Archive for January, 2008

Hannah Montana Once Again

January 30, 2008

Since it was a economist’s view from the Federal Reserve of Richmond on Hannah Montana concert tickets that started it, I figure this Freakonomics post yesterday serves as an appropriate coda.

Steven Levitt, a promise to his daughter to take her to a Hannah Montana concert, a sold out show…I won’t spoil the ending. Worth the read.

I quickly realized how out of touch with reality I am—the event was “sold out” and the ticket prices on various scalper sites were beyond reach for this academic’s salary. I concluded that I would take Annika to the local Wal-Mart and buy her a Hannah Montana CD and doll in lieu of the show.

Can I Drive Your Magic Bus?

January 29, 2008

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I don’t take the bus much. I prefer the subway. But a Harvard mathematician has created a very cool model for deciding whether it is optimal to wait for the bus or walk and catch the bus at a stop further along the route.

I’m not surprised that the optimal solution is the simplest: wait for the bus.

It also highlights quite nicely our inability to properly and objectively make decisions based on even just a few variables.

Anyone standing in the cold for 20 minutes waiting for the bus usually finds himself considering walking to the next stop. The risk, of course, is getting caught between stops and watching the bus go by. But 20 minutes in the cold is a long time to wait.

Every economist and business school student knows to ignore the sunk cost — the time already spent waiting — as it should have no bearing on the current decision at hand: wait or walk.

Knowing and applying are very different. We all do mental accounting and usually in an irrational way. A classic example is the Arkes and Blumers theater ticket example.

Season tickets to a theater are sold to three groups. One group pays full price. Another gets a small discount (13%) and the third gets a large discount (47%). Attendance for the first half of the theater season reflects the irrationality of the sunk cost effect.

Those who paid full price attended more shows during the first half of the season. Having spent the money, they wanted to get their value.

By the second half of the season, however, all three groups had similar attendance. The sunk cost of purchasing the season tickets was correctly ignored.

To make matters worse, there has been some analysis that we don’t apply the sunk cost principle as well to time as we do to money.

Most projects involve both. “We’ve invested lots of time and money into this,” is a common refrain. It’s why even those familiar enough with the sunk cost trap sometimes find themselves neck deep.

We can so easily misunderstand our own irrationality to time’s sunk cost even while properly identifying the economic sunk cost.

Where financial modeling is most prevalent, where supply and demand can be most accurately forecast, it is easier to avoid the sunk cost traps. Think the net present value of building a new oil pipeline or another semiconductor plant.

Hits based businesses where demand is often a complete unknown are the ones that sink into quicksand. It’s why the music and studio industries are spending so much time fighting piracy. In their own words, they are trying to defend their investments, their catalogs, their property.

Asset value is not the same as sunk costs. And I’m not suggesting the labels and studios stand there and wait for the bus.

But the constant fits and starts, subscriptions, streaming, RIAA wars, etc echoes the least effective tactic in the bus model: the person who waits then walks only to be passed by a bus only to wait again at the next stop. Repeat.

Guy Hands isn’t the first to correctly discard the sunk costs and apply a new rationale in how EMI will evaluate artist decisions going forward. While it remains to be seen how his plan will work, the more interesting choice will be on the artist side:

Whether successful artists will ignore their own sunk costs, both time and money, and make the right economic decisions for their future.

It’s hard for acts who have spent their whole career with that manager or this label. Loyalty is usually the rationale for the time based sunk cost trap. But Radiohead has already stepped to the head of the line as have The Eagles. Others will follow.

Thank you, driver, for getting me here (too much, magic bus)
You’ll be an inspector, have no fear (too much, magic bus)
I don’t want to cause no fuss (too much, magic bus)
But can I buy your magic bus? (too much, magic bus)

Goldman & Retail

January 23, 2008

In yesterday’s down market, Goldman and retail both managed to close up. And in today’s 500 point turn-around, GS and the other financials and retail led the markets higher.

