the lamp post in the street outside your window). Forget those visions of cellular replacing the wired broadband network; in the developed world it can't happen.
--The cost per-byte of cellular data will be significantly higher than the cost per-byte of wired data. The difference will be large enough that we'll be aware of it and it will alter the way we use our devices.
--Flat rate unlimited cellular data contracts will go up in cost, or will be replaced by much more variable pricing for most users. This is already underway at some operators. For example, Verizon is rumored to be about to move from $30 per month for unlimited data to a tiered plan that ranges from $30 per month for two gigabytes to $80/month for 10 gigs (link). I don't usually like consumer price hikes, but in this case the change is long overdue.
--As the relative cost of mobile data rises, most of us will use cellular data primarily as a supplement to the wired network when we're on the go. We'll become religious about turning on WiFi in our smartphones and tablets, and making sure it can connect at home and at work. Because cellular data is more expensive, many of us will try to avoid using very data-heavy apps on the cellular network.

This means cellular data use won't be carefree. That may not sound like a big difference, but in consumer terms I think it is. We've been making the assumption that cellular data can directly replace fixed-line data, just as cellular phones replaced fixed line phones for many people. "Go ahead! Use it anywhere! Be free!" But for an aggressive user of mobile data, that can't happen. Our use of cellular data is going to be much more nuanced, managed, and carefully thought out than our use of cellular voice. I think many of us will look at our cellular data budgets the same way we look at our automobile budgets. Some people will spend more, some less, but I think most of us will be aware of the cost and manage it actively.

The wired Internet will continue to set the tune. The ongoing role of fixed-line broadband means that many leading-edge web apps will continue to be designed around the capacity and responsiveness of fixed-line networks. This is another subtle but very important difference, because it means the mobile operators will continue to play catch-up to customer expectations set on the wired networks. There will be exceptions; some features of cellular data (such as location) will drive unique mobile apps. But in most application categories, rather than shaping the future of the Internet, mobile operators in the developed world will be pushed to deliver an Internet experience that evolved on fixed-line networks.


Here are the things I think we can change about cellular data:

--We can alter the share of total data traffic that moves through the cellular networks. By transferring spectrum and giving the operators other favorable treatment, we can make the overall capacity of the cellular data networks higher than it would have been otherwise. Basically, we can make the mobile operators bigger. That may delay the onset of mobile network congestion, and enable some classes of web applications to be more successful in cellular (for example, low-res video streaming). That can have a big impact on individual users and app companies. It will also have a big impact on the ultimate revenue and profitability of the mobile operators, which is why they are lobbying so hard.
--We can probably change the size of the average mobile data bill, but only temporarily. The more revenue streams we give to the operators, the more mobile data we'll probably get for a given user price. However, as I mentioned above, keep in mind that if mobile data is made cheaper, people will use more of it, which will eventually saturate the network and cause prices to rise. So any money we save on our mobile data bills will probably be temporary.
--The decisions we make in the next few years will profoundly change the economic structure of the wireless data industry. Changes in regulations and pricing rules will have a huge impact on the ability of small companies to compete with large ones in mobile, and will determine who pays for the whole thing. This could decide whether the mobile internet looks more like the wired Internet (low barriers to entry, lots of companies) or cable television (high barriers to entry, dominated by a few big players).

I think the most important thing about the three points above is that they're all driven by government regulation. The rules we set for the mobile Internet are going to determine the ultimate size of the mobile operators, how they are funded, how competition works in mobile data, and how much power is held by the various players.

That scares me. I prefer to have winners and losers in a market chosen by customer decisions, not government ones. You can't blame the mobile operators, or the big web companies like Google, for lobbying the government on these issues. But I don't think their interests are necessarily the same as the rest of the industry, let alone consumers. Also, most of the big players are driven by quarterly revenue, and in some cases they are pushing for changes that I think will help them in the short term but would actually hurt them in the long run.

