Felix Salmon

A couple of weeks ago, the WSJ’s Brody Mullins had a big story about the fact that the SEC was investigating a political-intelligence consultancy named Marwood. Marwood doesn’t seem to have done anything wrong, but the very fact that it was being investigated was, at least as far as the WSJ was concerned, front-page news.

This week, Mullins has done it again, this time with an SEC investigation of firms which provide financial data. Once again, there’s nothing in the story to suggest that any of these firms, which include Bloomberg, Dow Jones, and Thomson Reuters, have broken any insider-trading rules. And yet here’s a juicy front-page story all the same, based entirely on the fact that there was an investigation at all, regardless of whether the investigation actually discovered anything untoward.

I’d love to know the story behind these stories. It seems pretty obvious that they’re being leaked by the SEC, in a way that seeks to embarrass the subjects of the probes as much as possible. Marwood and Bloomberg and Thomson Reuters might have done nothing wrong at all, but if the WSJ determines that there’s front-page news here, then its readers are surely expected to conclude something about smoke and fire.

There’s a clear implication in the latest story, for instance, that the data companies in question (which include the WSJ’s corporate parent) did do something wrong, and that they’re just lucky the SEC can’t prove it in a court of law:

Investigators decided against filing charges because they couldn’t link the pattern to specific actions by media companies, people familiar with the probe said.

A key issue, one of the people said, was whether the government could prove in court that a time advantage for a trader of a sliver of a second—as little as a few thousandths—was enough to conduct profitable trades on confidential information.

Even so, these people added, investigators continue to have general concerns about the handling of federal economic data.

This whole thing has a decided whiff of “doesn’t the SEC have anything better to do”. For one thing, to answer the SEC’s question, it’s not at all obvious that getting information a few thousandths of a second ahead of anybody else would allow some computer somewhere to conduct a profitable trade on the information. Firstly, big economic data comes out before the stock market opens, which means that any profitable trades would have to take place either on the much less liquid out-of-hours market, or else on the bond market. Both of them are largely free of high-frequency traders.

Yes, there’s a lot of trading and jostling and positioning in the bond market in the run-up to a big data release, but I can pretty much guarantee you that all markets are in holding-their-breath mode when it comes to, say, the final couple of seconds. The traders and the algobots are short or flat or long, they’re waiting for the number, and then they’ll burst into action as soon as the number is released. If you want to trade a couple of thousandths of a second before the number is released, you’re going to be looking for a counterparty who doesn’t know what the number is but who is willing to trade anyway. It’s hard to imagine such counterparties exist.

The news agencies can blame themselves a little bit, here, because they have for many years been highly invested in the idea that if you get a certain piece of information first, even if it’s just by a fraction of a second, then you can make a huge amount of money. All of them get incredibly excited about the times when they move the market: when a story comes out, and then some financial instrument — normally a stock, but a commodity will do in a pinch — moves sharply on the news. They charge a lot of money for their real-time news feeds, and the implication is something like this:

1. The news hits the wire.
2. A smart trader, staring intently at his newsfeed, sees the headline cross the wire, and immediately groks the implications.
3. The trader then puts in a monster buy/sell order, picking off a bunch of tortoises who aren’t smart or rich enough to subscribe to the wire service in question.
4. The price moves sharply.
5. Monster profit!

It’s a lovely story, but it’s also a fairytale: things don’t actually happen that way. In the real world, when a piece of news hits a wire, at that point it’s public. And once it’s public, the market then reflects that public information in the share price. If you’re a broker-dealer who was quoting a security at one price before the news came out, you’ll now be quoting it at a different price after the news has come out.

The key question to ask is this: how many trades happened (a) at the old price, but (b) after the news became public? Most of the time, the answer is zero, or very close to zero. News headlines often move the market, but that doesn’t mean that someone has gotten financial benefit from reading them first.

The point here is that once a headline crosses the wire, that information is, by definition, public. And if it’s public information, it can’t be insider information. There are lots of good reasons why the U.S. government and rival news agencies would be cross if one of the wires published that information a fraction of a second before the other ones did. But just because someone is cross doesn’t mean that laws have been broken, or that inside information has been traded upon. An embargo is an agreement between a news source and a journalist; it’s not something to be enforced by the SEC.

So I do wonder what the SEC thought it was doing, here, conducting what the WSJ describes as a “technically and legally complex” probe. What exactly was the SEC hoping to achieve? And why is this weird investigation, in and of itself, newsworthy as anything other than a waste of government resources?

I’m in Munich, for the DLD conference, where Ben Horowitz took the opportunity to introduce the Rap Genius guys to the European digital-media crowd. But it’s actually Horowitz’s partner, Marc Andreessen, who has the best explanation of what the investment is all about:

Back in 1993, when Eric Bina and I were first building Mosaic, it seemed obvious to us that users would want to annotate all text on the web – our idea was that each web page would be a launchpad for insight and debate about its own contents. So we built a feature called “group annotations” right into the browser – and it worked great – all users could comment on any page and discussions quickly ensued. Unfortunately, our implementation at that time required a server to host all the annotations, and we didn’t have the time to properly build that server, which would obviously have had to scale to enormous size. And so we dropped the entire feature.

Andreessen calls this “annotate the world“, and, as he notes in his post, it’s a very old idea indeed; the prime example is of course the Talmud, although you can probably trace it back to Socrates and even earlier. Up until now, however, annotation has been given short shrift on the web.

We’ve had a few other things instead: there’s commenting, of course, which is being constantly reinvented but never seems to be done well, and there’s also the kind of layered editing history one finds at Wikipedia, which is very hard to navigate. The promise of Rap Genius is to take the granularity and teleological iteration of Wikipedia edits, and make give them the visibility of a comments section.

But is the opposite possible? Recently, two different people told me on the same day that they were going to launch a comments section based on annotations — where readers comment on individual sentences or paragraphs or arguments, rather than a story or post as a whole.