Market nervousness is understandable. What is popularly called a “credit crunch” isn’t. It’s a liquidity crunch. Rates are low enough that capital is historically damn cheap — if you can find someone willing to lend to you. For the triple A rated corporate names, the same who have been buying back their stock for two days, access to capital is still there.

On the CDO/MBS side there is still the issue of finding a willing buyer. It’s not that slicing and dicing mortgages is bad. It’s that no one really knew what was in the baskets or how to value them properly — and, more importantly, how to assess the risk. Fixing that will take lots of math models and a heck of a lot of back testing.

I don’t trade so the high volatility doesn’t do me any good. Would I have loved to buy GS at $175 yesterday in light of today’s $199 close? Sure thing but only those glued to a trader’s screen or fortunate enough to be online and paying attention at the time can reap. An investor has the luxury of ignoring a down day, down week, down year. Traders have to go to sleep every night hoping the positions they still hold don’t tank in the morning. Stomachs of iron. It’s why I don’t care what happens tomorrow.

We’re still a consumption society and retail will be the driver. And cheap capital is always good for the financials and the smartest one out there is Goldman.

Someone asked me the other day what I thought of Apple — hammered these past two days on the financial guidance in yesterday’s earning call. My answer was simply: too much risk with Steve Jobs. Only Berkshire Hathaway and Mr. Warren Buffet come close to how important the head honcho is to the company. Something bad happens to El Jobso and Apple takes a nose dive back to earth.

I’m not comfortable with being one bad jet landing away from a 50% drop. Love Apple, respect the hell out of what Jobs has done for it the past 10 years. It is because of that, because I see no one even close to being able to fill his black turtleneck that I avoid Apple. Sure, there’s Keith and Ronny and Charlie but lose Mick Jagger and the Rolling Stones just ain’t the Rolling Stones. Apple without Jobs? It was tried before and sucked serious wind.

What Happens Next?

January 22, 2008

Back in March 2007, I wrote:

Bernanke will no longer be worried about inflation brought upon by a hot housing market and rising commodity prices (e.g. oil) but will be looking a recession in the face. He’ll start to ease rates which will lower the APR on all those adjustable rate mortgages and inject more liquidity into the markets while companies increase capital spending yet again. Cheap money is king…

In the face of the the overseas market meltdown, today the Fed dropped the Fed Funds rate by a whopping 3/4 point — now down to 3.5%. And the markets still show a sharp drop at open.

What happens next deserves a cursory recap of what happened.

First, the sub-prime mortgage market imploded partially due to poor oversight and worse structure. Then, in a severe case of denial, the big banks who chopped and diced these fixed income baskets declared the pain would be contained to sub-prime only. Of course, they were wrong.

Whether it was poor visibility or just ignorance, the banks took write-downs then more write-downs then more. Pulling the band-aid off slowly always hurts that much more. Always waiting for another shoe to drop instills anxiousness, not confidence.

Finally, the Bank of China is now wary of its fixed income exposure, completing the virus’ spread globally.  Meanwhile, commodities continue to rise. Oil, orange juice, grain. All of them cost double or triple what they did but a few years ago.

So what happens next?

First, an economy does not live on monetary policy alone. The Fed can continue its rate cuts but Congress and the President will need to one-two punch with fiscal policy. Of course, it’s much easier for the Fed to act than Congress. We’ll get a fiscal package but what it will end up looking like is anyone’s guess.

Second, the banks must work through their mortgage portfolios. Until they are comfortable buying and selling CDOs again, we will continue to wallow in the mud. This can’t happen until the housing market bottoms out. Low mortgage rates alone can’t fix this as lower rates without banks willing to lend at those rates won’t do much.

While most of the country has already seen housing declines, there’s still a shoe or two to drop. It will bottom but we’re months from seeing the floor.

Long-term views are always the most comfortable. Being able to ignore the ticks of the daily market is a luxury the investor has that the trader doesn’t. I watch retail and Goldman Sachs.