I wish there were some scenario in which we could tell governments just to butt out and let the market decide, but governments are already deeply involved in allocating spectrum, and there's no practical way to undo that. So I think it's important that we all have a very thorough, open discussion of the government decisions to be made and the sort of wireless industry they'll produce.

That's what I'll cover tomorrow.

_____

In part 3, which I'll post tomorrow (link), I'll give my ideas on how we should structure the mobile data market. I'll also talk about the opportunities this new world of mobile data will create for companies in mobile. In the meantime, I welcome your comments and questions. This is a big, complex issue, and I don't pretend to have it all figured out.

The future of publishing: Why ebooks failed in 2000, and what that means for 2010

This post is adapted from a speech I gave at the O'Reilly Tools of Change publishing industry conference in February.

It's a great time for ebooks. There are at least six ebook reader devices on the market or in preparation. A major business magazine predicts that up to seven million of these devices will be sold next year. A major consulting firm says ebook sales will account for ten percent of the publishing market in five years. And an executive at the leading computing firm predicts that 90 percent of all publishing will switch to electronic form in just 20 years.

But the year isn't 2010 -- it's 2000, and the ebook market is about to go into hibernation for a decade. What went wrong, and what can the failure tell us about the prospects for ebooks in 2010?

I had a front row seat for the last generation of ebooks: In 1999 I was at Softbook (one of the early ebook reader companies), and later I interacted with the folks at Peanut Press (an ebook publisher) after they were bought by Palm. My short summary of the lessons I learned: Although some of the barriers that stopped ebooks in 2000 have been reduced, most of them are still in place. So I think the market isn't likely to grow as quickly as many optimists are predicting. However, the economics of traditional publishing are very vulnerable to a paradigm change. That change is likely to happen later than most people expect, but once it happens it'll probably move very quickly indeed. So stay out of the avalanche zone.

Here are the details on why, and how to avoid the avalanche when it does happen.


Why ebooks failed in 2000

I know I'm going to get some comments reminding me that ebooks didn't ever completely fail. They've been around for a long time, and some people read books on their computers every day. Granted. But the market for ebooks and ebook reader devices utterly failed to take off the way that most observers expected in 2000. It's important to understand why, or we may be at risk of repeating history.

I think the failure of ebooks ten years ago was due to five problems:

1. Not enough ebooks. The core customers for an ebook reader are reading enthusiasts, meaning they like to read a lot of books. If you ask them how many books they'd like to have available for their reader, they'll look at you funny and say, "All of them, of course. What's the point in paying for an ebook reader device that doesn't let you any book you want to read?"

In 2000, we had a huge problem with ebook availability. They were expensive to convert to ebook format (hundreds of dollars per title), and publishers were reluctant to make that sort of investment. I don't have any statistics on the number of ebooks available back then, but I remember that it was an ongoing, major problem for the company.

Today, the situation is better but not ideal. Looking at the New York Times bestseller list for February 28, all but one of the top 10 books in hardcover fiction and nonfiction were available in ebook format. However, there is still a problem with the timing of availability. Barnes & Noble had 15 books on its "Coming Soon" list for March 10, but only six of them were to be released as ebooks at the same time as they came out in print. That's a poor ratio, and would be a significant annoyance to an ebook user.

Looking at older books, availability seems to be hit or miss. Many more books are available in ebook format today than in 2000, but there are weird gaps. For example, many of the most popular works of Robert Heinlein (one of the leading science fiction authors of all time) are not currently available in the Kindle store, but are available for Barnes & Noble's Nook device. For Isaac Asimov (another all-time great), only a small subset of his work is available electronically from either Amazon or Barnes & Noble.

This sort of confusion frustrates many ebook users.