The promise here is twofold: it helps the conversation stay on topic, and it also raises the possibility of really improving the original post, keeping it updated and accurate, all through crowdsourced technology.

I like the idea of moving from comments to annotations, if only because existing commenting technology just hasn’t worked well at all, and just about anything else would probably be an improvement. It shouldn’t be distracting, however, which is a problem: the annotations at Rap Genius are very obvious, because they’re the heart of the site, while most bloggers and news organizations would not want to give their commenters quite that much prominence. And of course it should be social: I’m certain to be particularly interested in the comments of my friends.

The first versions of these systems are going to be clunky and annoying — version 1.0 of anything always is. The only way to learn what works in practice is to roll something out and see what happens. But if this takes off, it could be a significant evolution in the way that we talk about web content. Right now, for instance, if I want to link to something somebody said on a web page, I’ll normally just end up linking from Twitter to an undifferentiated page, rather than to the specific thing being said. And more generally, the conversation around things like blog posts tends to happen mostly on Twitter and Facebook, where it’s easy to miss and almost impossible to archive.

It would be amazing if annotation could change all that, helping to make comments more on-point and also providing a centralized archive of the conversation around any given story. I doubt that Rap Genius will be the company to do that, but internet comments are more of a bug than a feature these days, and I do think that annotation is a very promising way of potentially addressing the problems they have.

Talking of VCs who don’t like it when founders decide to sell, here’s Marc Andreessen on the subject of the $1.26 billion sale of one of his portfolio companies, Nicira:

That company, standalone, would have done about $2 million of revenue this year; we just sold it to a public company, VMware, for $1.26 billion. We think that [the founders] sold too soon and too cheap. We wish that they hadn’t done that. We’re happy for their outcome, and they’re at VMware, and I think they’re going to be a huge success at VMware. We wish they had stayed an independent company. Because if they had succeeded in their vision as an independent company, it would for sure have ended up being worth many multiples of the $1.26 billion.

But there’s a problem with this kind of attitude, which Andreessen is well aware of: he doesn’t invest forever, and at some point his limited partners are going to want to see a return on their investment. If companies don’t sell, and they don’t go public (Andreessen isn’t a fan of going public, either), then how can VCs get their exit? Andreessen has an interesting answer to that one:

We want to fund the companies which are so successful, and so in control of their own destiny, that they don’t sell, and they also, ideally, don’t go public. And then in 10 years, 15 years, they’re all sitting in our portfolio; they’re all big, and successful, and private. And then we get  just enormous pressure and backlash from our limited partners, our investors, saying, basically, where’s my money. Why haven’t you taken these companies public, why haven’t you distributed the stock.

It’s a smart way of putting it: most VCs would love to have the problem of (a) owning the next Google, or Amazon while (b) not having returned the relevant stake to their investors. But there are two big problems with this model, beyond the hypothetical-future-fights-with-LPs problem. The first is that VCs concentrate very much on something called compound annual growth rate: they tend to want to maximize their annualized return on any given investment, rather than their total return. And the bigger and more mature that a company gets, the harder it becomes to generate annual returns in the 25% range. If the LPs aren’t complaining about not getting their money back, they might well be complaining about being invested in large, mature companies — which is not the point of VC investments at all.

The second problem is bigger: you can’t build a large, mature company in Silicon Valley (where Andreessen Horowitz makes substantially all of its investments) without paying smart engineers in equity. Silicon Valley employees don’t dream of working for the same private company all their lives: they dream of the riches that flow from options and restricted stock. If the employees of one of Andreessen’s companies genuinely believed that the aim was to be a closely-held mature private company in 15 years’ time, it would be much more difficult to attract top-tier talent.

No one has yet cracked this nut. There might be ways of selling non-voting minority stakes to investors with genuinely permanent time horizons — university foundations, for instance, or sovereign wealth funds — but that still leaves the question of price discovery: how is anybody to say how much the company (and therefore the equity) is worth? So long as the founders and investors have an interest in keeping that valuation as low as possible for as long as possible, any employee selling equity into such a scheme is likely to wonder whether they’re getting ripped off.

So while I applaud Andreessen for aspiring to staying private as long as possible, I doubt he’ll ever have the problem he’s talking about here. Which is also why his LPs won’t be concerned by these statements in the slightest.

Nick Bilton’s column about the Instagram fairness hearing is annoying on a number of levels. When I mentioned one of them this morning, Dave Winer asked for “a brief post” explaining a bit more. OK then!

It’s worth saying up front that Bilton has got himself a genuine story here: it looks as though Instagram’s CEO, Kevin Systrom, was economical with the truth when he testified in front of the California Corporations Department in August. He said that Instagram “never received any offers” from any potential acquirers other than Facebook, and generally dissembled madly:

At the end of the hearing, regulators asked Mr. Systrom a third time about other offers: if there had been “any other inquiries from third parties about a possible acquisition of Instagram” after the Facebook deal was announced. Although Twitter executives had since tried to contact Mr. Systrom, he replied, “I and the board have not received any.”

The first annoying thing about Bilton’s column is that although he quotes Systrom at some length, he never provides a transcript of what was said at the hearing: we just have to trust him that he’s characterizing everything correctly. Bilton is happy to tell us what “the transcripts show”, so there’s no excuse for not showing us those transcripts as well. Once again, we’ve got a situation where the NYT doesn’t care about posting primary documents, and in this case there’s no copyright reason not to post them.

The second annoying thing about Bilton’s column is that he’s approaching decisions made in March with the benefit of great hindsight. “Given that the privately traded Twitter is expected to make $1 billion in revenue next year, which would increase its valuation considerably,” he writes, “Instagram investors might have made millions of more dollars.” But of course at the time that Systrom made his decision, he had no idea what Twitter’s 2013 revenue was going to be. And even Bilton, frankly, has no idea what’s going to happen to Twitter’s valuation next year: it’s just as likely to go down as it is to go up.