Consumption still drives the US economy and the drop in housing values makes Americans feel poorer and unable to tap their home equity to continue to shop. Strength in retail will be the key to confidence returning.

And watch Goldman Sachs, the smartest bank on Wall Street. As the Fed gives GS access to cheaper capital, they should be able to generate big profits.

Next? More uncertainty, more pain, more rate cuts, some huge Washington fiscal package that does little. A cold winter until the rate cuts start to actually take effect in the Spring when the banks with access to cheap money start to lend again.

Thinkpad X300 versus Macbook Air

January 20, 2008

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Back in October, I wrote that my current and beloved Thinkpad X61 would most likely be my last. I speculated I would be moving to the yet-to-be announced Mac ultralight. I hate Vista that much.

And just like that at MacWorld, Jobs announces the MacBook Air, Apple’s 3 lbs slim machine.

It’s a good thing Lenovo leaked its forthcoming Thinkpad X300 lest I be too tempted by the svelte Mac.

The specs on both machines are pretty similar:

Weight is 3lbs for the Air and 2.5lbs for the X300

CPU is a dual core 1.8Mhz for the Air and a Memron 2Ghz for the X300

Both have (optional on Air) a 64MB SSD drive

The Air is thinner. The X300 has EVDO and more ports.

At around $3k for each, these machines are more alike than they are different. But the real kicker? The Thinkpad X300 should have Windows XP as an option. I can avoid Vista.

It sure is tempting. Neither laptop is shipping so no decision to be made. I probably would be comfortable running XP for another year or so and see if Microsoft’s late 2009 next-gen OS can wipe the Vista bad taste off the mouths of a billion PC users.

And SSD drives should increase in capacity and drop in price in the next 12 months. I speculated that my X61 would be my last. The X300 may just keep me in the Thinkpad fold for one more generation.

A “Spear in the Neck of the Pirates”

January 15, 2008

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In just a few hours, Steve Jobs will take the stage at MacWorld 2008 for his keynote. The live feed will be on the net and there will be thousands of posts by the time he walks off the stage. Later this evening, every local and national TV news will report on the new products. Tomorrow, all the newspapers will carry the story.

The Cult of Mac – more aptly, Steve – is astounding to watch. No other company can generate this much buzz. For a reason. People like Steve’s products. They use them in their daily lives and praise them more often than they curse them. Not an easy task in the world of technology. And Steve has proven a knack for leading industries.

The latest industry Steve may lead: the studios that produce and distribute movies and television. It is anticipated that Apple today will announce a movie rental service for its iTunes product and perhaps an upgrade to AppleTV.

This comes as the WGA strike is now two months old — with the very issue of internet residuals at the forefront — and the movie and TV industries are facing important decisions that could impact the very health of the industry. A crucial fork in the road.

Will the studios learn from the moribund music industry and embrace change or follow the music labels down the false path that fighting piracy is the grail quest?

If Harvey Weinstein is any indication, it doesn’t look good.

Portfolio Magazine has an essay on Media Defender, a troubled grail seller hired by media companies to block their content from flowing freely through the P2P world. That Media Defender’s tactics rarely actually work seems beside the point.

“This is not Napster,” says Harvey Weinstein, the movie mogul who heads the Weinstein Co., a MediaDefender client. “Online piracy has got to be stopped. The biggest spear in the neck of the pirates will be (a) being vigilant, (b) prosecuting, and (c) in a way, making fun of them, finding a way to say, ‘That’s not cool—that’s anything but cool.’ If you had people who the young people respect in this industry—Brad Pitt, George Clooney, Shia LaBeouf—if these guys did public service announcements that said, ‘Don’t steal, stealing’s not cool,’ I think you can go a long way toward stopping this.”