2. Ebooks were too expensive. Many book buyers feel they get extra value when they buy a hardcover book. It's more substantial than a paperback, and has a nice slipcover. The pages don't turn yellow, and the printing is generally very clear. If they like the book, they can put it on a bookcase somewhere to show their friends how tasteful they are. An ebook has none of these benefits. To many users, it feels more like a paperback -- disposable, intangible, slightly cheap. But in 2000, many ebooks were priced the same as hardcover books.

Combine high book pricing with limited availability, and most people didn't feel ebook readers were a reasonable value. The market stalled right there.

The problem with ebook vs. hardcover pricing is that publishers bundle two sorts of value when they create a hardcover book: The physical product is more impressive, and you get earlier availability of the book, often a year or more before the paperback version comes out. Unfortunately, book buyers think most of the extra value they're paying for from a hardcover is the physical book. Meanwhile, publishers (and authors) often think the main value of a hardcover is early availability. Many authors and publishers don't want to say this to the public, but hardcover books are a tax on the most enthusiastic fans of an author.

E-publishing breaks that cozy little arrangement, by separating the early availability value from the better production value. Publishers couldn't figure out what to do about that in 2000. So they often did the conservative thing, pricing ebooks the same as hardcovers. To ebook customers, that felt like exploitation, if not outright fraud.

It still feels that way today.

The situation now is somewhat improved, in that ebook prices are often somewhat lower than hardcover prices. But it has not been resolved. For example, Amazon lists Payback Time by Phil Town as a hot new release. Its list price is $26.99 and the ebook price is $13.36, so that looks like a huge discount. But the hardcover version is already being discounted to $14.57. So the ebook price is about the same as the hardcover's street price. That's not acceptable to a lot of ebook customers.

Until very recently, Amazon had been subsidizing down the price of most ebooks to $9.99 in an effort to deal with conflicts just like this, but that arrangement broke down when challenged by Macmillan. The result was a very nasty public spat in which Amazon briefly pulled all Macmillan books (paper and electronic) from its online store. That drove many book authors into a frenzy, with most of them siding with Macmillan (examples here and here and here).

Hey, you want to know how to piss off an author? It’s easy: Keep people from buying their books. You want to know how to really piss them off? Keep people from buying their books for reasons that have nothing to do with them. And you know how to make them absolutely incandescent with rage? Keep people from buying their books for reasons that have nothing to do with them, and keep it a surprise until it happens. Which, as it happens, is exactly what Amazon did. As a result: Angry, angry authors. Oh so very angry.
Amazon apparently forgot that when it moved against Macmillan, it also moved against Macmillan’s authors. Macmillan may be a faceless, soulless baby-consuming corporate entity with no feelings or emotions, but authors have both of those, and are also twitchy neurotic messes who obsess about their sales, a fact which Amazon should be well aware of because we check our Amazon numbers four hundred times a day, and a one-star Amazon review causes us to crush up six Zoloft and snort them into our nasal cavities, because waiting for the pills to digest would just take too long.
These are the people Amazon pissed off. Which was not a smart thing, because as we all know, the salient feature of writers is that they write. And they did, about this, all weekend long. And not just Macmillan’s authors, but other authors as well, who reasonably feared that their corporate parent might be the next victim of Amazon’s foot-stompery.
--Science fiction writer John Scalzi

Hey, Amazon. When cutting off publishers, don’t start with the one that has the most science fiction writers. We will blog you dead!
--Science fiction author Scott Westerfield

What is it about the tech industry and authors? Both Amazon and Google have shown a unique ability to make authors bond with publishers, people they otherwise tend to view as parasitic scum.

The relationship between Amazon and Macmillan is very complicated, and I don't want to get into the details of their contracts here. There's ample evidence for labeling either one of them a villain and/or idiot if you want to. But my point is that ebook pricing remains screwed up today. Maybe not as uniformly screwed up as it was in 2000, but it's still a mess.

3. The hardware form factor was wrong. When ebook readers failed to sell well, ebook producers tried to focus on other electronic devices -- PCs, PDAs, and smartphones.