The third annoying thing about Bilton’s column is that he’s he’s desperate to find a deeper scandal here, beyond the issue of what Systrom said when under oath. The fairness hearing, he says, “sought to determine if Facebook’s acquisition of the photo sharing service was in the best interest of Instagram investors”, and it’s possible that if Instagram had put itself up for a more public auction, then the final sale price could have been higher. “It is possible investors would have been better off selling in an open auction, to Twitter or even to Google or Microsoft,” writes Bilton, as though it’s somehow self-evidently scandalous that anybody might ever sell their company for less than the maximum possible amount of money.

But the fact is that the fairness hearing was not at heart an attempt to see whether Instagram sold for the maximum possible amount of money. It was rather, as the name implies, an attempt to see whether the price paid was a fair one. It was necessary because Facebook issued new stock to pay for Instagram, and as a result of issuing stock the company had to go through an arduous registration process with the SEC. In California, a fairness hearing is just a cheaper and easier way of being able to issue stock without having to go through the SEC — so that’s what Facebook did.

Bilton’s most annoying sentence comes when he writes this:

Although it might seem unimportant whether wealthy investors made a few million dollars less than they could have, those investors often represent funds that include workers’ pensions and mutual funds.

Firstly, wealthy investors, just like much poorer investors, always make less money than they could have; no one ever succeeds in maximizing their returns. This is especially true of investors who take minority positions in closely-held private companies. As Bilton notes, Instagram was controlled by its two co-founders: they could and did, within reason, sell to anybody they wanted, at whatever price they wanted. What’s more, Systrom was no naïf in such matters: he had a previous stint in Google’s M&A department on his résumé. The venture capitalists who invested in Instagram, like all venture capitalists, knew full well that they were taking a risk that the founders might sell for less money than the VCs wanted.

It’s one of the most well-known and biggest risks in the VC business: when founders are faced with the opportunity to make an eight- or nine-figure sum for themselves, they are very tempted to accept that offer, even if they would be better off holding tight. What’s more, personal relationships often make founders more receptive to approaches from certain individuals (like Mark Zuckerberg) than from other potential acquirers.

A VC investing in Instagram, then, or any other company controlled by its founders, is well aware that if the founder decides to sell to a certain company at a certain price, then that’s what’s going to happen. Even when the founder doesn’t control the company, the same thing can happen: once Arianna Huffington decided she wanted to sell the Huffington Post to AOL, for instance, her investors basically had to go along. The people running the venture capital funds take those risks on behalf of their own investors, the limited partners in those funds. And if you’re not comfortable with such risks, you certainly should never be an LP in any venture capital fund.

And while it’s true that pension funds do sometimes invest a small percentage of their holdings in venture capital, that really doesn’t change anything. I see this kind of argument all the time: talk to any demonized vulture funds, for instance, and they’ll very quickly bring up the fact that some of their investors represent pensions and teachers and motherhood and apple pie. (For a classic example of the genre, take a look at the press release headlined “US teachers march on the Capitol for a solution on unpaid Argentine bonds”.)

Bilton’s wrong about mutual funds: they don’t invest in venture capital. But never mind that. Systrom controlled Instagram, and he sold it for a billion dollars before it had a single penny of revenues, making his VC backers lots of money in the process. He had every right to do that, even if there was a better formal offer on the table from Twitter or someone else, which there wasn’t. His minority investors were never an obstacle in his way, and they never had any right to hold out for a better deal.

In fact, the only obstacle between Systrom and the Facebook acquisition was antitrust concerns. If the antitrust authorities thought that Facebook and Instagram were getting together in a sweetheart deal to sew up a large part of the social-networking market, then they could block the whole thing. Systrom didn’t dissemble in front of the fairness hearing because he was worried about being accused of short-changing his minority investors. Instead, he dissembled in front of the fairness hearing because he was worried that the FTC might block the deal on antitrust grounds.

In any event, it’s the dissembling which is the story here, not the fact that Systrom might have been able to get more money from someone else. It’s not a crime to sell too low.

As Henry Blodget realizes, the most interesting part of the latest speculation about Bloomberg buying the FT is buried en passant:

Factions within his company have argued that it would be smarter to buy a digital property, pointing to the Web site LinkedIn as an example.

As Blodget also notes, this isn’t really an either/or choice: the price tag for LinkedIn would be so gargantuan that it would make very little difference whether Bloomberg also bought the FT or not. But a billion dollars — the much bandied-about price tag on the FT — is still a large enough sum that anybody paying such a price has to have a pretty clear strategic reason for doing so. And if you’re going to start putting serious money against a strategic vision, then it makes sense to be very clear what that strategy is, and what it isn’t.

The purchase of the FT would basically be a soft-power move. Bloomberg has a stated aim of becoming “the world’s most influential news organization”, and the FT would be a helpful fill-in acquisition on the road to that goal. Bloomberg’s influence started in the financial markets, but the company has become more ambitious than that, so it’s investing other ways of reaching important people who might not have any need or desire to spend $20,000 a year on a Bloomberg terminal. And the investment in news outside the Bloomberg wire is paying off: Bloomberg TV got the first Obama interview after the election, for instance, while Bloomberg Businessweek had that juicy interview with Tim Cook.

Still, the FT is a news product, which would fit within the broader Bloomberg News operation, and wouldn’t really alter the mission or the economics of the company as a whole. Bloomberg makes its money selling terminals to Wall Street, and it sells those terminals as a one-stop shop for everything you need, from the Lebanese yield curve to the flight schedule between Rio de Janeiro and Santiago de Chile. One of the things that Bloomberg subscribers want is high-quality news, and thus was Bloomberg News born: its first job is always to give the terminal subscribers the news they’re demanding.