Sure, the quixotic pursuit of pirates has sapped the music industry of any real chance of embracing its fans. Sure, shelf space for DVDs is following the shrinking trend of CDs — even if Warner Bros may have ended the fight in favor of Blu-Ray. Sure, the movie industry has the benefit of learning from the implosion the music industry has self-inflicted. But screw all that. Let’s spear pirates in the neck!

Today, at least, it seems the studios are playing ball, letting Steve work his magic to get consumers excited again. And sure, the studios look to the music biz and see a declining model while Apple rakes in billions. Which makes them nervous. But they would be wise to remember that it isn’t because of Steve that the labels are dead.

The labels killed themselves by ignoring consumer demands, relying on formula and stale strategy, and, most stupidly, focusing on killing piracy as the grail that solves everything. The labels have made themselves into consumer adversaries wielding lawsuits and DRM then wondering why consumers hate them so.

Later today, as Steve takes the stage, as thousands pour in to hear him speak and millions more read and hear about it from the news, the studios should stop and consider exactly what kind of relationship they want with consumers in the coming years.

Do they want consumers to listen and care — like Steve?

Or do they want to be ignored and hated — like the labels?

Lest they forget, at the end of the day, these are multi-generational brands. Whether it be Tinker Bell’s wand magically making Disney’s logo or the 20th Century Fox trumpets or MGM’s lion’s roar, consumers have a lifelong association and relationship with these companies.

Sure, good content is the crucial key to longevity, but the studios have proven for decades that a few bad movies here and there won’t kill the golden goose. And yes, stars and name brand directors and adapted screenplays generate the buzz but the studio brands ultimately span multiple generations. Will Rogers, Betty Grable, and Shirley Temple are long gone from Fox as are Humphrey Bogart and Doris Day from Warner. But the studios survive.

The record labels are losing artists. Tim Clarke, Robbie Williams’ manager called EMI’s head honcho, Guy Hands, a “plantation owner.” And EMI is set to slash one third of its workforce today. The WGA strike has canceled the Golden Globes and Oscar is just around the corner. All the while Steve Jobs is about to bask in that annual worship ritual known as the MacWorld keynote.

Decision time for the studios: Listen to and give the consumers what they want or beat them upside the head with DRM and lawsuits?

Do they want to be loved like Steve or hated like the labels?

Fruit and Flowers

January 14, 2008

The Economist has a not-so-sunny view of the music biz focused on EMI.

Sure, EMI is saving money these days by cutting the RIAA payments and eliminating that (cough) sundries budget. Drastic head count reductions to follow. After all, with the loss of all those artists, might as well slim down. Let the axing begin!

Now, having got rid of most of EMI‘s senior managers and revealed embarrassing details of their spending habits (£200,000 a year went on sundries euphemistically referred to in the music business as “fruit and flowers”), Terra Firma is due to produce a new strategy later this month. But many observers reckon the private-equity men are out of their depth.

The Stupid Contest

January 8, 2008

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In an expected move and coming quick on the heels of Warner Music’s announcement, Sony BMG has announced it will offer DRM-free downloads. This means that now all four of the major labels have embraced a DRM-less solution in one form or another. Good news?

Not so quick. It seems each of the major labels is intent on trying to out stupid the others. Anyone taking an even cursory view at the music biz can understand what a tough job that is but Sony may just take first place this week.

This is how the Sony BMG system will work:

Find the album you want. Then drive to the store and purchase a digital album card. Drive home. Scratch off the silver mystery crap. Go to the website. Enter the 297 digit code in 3 point font from the back of the card. Download MP3 goodness.

Seriously. The only thing I made up is the 297 digit code. Everything else is true. You have to go to the store to buy the physical card to download the digital files. Really.

It’s like offering a video on demand product where you go to Blockbuster first to get the code to drive home and enter into your cable box. WTF are these guys thinking?

This is a product that makes the Ringle look like pure genious. Sure, US physical album sales fell 10% last year, artists are defecting labels in droves, and pretty soon you’ll be able to buy one of the big four for less than the price of a latte, but here comes Sony BMG to the rescue.