The trouble is that for most people, the ergonomics and psychology of reading are wrong on computers and smartphones. A laptop is the wrong size and weight to create an immersive reading experience, and the backlit displays on most laptops create eyestrain compared to reading ink on paper.

PDAs and smartphones are too small for immersive reading for most people, and besides people are usually in a different mindset when they use a pocket device. They use it briefly, in short spurts throughout the day, when they are bored or need to find a bit of information. It's like the information equivalent of snacking. A reference book might be useful in this context, and holy books like the Bible sell well in electronic form because some people take comfort in reading a bit of them every day. But for most people, a pocket device isn't something that you'd curl up with for a couple of hours, the way you would with a book.

This is an area where we're obviously making a lot of progress. Amazon and Sony have both been willing to subsidize their tablet devices for years while the ebook market develops, and Apple and other big computer companies are now entering the tablet market, not to mention a host of smaller startups.

Just remember that most electronics companies are sheep. If tablets don't sell well, they will exit the market as quickly as they entered it.

4. Periodicals weren't ready. Although we call these devices "ebook readers," if you look at user attitudes and usage patterns, in many ways they are a better fit for reading periodicals (newspapers and magazines) than they are for books. Most printed magazines and newspapers are viewed as disposable, so many people don't object to paying the same price for an e-version as they do for the printed version. And most periodicals can be read in short bursts, which fits the usage pattern for mobile devices.

Even better, an e-magazine can get to the reader faster than a printed version, because it doesn't have to be printed and mailed.

When I was at Softbook, there was a lot of user interest in getting magazines on our devices. Unfortunately, very few were available, and the effort to get them converted started too late to save the company.

Today, there are electronic versions of a number of publications targeted at the ebook readers. But a couple of additional problems have surfaced. One is that often the e-versions are inferior to the printed versions. On the Kindle store, 64% of the reviews for the e-version of The Economist magazine are a single star (the lowest possible rating). Here are some sample comments:

"I was very happy and interested in the Economist on Kindle despite the cost until I learned that the subscriber content on the Economist web site is not included....For the cost involved the Kindle subscription should at least equal the print subscription benefits."
"Why does it take a week to make the Kindle version available. I find it very convenient to read and search but do not want to be a week behind in reading."
"I only receive part of the magazine. Overseas users don't get images -- including the cover image and graphs/charts."
"Many of the charts and graphs are so small the legend is unreadable which in turn renders the displays meaningless."

Time Magazine, 46% of reviews are one star:

"This is a rather embarrassing electronic version of Time Magazine. There are NO pictures, no charts, no illustrations. Instead whenever you run into an article that has these in any decent amount, they've inserted an entry telling you to go get a PDF or print version....It looks and feels like some cheap RSS reader collected this rather than being an electronic version of the magazine."
"I'd like to read some parts of Time but not others, so I very much miss having a convenient table of contents. As it is, we have to (slowly) leaf thru all articles to find out what's of interest."

Wall Street Journal, 50% of reviews are one star:

"The pricing makes absolutely no sense: $99/year for the WSJ print edition with the Online Web edition included. $119.88/year ($9.99/month) for the Kindle edition.... That makes no sense because I could buy the Web edition and read it through the Kindle Browser for no additional charge."
"I also subscribe to the print and wsj.com which shows how the Kindle edition is very limited in his layout and pizzaz....Compared to the NYTimes Reader or even the wsj.com it is a sad commentary on their apparent lack of effort. There should be a more detailed table of contents instead of just very general catagories of articles. To find a specific article is sort of a blind proposition...being forced to go through the all article until you find what you're looking for."

In fairness, some other publications are better-reviewed. The Kindle version of the International Herald Tribune has an average rating of four stars, as does the New England Journal of Medicine. But overall, there are a lot of teething problems as the publishers figure out how to produce their e-versions and how to price them. This is likely to hinder customer adoption until the problems get sorted out.