Buying LinkedIn, by contrast, would involve moving far beyond the terminal and into a much bigger world. Bloomberg’s business has — somewhat amazingly — not yet been disrupted by the internet. To the contrary, Bloomberg has been able to piggyback on the bandwidth revolution, and can now sell terminals in Riyadh as easily as it can in London. But there’s a limit to how many people are willing and able to spend $20,000 a year on an information terminal, especially given how much richness of information can be found on the internet for free. And Bloomberg is running up against that limit. Which means that the company is faced with a choice: either continue to reap the spectacular dividends from the existing franchise, or else try and grow, somehow, beyond the confines of the terminal.

If Bloomberg opts for growth (and there’s no reason why it should, given that it’s not a public company), then it’s easy to see why LinkedIn could be a very smart way of getting there. In the beginning, traders got Bloomberg terminals because of the unrivaled fixed-income analytics. But for many years now the terminal’s killer app has been its messaging product, which alone is worth $20,000 a year to many if not most of Bloomberg’s subscribers.

More than five years ago I was describing Bloomberg as “the world’s first social-networking billionaire”. With apologies for quoting myself:

Bloomberg invented social networking before Mark Zuckerberg was even born. Bloomberg LP was founded in 1981, and Bloomberg saw very early on the huge potential of two-way information flows. Rather than just sending information to his clients, he would allow them to ask specific questions and get immediate answers. Once that was possible, it was relatively easy to allow them to message each other. Long before email really took off, Bloomberg messages were regularly flying all over Wall Street, both within firms and between them.

At the center of it all was an open directory of pretty much everybody on the Street. Everybody had his own page on Bloomberg, could be found very easily, and could communicate equally easily with anybody else on the system, bypassing the phone calls and layers of secretaries which had previously intermediated the conversation. It wasn’t long until a Bloomberg became as necessary as a telephone as a tool for keeping in touch. And even today, long after every firm has opened its systems up to the internet and email, many research notes and messages continue to be sent out on Bloombergs instead.

Since then, however, the social-networking world has exploded, even as the Bloomberg network hasn’t. The astonishing rise of Facebook and LinkedIn show the power of network effects: everybody’s on them because everybody’s on them, while attempts to build smaller, more “exclusive” networks invariably fail. Bloomberg might have been the first social network, but it shunned rather than embraced the open internet, and today it’s in pretty much the same place it was in five years ago: extremely profitable, but with limited growth potential.

The acquisition of LinkedIn would be a clear declaration that Bloomberg had its eye on more than just the people with $20,000/year terminal budgets, and was interested in reaching the professional world more broadly. LinkedIn has not taken off as a messaging medium in the way that Bloomberg did, but in many ways it’s the closest thing there is to Bloomberg Messenger for the rest of us. Bloomberg knows, on a deep institutional level, how professionals network and message each other; LinkedIn has a network which dwarfs Bloomberg’s. The two together could be a formidable combination.

That said, I don’t think LinkedIn would be worth the money, for Bloomberg. If you’re thinking of acquiring a company, the first question to ask is how much it would cost to build something similar yourself. And if Bloomberg wanted to port its network over to the internet, so that it was available to people who don’t subscribe to the terminal, the benefits could be similar while the cost (including any drop in terminal subscriptions) would surely be much lower.

Pricing would be tough; I suspect that Bloomberg would want to charge something reasonably substantial for the service, positioning it somewhere in between LinkedIn, which is free, and the terminal. The trick would be to make it expensive enough that current Bloomberg subscribers wouldn’t need to worry about getting constantly spammed by random nobodies. Maybe that’s not possible: maybe the universe of Bloomberg subscribers is the maximum size that an open network, where everybody is connected to everybody else, can get. At some point, surely, spam starts becoming a problem.

But surely it’s inevitable that Bloomberg’s social network will make its way onto the internet at some point, somehow. When that happens, it will become an immediate and obvious competitor to LinkedIn. And if LinkedIn is worried about that potential competition, maybe it should be receptive to any overtures it receives.

Mobile devices are wonderful things, just as cars are. But both can cost lives, as Robert Kolker explains in a great NY Mag article:

Cars still speed, drivers still drink, and jaywalkers still pay no attention, especially with smartphones to distract them. “I wonder if we’ve reached a critical mass where so many people are looking down and so many people are listening to headphones and so many drivers are texting that the probability of an inattentive walker and an inattentive driver is much greater,” says Sam Schwartz, a.k.a. Gridlock Sam, the transportation consultant and traffic guru.

Schwartz is speaking purely anecdotally, of course: there are no reliable statistics on such matters, and I doubt there ever will be. But it’s undeniable that when people are staring at a mobile phone, they become much more oblivious — and much more dangerous.

As smartphones make our streets increasingly dangerous, it’s incumbent upon local government to try to mitigate things as much as possible. A world where everybody’s looking at a screen cannot be a world where cars can careen around the city at 40mph without any risk of getting a speeding ticket. Fast cars are lethal things, and have no place anyway in a dense city where the interplay of automobiles, bicycles, and pedestrians constitutes a highly-complex dance. So we should slow them down, using all manner of traffic-calming measures. (My favorite, which seems to be used far too sparingly, is to put louvers on traffic lights so that cars can’t see the color of the light at the end of the block. When they can, they often speed up to make it through.)

But the distraction of smartphones isn’t just physically dangerous: in reducing our awareness of our surroundings, it has broader corrosive effects. Alastair Bland has a good post on the way that GPS devices mean that we stop needing to pay attention or to learn the kind of things that maps can teach us:

A study conducted in Tokyo found that pedestrians exploring a city with the help of a GPS device took longer to get places, made more errors, stopped more frequently and walked farther than those relying on paper maps. And in England, map sales dropped by 25 percent for at least one major printer between 2005 and 2011. Correlation doesn’t prove causation—but it’s interesting to note that the number of wilderness rescues increased by more than 50 percent over the same time period. This could be partly because paper maps offer those who use them a grasp of geography and an understanding of their environment that most electronic devices don’t. In 2008, the president of the British Cartographic Society, Mary Spence, warned that travelers—especially drivers—reliant on electronic navigation gadgets were focusing mainly on reaching a destination without understanding quite how they got there.