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(Howard Stringer commuting to his Sony office)

That this plan was approved truly astounds me. Why would any artist stay with a company that would launch this?

Somewhere in all of these record label announcements is the eulogy for them all. And Steve Jobs is laughing his ass off.

Blu-Ray By A Nose

January 5, 2008

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Back in October 2006, I wrote that I was sitting out the Blu-Ray versus HD-DVD wars and a year later when Dreamworks took a cash payment to go with HD-DVD, I wondered if the stalemate would be permanent.

Now news comes that Warner Bros. will go Blu-Ray exclusively. The reason? Because the format war was not only hurting both formats’ player and disk sales but was also beginning to eat into DVD sales as consumers stopped buying disks altogether. Warner Bros. smartened up and decided that continuing a war when ever more download movie options are coming online — including the rumored AppleTV streaming rental product — would be a bad move.

This is, to be sure, a big punch but not the knock-out blow. That could come from Apple on January 15, 2008 during MacWorld. If Apple finally adds Blu-Ray drives to its refreshed MacPro line, HD-DVD doesn’t stand a chance.

The irony will be that Apple will most likely deliver the knock-out punch to HD-DVD and elevate Blu-Ray as the victor just as it brings its AppleTV product into the realm of usability by adding both internet streaming capability and 24 hour movie rentals. Since high def content most likely won’t be available on Apple’s streaming product, Blu-Ray will have some time to get traction with consumers.

I’m not jumping on Blu-Ray just yet. I’ll watch how things shake out in the next few months but I certainly have my eye on my first Blu-Ray purchase: Planet Earth.

New Year

January 4, 2008

Nothing like welcoming in the New Year with a head cold for six days and counting. So what could possibly get through my marshmallow filled head and out of bed to get me to write?

The rumors that Jay-Z will head up a record label for Apple.

I’ve got such a hard time eating this one. It just tastes bad.

First off, Apple has enough of a fight with the labels. With WMG’s recent move to offer its wares DRM-free on Amazon, Sony remains the only major label holdout still drinking the DRM kool-aid. All those DRM-less tracks pose a direct threat to Apple. The labels are trying to gather for a fight. Sure, it’s pretty much too late but it’s a fight.

So why would Apple directly compete with the labels so brazenly? The labels are already freaked out by 1 Infinity Loop. No need to take them head-on when they are perfectly capable of defeating themselves.

Secondly, the very concept of a record label is now archaic. One of a label’s main functions is to find, sign, and nurture new talent. Apple should have no desire to enter that venture capital game. Leave the A&R to others. Sell music that someone else has paid to make.

Apple is a retailer. There are ways to offer bands without major label distribution a spot on iTunes. Apple already does this. It should continue to do so without venturing further back in the supply chain.

Third, Jay-Z would be a strange choice for Apple considering the demise of hip-hop’s marketshare. Nothing against Jay-Z. He’s A-list talent but the fit with Apple just isn’t there.

I could see Jay-Z acting like a celebrity buyer, hand-picking those artists who submit their wares to Apple for possible promotion on iTunes. A programmer choosing who to push. But that’s different than acting as a label, than sourcing and recording new talent. The recordings are already done. Jay-Z would just be picking the wheat from the chaff from an already harvested field. But Apple already has people who do this.
But all things Apple become front page fodder. Success begets rumor like nothing else especially in the music biz where the edge of the cliff keeps inching ever closer.

2008 will be another terrible year for the labels. Guy Hands will continue to captain the sinking ship known as EMI as ever more artists jump off his label. Ticketmaster is losing Live Nation which itself will have to contend with a 2008 devoid of huge touring names. Consumers will continue to buy iPods and Guitar Hero III and the music industry will flounder until it becomes too much.

There will be some major change in 2008. There has to be. In the chaos is opportunity, especially for the artists. They just have to, as Apple suggests, Think Different.


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