5. Poor marketing. In my opinion, the right way to create a technology product is to identify a group of customers who have a major problem, and to solve that problem decisively. It's not clear that ebooks, especially as they are constituted today, do that. Paper books simply aren't broken, from the perspective of most users. S. David Mash had a good quote on this (link):

The reading device for the paperback is widely available for free (sunlight). This device can be used for other tasks as well.

A lot of the investment in ebook devices today seems to be driven more by strategy than by user needs. E-books are believed to be an important future business opportunity, and companies are maneuvering to be in position when that opportunity takes off.

The problem is, unless they solve a user problem, and communicate it to the users, the market won't take off in the first place. This tripped up the ebook companies in 2000, and I think it is still true today. Check out Amazon's pitch for why you should buy Kindle:



Can you spot the problem? It's a list of features, not a list of benefits. Now let's look at Sony:



They're doing a tiny bit better, in that they do list a user benefit. Unfortunately, how many people do you know who want to carry 350 books at one time? I call this situation "phantom value," and it's something that happens a lot to tech companies. They've made a product without really thinking through the value proposition. When it comes time to market it, they pick one feature of the product and try through brute force to persuade customers that they should care about it. Usually the only people they convince are themselves.

This same thing happened when the music industry was first trying to defend itself from MP3 players. There was a huge fuss over the superior audio quality of CDs, and a lot of people in the music industry put a lot of effort into talking up the quality aspect of CDs. The only problem was that the average music listener couldn't hear the difference and didn't care about it.


What it means for ebooks in 2010

Although ebooks are doing much better than they were in 2000, there are still very significant structural barriers to the broad adoption of ebooks. We're in a chicken and egg situation where the content isn't fully ready for use because there aren't enough device users to force investment, but people won't buy more devices until the content gets better. As long as Amazon and Sony continue to subsidize the market, I think it will continue to grow moderately. And I think the iPad and related tablet products may help. But overall, the prospects for near-term explosive growth don't look good.


What happens next, and what can we do about it?

First, let's talk about a couple of opportunities. Paper books published today are not broken, but there are a couple of notable places where the publishing industry as it works today really is breaking down, and ebooks could help.

Save the short story. The first problem is the market for short stories. I wrote about this several years ago at length (link), so I won't repeat the whole situation here. But a quick summary is that the magazines that used to produce a lucrative market for short stories have mostly gone out of business or moved on to other sorts of content. As a result, authors have relatively little incentive to write short fiction these days.

Speaking as someone who grew up reading and appreciating short fiction, this is a loss for readers and an opportunity for e-reader devices. Short fiction is a great fit for e-readers because it can be consumed in small bites, and if authors could sell directly to their readers, the revenue could eventually be good enough that people would go back to writing short fiction. Plus it would give e-reader devices a real benefit -- content that you can't get anywhere else.

What's missing is the marketplace to make that happen. We need the equivalent of an iTunes store for short stories, tied to a mass market tablet device.

Free the backlist. At the O'Reilly conference I heard a fascinating statistic from Brewster Kahle of the Internet Archive: 70% of all the books ever written in English are out of print but still under copyright. In other words, you can't legally make copies of them, but there's not enough demand for them that the publishers can afford to reprint them. They are orphans.

These aren't just obscure books. In science fiction, my favorite category, award-winning books from the 1950s and 1960s are frequently out of print, and forget about finding less-known books even from major authors. The best you can do is a used book search, which if you're lucky will get you a smelly and dog-eared paperback in the mail. And those are the famous authors! Books from many others are unavailable in any form.

In my opinion, this is appalling. And it's also an opportunity.

Kahle is working on a project to let universities lend out electronic copies of the books in their stacks, which include many of these orphan books. As I understand it, the idea is that the library owns the right to lend out one copy of the book. If a central server keeps track of that single electronic copy, it's possible to legally read e-versions of orphaned books. It sounds like an incredibly cumbersome approach -- and it is. But it's better than nothing, and once again it's producing content for e-readers that can't be obtained any other way.