I love maps, be they old or new, paper-based or digital. And if I’m on a hike, or even just giving directions in a car, I feel lost without one. (The main thing I hate the most about Apple’s iOS maps compared to Google’s is that if you use them for directions, they won’t let you zoom out, examine your route, look where you’re going next, etc. Apple’s maps infantilize: they basically say “we know where you are, we’ll tell you what to do, don’t worry your pretty little head about it.” While Google’s encourage you to explore your surroundings much more, look at alternative routes, and generally be aware of where you are.)

Sadly, I’m in a tiny minority here. Most people have no love for maps at all, and positively dislike map-reading, avoiding it as much as possible and finding it quite difficult. For decades they were a regrettable necessity — but now that we don’t need them any more, we’re jettisoning them as fast as we can, and relying instead on passively receiving turn-by-turn directions from some algorithm. Those algorithms are undoubtedly helpful, but insofar as they allow us to stop paying attention to our surroundings, they also hasten our evolution into people whose entire experience of the world is intermediated by some kind of digital device. Which cannot possibly be healthy.

I’m a huge fan of Google’s driverless car, and I can’t wait for its broad adoption: it promises to reduce accidents and fatalities enormously. But it also promises to reduce our real-world horizons even further. I’m reminded of this anecdote from Chrystia Freeland:

The wife of one of America’s most successful hedge-fund managers offered me the small but telling observation that her husband is better able to navigate the streets of Davos than those of his native Manhattan. When he’s at home, she explained, he is ferried around town by a car and driver; the snowy Swiss hamlet, which is too small and awkward for limos, is the only place where he actually walks.

Our phones are cutting us off from the world: they’re turning us into mini versions of Eric Packer, the cloistered billionaire in Don DeLillo’s Cosmopolis (and played by Robert Pattinson in the movie). It’s unhealthy, and yet it’s also inevitable, and of course it carries much more upside than downside. I do wonder, however, what the logical conclusion is, and how the world will change as a result.

My theory, when it comes to buying lottery tickets, is that if you have disposable income to spare, then often the dreams and fantasies that accompany your lottery ticket purchase are in and of themselves worth $1. This is true not because dreams and fantasies are wonderful amazing and valuable things, although they can be; it’s more true because $1 is a very small amount of money. All too many people spend a significant percentage of their disposable income on lottery tickets, and that is a tragedy.

Now Ian Bogost has come along with a similar theory, relating to Kickstarter. Funding projects on Kickstarter is in itself “another form of entertainment”, he says:

What if Kickstarter is more about the experience of kickstarting than it is about the finished products? When you fund something like OUYA, you’re not pre-ordering a new console that will be made and marketed, you’re buying a ticket on the ride, reserving a front-row seat to the process and endorsing an idea. It’s a Like button attached to your wallet.

Bogost is proud of a pen he spent $100 on but never uses: “it’s a memento of the excitement I felt after first seeing the product”, he writes:

When faced with the reality of these products, disappointment is inevitable–not just because they’re too little too late (if at all) but for even weirder reasons. We don’t really want the stuff. We’re paying for the sensation of a hypothetical idea, not the experience of a realized product.

This is a cute conceit, and contains more than a germ of truth. At the same time, however, it starts to fall apart when Bogost compares Kickstarter to QVC, saying that what QVC is really selling is “the excitement of learning about products for the first time and getting in early on the sale”. That might indeed be part of why people are so eager to pick up the phone and order when they’re watching home shopping channels, but it’s not what QVC shoppers think that they’re paying for.

A lot of the relationship between merchants and consumers, these days, is a kind of escalating cold war: as fast as merchants’ sales techniques become increasingly sophisticated, so do consumers learn to see through them and compensate for them. If we look today at advertisements from 50 or even 20 years ago, we’re astonished that they worked at all.

And so it seems to me that Kickstarter is in some ways much like QVC was when it launched: a state-of-the-art sales and marketing platform. It’s highly social: Jeanne Pi has determined that your chances of raising $10,000 on Kickstarter are just 9% if you have 10 Facebook friends, rising to 20% if you have 100 friends, and 40% if you have 1,000 friends. And it’s done a very good job of walking the fine line between do-gooding, on the one hand (charity campaigns are specifically banned), and overt commercialism, on the other. Many projects are rejected, and Kickstarter’s Yancey Strickler is keen that everything on the site be creative, in some way, rather than just being some superficially clever gadget that you might see in the SkyMall catalogue or in a late-night infomercial. He doesn’t always succeed, but if you strip out the outliers, the big million-dollar headline-grabbers, he’s doing a better job than you might think.

Or, to put it another way, the simple “you could win a million dollars” sales pitch works for selling lottery tickets only combined with a deeply-discounted $1 ticket price. Make something cheap enough, and you can sell just about anything. Kickstarter, by contrast, with a much more sophisticated pitch, manages to deal in much higher dollar amounts per transaction.

Here’s the problem: while “I’m buying a dream” makes a certain amount of sense for a $1 lottery ticket, it makes much less sense for $100 vaporware. Just speaking for myself, if I’m spending $100, I want significantly more than just a dream. That’s more money than I’ve spent on lottery tickets in my lifetime. And I’m rich — I’m reasonably sure that I have more money, and more disposable income, than the majority of the 40,000 people — and rising fast — who are funding Ouya.

Maybe that just makes me a tightwad, and maybe America has millions of people who are happy dropping $100 on the experience of funding some exciting new project, just for the way it makes them feel. But it seems to me that one of Kickstarter’s greatest successes is the way in which it has managed to change the way we think about cost. I funded Tomorrow magazine, for instance, to the tune of $15. (On average, the magazine’s 1,548 backers paid more than $25 each.) If some as-yet nonexistent magazine had sent me a piece of direct mail, asking $15 for its launch issue, I would never have paid that. Even if an existing magazine looked really good on the newsstand, and had a cover price of $15, I would similarly never pay that. But somehow the idea that by paying the $15 up front I was helping to create that magazine — that was enough to get me to pay. That, and the fact that the founders of Tomorrow magazine are in my social graph — I’m helping out friends as much as I’m buying a product.

