Nostradoofus

VC investment in GPL projects. The very idea recalls an old military saying about the F-14 Tomcat (or, some claim, the F-4 Phantom): “America’s proof that given a big enough engine, even a brick can fly.”

Certain GPL investments similarly remain commercially airborne with immense investor thrust behind them. But this will be unusual, and the main result will simply be to consume a lot of fuel. Software has been so successful for VCs for so long that it’s taking an inordinately long time for them to recognize the sea change: GPL closes down the old opportunities in software, and creates new opportunities that are not in software, at least not directly. Why? Basic microeconomics, and basic Michael Porter.

Software investments traditionally generate returns in two possible ways. First, you can create high customer switching costs through software complexity and/or ownership of proprietary interchange formats. Second, if you can capture enough of the market to permit enormous fixed investment in your source base, outspending any other potential entrant — economies of scale.

GPL does away with both of these possibilities. Economies of scale become impossible, because your fixed investment is automatically shared for free, no matter how large. Switching costs become nearly zero, because file formats and feature sets are no longer proprietary. In both cases, no matter how big you get, any 15-year-old in his bedroom can download your source code and compete with you.

This does not eliminate market power, it just moves it around. Anybody in the business of selling licensed software (Microsoft, Oracle, etc.) is in decline. They can’t possibly compete with a price of zero — all they can do is slow down the transition through FUD and customer relationships. Over time, all such product business will turn into service businesses.

But the biggest companies can mine their patents. A likely endpoint for Microsoft, 15 years from now, is as a seller of services and a licensor of its vast patent library. How large that business may be is not knowable.

And users of open source will thrive, when they can set up switching costs that are not related to the software itself. Google, eBay and Amazon all have this quality.

Nothing in this article should be construed as yet another dull argument about who is evil and who isn’t. I happen to think Google may become a larger, more powerful monopoly than Microsoft at its peak. That is not to say Google or Microsoft are good or bad — I’ll leave the moralization to the guys at Slashdot, because they’re so good at it.

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eBay is not the only deflationary force on the Web. The improved availability of replacement parts has a similar effect.

My toddler son (we’ll call him Baby Godzilla, though that’s not his real name) recently tried to eat our DVD remote. Though he couldn’t bite through the plastic, B.G.’s caustic saliva immediately corroded and disabled the remote. Like most DVD players, ours can’t be used without the remote.

As late as 2002, it would have been prohibitively time-consuming to locate a replacement part for a three-year-old Toshiba product. Net of the value of our time, it was simply cheaper to junk the working player and buy a new one for $60.

Not now. In 10 minutes we found the exact replacement OEM remote for $25 including shipping. Not exactly a bargain, but much cheaper than buying new. The world economy just deflated by $35. Do you hear it hissing?

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What happens to the price of new things when you can get absolutely anything used?

Any frequent eBay user has done something like what I did last month. I decided to upgrade a creaky 2000-vintage Dell server with 5 new hard disks. Each disk needs a little mounting tray, made only by Dell. Total cost to buy the trays and disks through Dell is about $1,000.

Enter eBay. After a 5-minute search, I found a guy in Arizona selling the exact same thing for a total of $75, including shipping. How does the guy in Arizona do it? He buys and disassembles ancient Dell servers, adds overstock new hard disks purchased in bulk, and resells to guys like me. EBay is almost perfectly competitive, so prices are driven nearly to marginal cost. Total saving: 92.5%.

EBay is still growing fast, of course. What happens between now and the equilibrium point, someday in the future, when everyone routinely buys and sells used items that way?

Beneficial deflation.

Prices on all readily shipped manufactured goods appear likely to fall in real terms. The longer an item lasts, the farther the price seems likely to fall, as the market is saturated with an ever-growing supply of used items.

Given the global imbalance in manufacturing these days, you might interpret this as great news for the US, and terrible news for China. What happens to China’s toy manufacturers (which now make 85% of all new toys worldwide) if parents suddenly start buying used toys for Christmas? Don’t laugh — it’s still very early in this transition. Culture can change in unexpected ways when presented with huge financial incentives.

If something like that happened, toy makers would be forced to compete on a large scale with their own past output. The results aren’t pretty. Manufacturing overcapacity. Falling prices. Intense pressure to innovate and automate. It’s a consumer’s dream and a manufacturer’s nightmare.

Naturally not every product works as a used item. But this force is so powerful, and its effects so far-reaching, that it might not be such a bad thing that manufacturing is all going offshore…

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There is a battle brewing between Google and eBay. Google looks stronger.

Adwords is a significant substitute for eBay. Small vendors can buy customer visits through micropayment advertising, as an alternative to paying eBay an auction fee for access to eBay visitors. Signals have been accumulating for some time:

1. eBay discovered in January that it no longer has power to raise auction prices, because larger sellers are balking.
2. eBay announced it is entering the private-label merchant site business, to slow down departures of its major sellers.
3. Google announced Tuesday it is entering the payments business.
4. It’s been true since Adwords inception that Google does not accept PayPal as a form of payment.
5. Meg Whitman was caught angling for Eisner’s job at Disney a couple of months ago.

Taken together, one might infer that Google plans to eat eBay’s lunch, and eBay is scared. Will be interesting to see what happens.

I don’t mean to suggest eBay would cease to exist. Their auction business is still great, still a natural monopoly. However, a big chunk of eBay sales (a third? don’t know for sure) come from professional sellers that aren’t really auctioneers, but rather fixed-price vendors holding auctions to take advantage of eBay’s network. They would probably rather operate their own websites and run their own ads, if they can make just as much that way. Their presence on eBay has never made sense to me — private sites and Adwords are a simpler, better branded, more logical arrangement, if the scale and ROI are similar.

Say you are a doctor trying to collect payment from Blue Cross. You employ an offshore call center to do your collections. Your guy in India phones Blue Cross, which also employs offshore call centers to process payments. The call is patched back to India. Presto! Two call centers are yakking with each other on your nickel.

Picture two sari-clad women walking into a Bangalore office building each day, saying, “Morning Ralph. Morning Sam.” They sit with headsets in adjacent cubicles, arguing about American medical payments — with each other — for 8 hours. “Good night Ralph. Good night Sam.” Repeat for 40 years.

Adam Smith works in mysterious ways.

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