The project is called BookServer, and 1,000 more books are being digitized every day (link). It's the most hopeful thing I've heard about the future of libraries in years.


Rethink the periodical

The Internet is flooded with videos of prototype electronic magazines that publishers have been working on. Most of them look pretty similar -- there's an electronic image that looks just like a printed magazine page. The user moves from page to page by swiping a finger back and forth on the device's screen. You can zoom in to look at a graphic more closely, and zoom out to a thumbnail view that shows several pages side by side. The pages include both ads and stories, just like the magazine. In some prototypes, static pictures are replaced by videos and animations. Most of the demo is made up of page swiping and zooming, and you're left thinking, "hey, that looks just like a print magazine on the screen."

I am reminded of this:



It's called the Horsey Horseless Carriage. Time Magazine wrote about it in 2007 (link). It was supposedly an early automobile design in which a horse's head (thankfully a carved wooden one rather than stuffed) was mounted on the front of an automobile. The idea was apparently to make the car look more like a horse-drawn carriage, so the real horses would not be frightened by it. Just as striking as the horse's head is the rest of the car's design. From the wheels to the body design to the weird tiller the driver uses to steer, it is a basically a horse-drawn carriage that has a motor affixed to it.

We laugh now because we know the carriage needed a total rethink to translate it into a car -- everything from the wheels to the controls to the seat designs had to change radically. And yet when it's our turn to create something new, we create electronic magazines that look just like printed magazines.

It's a failure of the imagination, in my opinion. Most of the design of a magazine was driven by the economics of printing and mailing a paper publication. Why are the ads and text arranged the way they are? Because in a paper magazine, you can force people to skim past the ads while they look for the articles. Why is a magazine that particular size? Because that's what the post office will deliver, it fits easily in mailboxes, and it's a paper size we're used to handling. Why does it come out once a month or once a week? Because you have to bundle up a critical mass of content and ads before it makes financial sense to mail it. And on and on and on.

None of those assumptions apply to an electronic publication. They are all rules that we've absorbed from the print world, so deeply that we don't even think to question them. Some of those assumptions may still make sense in the electronic world, but many of them won't. One area where I feel strongly that our assumptions are faulty is advertising.

People reading paper magazines are used to fumbling past ads while they read. It's a standard part of the experience. But people using an electronic device have been conditioned by the web to expect to click and jump directly to the content they want. Making them flip through simulated electronic pages full of ads simply won't work. That means the ads in an electronic publication probably can't be as numerous as they are in a print publication. What's worse, the ads that pay the most money -- the inside front cover and the back cover -- don't even necessarily exist in an electronic publication.

I think some magazines believe they can force the current ad experience on users. Some of them even have persuaded themselves that readers see the ads as part of the value of the magazine (see my discussion of phantom value, above). But publications need to understand that they'll be competing with a new crop of publishers who grew up online and are not hamstrung by the same thinking.

The best example of this new thinking is Yahoo. It's very trendy to dismiss Yahoo these days because it's not Google, but in reality the company is a very different beast. Google is all about search and direct-response advertising associated with it. Yahoo is basically an electronic publisher supported by "display" ads -- brand-building ads created by large national advertisers, targeted at the specific demographic groups Yahoo delivers.

Yahoo today runs a hugely successful electronic newspaper. It has a news section:



A finance section:



And a sports section:



All of them are totally supported by ads, with no subscription fee.

If you're a magazine or newspaper publisher, you may think that e-publishing finally gives you a path out of the free-web-content trap. But ask yourself what happens when companies like Yahoo realize they too can create electronic publications for ebook readers. Will they charge for subscriptions, or will they create completely ad-supported publications? What does that do to your business model?