I think that’s the real key here: I’m not paying for the sensation of a hypothetical idea, so much as paying to support the individuals whom I like and admire. And Kickstarter neatly wraps that charitable impulse in a commercial transaction, which makes it easier to ask for — and receive — more money than either approach would yield on its own.

The question is: how sustainable is this model? It’s common in capitalist societies for local merchants to be able to charge higher prices, largely because they’re more convenient. Has Kickstarter invented a new form of online commerce, where merchants who are close to you on the social graph, rather than in terms of physical geography, can thereby charge a premium for products which would never fly in the open market? (I don’t get many catalogues in the mail offering goods which don’t yet exist, and which might not ever arrive.) Or has Kickstarter merely perfected the art of sprinkling social fairy dust on what are fundamentally commercial transactions, and eventually, as other merchants do the same thing and the public gets wise, the effectiveness of the fairy dust will diminish?

I suspect the answer is somewhere in the middle, and that Kickstarter is a bit like Groupon in its adoption profile. The early adopters tend to be the most zealous about it, and as the platform matures, the added value that it can generate per customer will necessarily diminish. At the same time, the customer base will almost certainly continue to rise pretty quickly. So the aggregate value being generated by Kickstarter is likely to continue to rise.

Over time, I think that fewer projects will be able to raise millions of dollars selling clever as-yet-nonexistent gizmos for $99 each. These projects nearly always tend to understate the risks involved, and especially the risk that the project will fail, and the funders won’t actually receive anything at all. That’s natural: the founders are in sales-pitch mode. But as consumers get wise to those risks, especially if one or two high-profie million-dollar Kickstarter successes end up producing nothing at all, then at that point we’ll realize that the funders weren’t just buying a dream after all. They really thought they were buying a product.

I had a fascinating conversation last night with a chap from Kickstarter, a site designed to help creative professionals realize projects. And it’s still doing that, pretty well. But there’s clearly a degree of mission creep at Kickstarter, too — especially with regard to some of the most successful and highest-profile projects on the site.

“A project is not open-ended,” says Kickstarter: “Starting a business, for example, does not qualify as a project.” Yet that’s exactly what Matter is doing with Kickstarter.

What’s more, Kickstarter can only be used to fund projects “from the creative fields of Art, Comics, Dance, Design, Fashion, Film, Food, Games, Music, Photography, Publishing, Technology, and Theater”. Which one of those fields is a bar of soap supposed to fall into? Design, I guess. But if the fields of Design and Technology can be so broadly construed as to mean anything, they ultimately mean nothing. And the bar of soap — just like Matter or the famous $1.5 million iPhone dock — is at heart an attempt to start a business, much more than it is an attempt to fund a creative project.

The bar of soap and the iPhone dock are glossy and sophisticated sales pitches: one of the questions yesterday was whether they were closer to SkyMall or to QVC. But there’s a huge difference: SkyMall and QVC sell products which exist. On Kickstarter, you’re buying a hypothetical future product. And I worry that this is going to end in high-profile tears and recriminations at some point, the first time a big funded project fails to produce what it promised.

Getting a product to market is hard. Even companies with business plans and executives and millions of dollars in funding — and a fully-functioning product — can fall down on that front. Look for instance at the Switch lightbulb: in July 2011, Farhad Manjoo of Slate said it would go on sale in October 2011 for $20. In August 2011, Dan Koeppel of Wired magazine ran an article saying that the bulb would go on sale in October for $30. But here we are in March 2012, there’s still no sign of the thing, and the company’s Facebook page is filling up with comments saying things like “I’m going to start my own company making a product that no one can buy. Hmm….what should I not sell? So hard to decide.”

There are two big hidden risks which I think that Kickstarter should emphasize much more than it’s presently doing. The first is on the side of the person with the project. It’s easy, when you’re trying to raise funds, to promise lots of things to lots of people, in that glorious utopian future where you’ve raised the cash that you need and you can actually finish your project. So then you finish the project, and you’re still incredibly busy and stressed, but now you have hundreds or even thousands of things to send out. Which can be a decidedly unpleasant chore. Kickstarter buries its page warning about how shipping “may end up being a bigger part of your budget than you thought”, and doesn’t really talk at all about the massive time commitment involved. For rewards which are individually hand-made, the result can be something much sloppier than the project owner originally intended. Which isn’t really good for anybody.

The bigger risk, however, is on the side of the funder — and that’s the risk that the project will get funded, you will spend your money, and you will end up getting nothing in return. For original-concept Kickstarter projects, that’s probably OK: you supported the arts by funding an artist, and you hoped to get a memento of that funding, but the reward was just a reward, and not necessarily the main reason you funded the project. For things like bars of soap and iPhone docks, however, the great majority of the funders are thinking of themselves as buying a thing. And they’re not properly discounting the very real risk that they will end up with nothing at all.

Even the most well-intentioned projects can run into unanticipated obstacles, some of which could be fatal to the project. And of course there’s the risk too of outright merchant fraud. You put together a glossy Kickstarter video, raise a few hundred thousand dollars, and then just pocket the money while telling everybody that the project is taking longer than expected.

In either situation, your funders have very little recourse. They may or may not, at some point, be able to get a refund from their credit-card company, if they paid with a credit card. But it’s extremely unlikely that they’ll be able to get a refund from the project owner.

