Wednesday, February 27, 2008

The promise and perils of DRM-free music

It has been a fascinating few months for digital music. We've seen Apple become the second largest music retailer in the US, and we've also seen all the major labels sign up to sell music digitally, on Amazon, as MP3's, and DRM-free.

I'm worried about the latter development. Yes, the labels see the need to thwart Apple's growing channel power (which stems from their control of the "rendering interface"). If iTunes becomes the de-facto channel for buying digital content, it seems like only a matter of time before Apple starts to get a larger fraction of the revenue (right now, seems like the labels get at least ten times what Apple gets in operating income when you buy an iTunes song). This kind of channel control becomes even more critical as video and books become digital.

But if the music labels give up rights and distribution, they need a new business model. I see why they'd want to stymie Apple's growing channel power, but I'm really not sure this "DRM-free" choice is a good strategic move. I always felt that the pure digitization of music represented an opportunity for the labels to manage digital rights. As one of my student groups pointed out on Monday, 90% of music sold legally is still DRM-free -- all music sold on a CD.

So embracing DRM seems like a good way to sustain control in a digital future. I guess the labels didn't understand that they should have taken control of the DRM and rendering standards as well. They could have if their executives were tech savvy, or if the people who understood technology were the decision makers. But they were not. Giving these standards to Apple resembles the mistake IBM made by giving the operating system to Microsoft back in the early 80's, when PC's were new. Which has led to Microsoft capturing a vast majority of the revenues from PC sales over the decades -- $20 billion in operating income this year alone from Windows and Office.

Stripping DRM is perilous at this point. Owning the DRM standard and the rendering interface are what will define market power and channel c0ntrol in the digital economy. Apple has this to lose -- but they need to share if they want to leverage it over the next decade.

Monday, February 25, 2008

Micosoft and Yahoo: More than just a marriage of search

As Yahoo waits for a higher bid and Microsoft contemplates a proxy fight, it is useful to take advantage of this lull to think about why this merger makes sense. Everyone is thinking search, online advertising and the (losing?) battle with Google on these fronts, a strategic focus that has been sharpened further with the release of the text of a memo from Kevin Johnson a couple of days ago.

However, let's take a look at Microsoft's revenue breakdown (these numbers are from their most recent 10-K):

(read "Client" as "Windows" and "Business Division" as "Office")

Sure, acquiring Yahoo could provide some momentum to the flat online services revenue curve. But this is still a pretty small slice of Microsoft's revenue pie. Even more telling is this breakdown of operating income, reminding us that a vast majority of the money Microsoft makes still comes from Office and Windows, and the rest from their enterprise business.


Alright. Now, I just finished Nick Carr's new book, The Big Switch, and I have to say that his arguments and technological sophistication have become admirably nuanced. This is a prescient read, one I'd recommend highly. So, let's say we're evolving towards a (distant) future in which a lot of basic IT infrastructure moves to massive computing grids. Microsoft has deep (although perhaps not all willing) customer loyalty in the PC world, and an impressive revenue stream (~$11B) from its server customers. If they're thinking ahead about a future in which this software is delivered over the Internet, wouldn't an ideal acquisition be a company with deep and diversified consumer relationships in the online world? And with technological sophistication and experience in delivering rich computing experiences over the Internet? Frankly, to me this sounds a lot like Yahoo! (which, Google aside, is one of the most Internet technology-savvy companies there is). Yahoo! is the online truly diversified portal left standing. It has an impressive range of properties that engage it's consumers. And notice the technological leadership it has taken with Hadoop.

Perhaps some of this is speculative thinking. And maybe the specter of a Google-owned online advertising world is part of the short-term motivation for the acquisition, and maybe online advertising will be the revenue engine for specific kinds of consumer software in the near future. But to me, this merger (which seems like it will happen) won't just be about search. It will determine who owns and controls future consumer and enterprise computing.