I think the periodical has to be rethought much more thoroughly than it has been to date. At its core, the thing that makes a magazine or newspaper valuable to readers is its editorial staff -- a group of writers, editors, and artists who work in synergy to produce a unified product. Rather than asking how to make a magazine electronic, we need to ask what must be built around an editorial staff to make it viable in the electronic world. I don't know what the result will be, but I'm pretty sure it won't look like a print magazine scanned and transferred to a screen.


Publishers: Rethink your value

Although publishers today are focusing on what ebooks do to their distribution channels, the real threat to them, in my opinion, is the likelihood that in the future authors will publish their books directly to the public, bypassing the entire publishing value chain. To understand this challenge, it's necessary to look at the current value chain for books...

An author typically gets about 12% of the list price of a book. The rest of the revenue is consumed by the distribution channel -- the publisher's overhead, the cost of printing and shipping books, the expenses of the bookseller, etc. This is not to say that publishers and booksellers are getting rich. Typically a small number of bestselling books generate the revenue that covers the losses a publisher takes on everything else it publishes. Something similar happens to bookstores. The reality is that the whole publishing value chain is grossly inefficient -- it absorbs a lot of cash, and almost no one gets rich from it.

This distribution chain was stable only when it was the sole way to get a book to a customer. It's already under attack by Amazon, which avoids the overhead of a physical bookstore; and by discount retailers who skim off the best-selling books, absorbing the revenue that formerly supported local bookstores. But that's only a prelude to what's coming.

Because authors get such a small percentage of the sales price of a book today, any system that let them capture more of the revenue from a book sale will be very attractive to them, even if it sells a lot fewer books.

The chart below illustrates my point. For simplicity, I've assumed a best-selling author who gets 15% of the book's revenue, a bit more than usual. The author's new book is going to sell 100 printed copies through the traditional retail channel at $20 each. That means the total revenue for the book will be $2,000, of which the author gets $300.

But if the author sells the book direct to the public as an ebook, he or she will be able to keep 70% to 80% of the revenue (because that's what the online content stores are typically returning). If the store's cut is 25%, the author will make $300 after he or she sells only 20 books.



The red and blue bars show the author's revenue as ebook readers reach various levels of penetration in the book-buying population. The chart's kind of complex, but its main message is that once e-readers are in the hands of about 20% of the book-buying public, an author has a financial incentive to sell direct rather than selling through a publisher.

Fortunately for publishers, e-readers are far below 20% penetration today. They're probably at about 2%. So the business is stable for the moment. In fact, it's probably a little more stable than a lot of publishers believe. We're likely to have a latency period of at least several years while the e-reader installed base gradually grows. During this time nothing terribly dramatic will happen to publishers, and they may think they have the situation under control. But then we'll reach a tipping point, and suddenly established authors will have a financial incentive to go direct rather than bothering with paper publication of their books. Once that happens, all book buyers will have a very strong incentive to get e-readers -- some books by bestselling authors simply won't be available in paper form, or will be available first electronically. This will drive more rapid sales of e-readers, which will give authors even more incentive to bypass the publishers.

Once the dam cracks, the water will move very quickly.

Some notes on this scenario:

--I simplified the pricing story by assuming that ebooks are priced the same as hardcovers. They aren't, so the tipping point is probably a bit higher than 20%.

--On the other hand, Macmillan's move to raise the price of ebooks actually brings the tipping point closer. Every time ebook prices go up, that creates more incentive for an author to go electronic.

--The authors most likely to switch to electronic publication are the established names who don't need a publisher's help in marketing. Those authors are also often the most profitable for a publisher. That means the impact of the switch may be even greater than what I laid out here.

--Products like the iPad bring the tipping point closer, because they are tablets that do other things than just reading books. This bypasses the chicken and egg situation that killed e-readers in 2000. Every time Apple convinces someone to buy an iPad to do browsing or watch videos, that's another potential book-buyer who's ready for ebooks.

--The competition between Apple and Amazon will also probably bring the tipping point closer, because it holds down the cut charged by the online ebook stores. In January, anticipating the iPad announcement, Amazon cut its charge on self-published ebooks to 30%, matching Apple's terms on the iPhone app store (link).