Kickstarter doesn’t keep statistics on the number of projects which get funded but not completed, or the number of projects where funders fail to receive what they were promised. It’s hard to know how such statistics could possibly be generated, since projects don’t come with deadlines by which the rewards are deliverable. I, for one, have a number of Kickstarter receivables coming to me; I don’t have them listed anywhere, however, and if they don’t arrive, I’m not going to be particularly upset. There are 12,521 people expecting an iPhone dock, however, and 21 of them have paid upwards of $5,000 to receive 100 docks or more. If I was expecting a shipment of 100 iPhone docks, I’d consider that a real business contract, rather than a much fuzzier form of support for some creative project.

The JOBS act which recently passed in the House would allow Kickstarter to allow project backers to receive equity, rather than specific rewards, in return for their money. The regulatory and compliance costs for Kickstarter would surely be enormous, but might well be worth it, given that SecondMarket is now valued at $200 million. But before Kickstarter moves into the realm of equity stakes, it should probably start thinking much harder about the way in which it’s becoming a shopping site. Because if it doesn’t have a good way of regulating the people on its platform who are fundamentally just selling things, then it’s going to have a really hard time becoming a platform for people selling ownership stakes in companies.

In the general atmosphere here in Davos of worry and apprehension, it was great to be able to sit down with Esther Dyson this afternoon and get a dose of refreshing optimism — and about Russia, of all places. There’s an elite group of Russian technologists here — Dyson, a lifelong Russophile who’s fluent in the language and on many boards of Russian technology companies, introduced me to both Arkady Volozh of Yandex and Anatoly Karachinsky of IBS. And she’s convinced that the success of the Russian technology sector can not only make for thriving companies but also for a much improved country.

I was skeptical, but Dyson made a number of good points. For one thing, it’s really hard to build a successful software company through corruption and bribery and other dark arts — especially when you’re creating websites which are judged on their broad popularity. And while natural resources can be stolen, human resources really can’t be.

More importantly, a whole generation of Russians is growing up on the internet, freely using Russia-developed websites which are every bit as good as their US counterparts. Their life online is transparent and not controlled by large and oppressive bureaucracies, and Dyson is convinced that once they’ve experienced that much freedom online, they’re going to start demanding it in real life as well.

Not immediately, of course: Putin is going to win the next election, and he’s going to do so legitimately. But at some point a majority of the Russian population will have no memories of the Soviet era. And already that younger generation is both demanding change and driving growth.

They’re fantastic engineers, for one — look at the way, for instance, in which Boeing does a large part of its engineering work in Russia. Or, more generally, at the Israeli technology sector, much of which is powered by Russian emigres. Russia has many problems, but there’s no doubt that its computer-science colleges are churning out a lot of smart graduates, and that the likes of Karachinsky are hiring those people at a rate of thousands per year. And they’re not robots, either: these kids are creative.

Dyson is intimately familiar with projects like Digital October in Moscow, and she’s a huge fan. Meanwhile, of course, there are the much larger phenomena which get a lot of global attention — things like Mikhail Prokhorov’s bid for the presidency, or the massive Skolkovo science park. If these things fail — and there’s a good chance that both of them will — that’s not necessarily a bad thing: free and successful societies have lots of failure. And importantly, when you look at both of them, you see hope and optimism. Which are not what you might call classic Russian traits.

I’m not entirely convinced. The population of Russia has been declining for the past 20 years, and is continuing to shrink: there are 14.2 deaths per 1,000 people per year, and just 12.6 births. And if you look at the weirdly-shaped population pyramid, you can see that the post-Soviet generation is dwarfed by its more conservative elders. It’s going to take a very long time indeed before they can or will effect any real change.

Still, if there’s any hope for Russia, it’s in the idea that democracy will percolate up from youth and the internet, rather than being demanded in some kind of revolution. As Prokhorov says, “every time we have a revolution, it was a very bloody period”. Russian democracy is not going to mean a US-style free-market economy: Russia tried that, in the 1990s, with disastrous results for the broad population. But a wired country is, by its nature, always going to be a little less corrupt. And a little more hopeful.

Maija Palmer, with another one of those end-of-email articles, finds this intriguing story:

Andy Mulholland, chief technology officer at Capgemini, says email works poorly for people working in unstructured roles, such as engineers solving IT problems. “Someone asks you a question you don’t know the answer to, so you send out emails to everyone you know. Out of 20 people, 19 have their time wasted and the 20th gives you half an answer,” he explains. Social networking, in this case, can give faster and better answers.

He cites a recent example where an engineer had an unusual problem with some Unix code. He posted the question on Yammer, and within two hours had an answer from someone in the company he didn’t know, in a department of the business he barely knew existed.

On its face, this doesn’t make a lot of sense. If you’re worried about wasting people’s time, why is it better to waste hundreds of employees’ time on Yammer than a couple of dozen over email? I think the answer to that question is the key to understanding the power of social networks.

The Yammer solution here is clearly superior for the person asking the question, in other words — but why is it superior for all the people reading and thinking about and maybe or maybe not answering it? After all, they spend much more time on this question, in aggregate, than any email cc list would.

But it’s voluntary time: Yammer is the kind of thing which fits neatly into whatever interstices one has in one’s day. It doesn’t ping at you and annoy you and distract you at inopportune moments.

Social networks are also supererogatory: they have none of the feeling of being forced to read and participate that comes with almost all corporate emails. Much of the current case against James Murdoch, for instance, is based on the idea that if he was emailed something, he must have known it. No one would dream of making the case that if some fact was revealed on a Yammer board, and Murdoch had access to it on Yammer, then he must have known that fact.

Related to that is what you might call lurkability: you can spend as much (or as little) time as you like on these boards, learning about anything you’re interested in, without being formally copied-in on anything. Something which might be a waste of time to you can be useful and valuable to me — and social networks are a great way of giving people access to the stuff they find valuable, without anybody having to second-guess what it is they want to know.

Finally, if and when you do choose to participate, you get to do so in public. The engineer who answered that question got noticed, in a good way, and no one else took credit for what he said or tried to hide his participation in the process. No space is entirely free of office politics, but social networks, because they’re public, make such politicking rarer and less harmful when it does happen.