Six critical questions for book publishers

Are publishers doomed? Not necessarily. I think we're going to end up with a range of situations in which some authors sell direct on their own, some use selected services to help them self-publish, and some partner with publishers for services similar to the things they do today. But the publishers will be dealing with new competitors and new economics, and they'll need to rethink who their customers are, and what unique value they can add from the perspective of those people. The time to do that thinking is now, before e-readers reach the tipping point. Here are the questions to ask:

1. Who is my customer, the author or the book-buyer? Most publishers today would say "both," and might add the bookstore to that list as well. But that reflects the print publishing channel structure. In the electronic world, those audiences do not have to be bundled together. There may be some publishers who partner primarily with authors, and are more or less invisible to readers. There may be other publishers that play a very prominent role in the eyes of readers (examples below). The point is to understand which type of publisher you are, and adjust your business accordingly.

2. How much value do my editing services add from the reader's point of view? I've seen quotes from publishers saying that ebook consumers will want to pay more for ebooks that are properly edited. If you believe this, I invite you to re-read the discussion of CDs vs. MP3s above. If a book is poorly edited, people will just blame the author. That means editing is actually a service for authors, not readers. Which brings us to the next question...

3. How much value do my editing services add from the author's point of view? Many authors acknowledge that their editors add tremendous value to their books; others hate their editors. But the key question is, could they hire a freelancer to do the same thing? Question for a publisher: What if some of the people you just laid off form an editing cooperative and then contact your authors with a cut-rate offer?

4. How much demand generation do we really do? This is a place where the perspectives of authors and publishers often differ. Publishers tell me that they do a lot to create demand for books. Authors typically say the publishers just shovel books onto the market and wait to see which ones sell themselves. If the publisher doesn't generate demand, then an author might as well self-publish electronically as soon as it pays more money.

5. Which brand are the readers buying? This varies tremendously from publisher to publisher. In fiction, the author's name is generally the brand that readers respond to. No reader cares who published Steven King's latest book; they just buy Steven King. But in other fields, especially nonfiction, it's more common for a publisher to control the brand. Think of the For Dummies franchise, or Sunset's How-to books, or the role that O'Reilly plays in technical books. I think e-publishing may make those brands even more powerful. A traditional publisher can help a paper book sell well by working behind the scenes to get bookstores to promote it -- put it on the table out front, place it on an endcap, and so on. Most of that promotional opportunity doesn't exist in an online store. Instead, your product is just tossed out there in a sea of other products, and it has to succeed or fail on its own. In that world, a recognized brand naturally floats to the top. That's why the Madden football game on iPhone costs $7 while many other iPhone games sell for 99 cents.

6. What sort of book am I selling? Writer/publisher Craig Mod wrote a splendid essay discussing the difference between books that have form and books that do not have form (link). Books that have form get some value from the physical book itself -- maybe it's the arrangement of text and images that creates a certain impression, or maybe it's the need for something physical (think of a coffee table book or a gift book). Those books are not going to be cannibalized easily by electronic publishing.

On the other hand, formless books (those that don't get any special value from the physical form of the book) are ripe for the picking. Think paperbacks and general-consumption fiction and nonfiction.

I'll leave you with Craig's hopeful picture of what this all means for the future of books:

You already know the potential gains: edgier, riskier books in digital form, born from a lower barrier-to-entry to publish. New modes of storytelling. Less environmental impact. A rise in importance of editors. And, yes — paradoxically — a marked increase in the quality of things that do get printed.

When we're confronted by all the downsides of change, it's important to remember that change also brings progress. If publishing gets a lot more efficient, we should see greater diversity of new sorts of publications, as well as the rebirth of a lot of old books and stories that we can't get to today. That's a future to look forward to -- as long as you can figure out how to keep your job during the transition.