It’s also much easier to share information you find on a social network: worries that some piece of information might be confidential tend to be much smaller and much less important. As a result, such networks have much less friction than email does.

And anything which reduces the mounds of emails we all have to deal with every day has got to be a good thing. My work email account, in particular, is a nightmare: it’s 95% unsolicited PR pitches and 4% internal emails going out to enormous distribution lists which I have no interest in at all. Which means I have to go to a lot of effort to find the 1% of emails that I actually want to read. There’s got to be a better way.

What’s behind the rise in bus travel in recent years? It certainly seems very impressive, according to the latest research from DePaul University.

Here’s how Bloomberg’s Jeff Plungis characterizes it:

Megabus.com and BoltBus led U.S. curbside bus companies that boosted trips by 32 percent this year as travelers opted to leave their cars behind and surf the Internet while traveling.

And here’s Matt Yglesias, with a slightly different take:

Like Duncan Black, I’m far from certain that the right way to understand this is actually as intercity bus trips substituting for intercity car rides. The way I would primarily interpret it is as these services leading to additional trips that wouldn’t otherwise have been taken. Instead of riding Amtrak to New York once a year, you ride the bus three times instead.

If you look at the data, Yglesias seems closer to the mark than Plungis. Could the massive 30% rise in curbside bus ridership be accounted for by the 1% fall in private autos? Possibly. But it’s more likely that something else is going on.

Both Plungis and Yglesias, I think, miss the elephant in the room, and the obvious reason why the DePaul measurements for bus ridership have been growing at such a startling rate. Here’s how the paper puts it:

The analysis we provide also excludes all “Chinatown operators,” which have significant different qualities than mainstream operators. As a general rule, those carriers listed on the GotoBus.com web site are considered for purposes of our study to be Chinatown operators. Many of these carriers do not invest in a brand identifiable by the paint scheme or insignia on their buses.

Indeed, DePaul specifically excluded the dramatic growth of California’s USAsia Bus Lines, just because they determined that it counted as a Chinatown operator.

The obvious theory, then, is that big operators like Megabus and Bolt Bus saw the huge success of the Chintaown bus market and saw an opportunity there. They brought in branding and professional marketing and wifi and much higher safety standards, and succeeded in taking a huge amount of market share from the Chinatown operators who were never part of the DePaul survey in the first place.

That theory is borne out by my own anecdotal experience: when my friends took the bus from New York to DC or Boston ten years ago, it was normally a Chinatown bus. Today, it’s more likely to be a Bolt Bus, or even a higher-end product like the Limoliner.

In other words, the DePaul data is consistent with total bus ridership actually staying constant, with the recognized curbside buses simply taking ridership share from unrecognized Chinatown operators. In reality, I suspect that bus ridership is growing. Just not nearly as fast as the DePaul paper would have you believe.

As for the much-vaunted wifi on these buses, it’s basically the same as the wifi on Amtrak, or from Gogo in-flight: in a word, crap. If you’re working on a laptop and can download emails or web pages in the background while reading or writing something else, then it’s fine. But it’s pretty much useless for people on iPads, where the lack of multitasking means you can’t read one thing and download something else at the same time.

It seems to me that the travel industry in general has done a very bad job of adjusting to the fact that most wifi-enabled devices these days are not laptops. I even stayed at one pretty high-end hotel in England, recently, which thought that providing an ethernet cable was a perfectly good alternative to providing wifi, and which didn’t have any kind of Airport Express devices or similar that it could lend out to guests who didn’t have ethernet ports on their computers or tablets.

So far, no one’s really cracked the problem of the mobile web — we’re still in a world where connecting to the internet when on the move is far too difficult, and needs to be configured (and often paid for) on a device-by-device basis. Companies like Lightsquared want to change that, but for the time being they’re vaporware, and I’m not holding my breath for them to arrive. Which means that for the time being it’s a bit of a stretch to say — as Plungis, for one, does — that the mobile web is actually changing the way we travel from city to city.

I spent Wednesday night in Silicon Valley, at a very geeky discussion of Bitcoin, the unregulated digital currency which managed to get a lot of anarcho-utopians very excited. But Bitcoin fever seems to be on the wane right now, and the number of real-world places where Bitcoins can be spent is still, to a first approximation, zero.

One of the subjects we spent a fair amount of time discussing was the question of chargebacks and reversibility of transactions. Bitcoin was designed to be as cashlike as possible: once it’s spent, it’s gone. As one user discovered in spectacular fashion.

There are good reasons for setting payments systems up in a non-reversible way: it makes things much simpler and easier, for starters, and there is real demand out there for a digital equivalent of cash. On top of that, many Americans are unaware of the rights they have when money is spent on their credit or debit card, by themselves or others.

But consumer-advocacy organizations like Consumers Union are very aware of those rights. And as we move, very slowly, into a world of mobile payments, Consumers Union is trying its hardest to ensure that such payments are as reversible as possible.

Most cell phone and tablet users can purchase digital goods and charge them to their monthly bill or prepaid phone account. But they may not get the protections they need to limit their financial liability if something goes wrong with the transaction…

“Consumers using mobile payments should get the same strong protections they currently enjoy when they make purchases with a credit card or debit card,” said Michelle Jun, senior attorney for Consumers Union, the nonprofit advocacy arm of Consumer Reports. “But we found that consumer rights can vary widely between wireless carriers and the protections carriers claim to provide are often nowhere to be found in customer contracts.”

Jeremy Quittner wrote up the Consumers Union findings under the headline “Banks More Consumer Friendly than Carriers for Mobile Payment”:

Banks have been much maligned for nickel-and-diming their customers, but in another area — cardholder fraud protections — they are being praised as consumer champions.

A Consumers Union report released Wednesday shows that protections for purchases that consumers make using their mobile phone numbers are much weaker than those consumers get from standard cardholder agreements regulating their credit or debit card purchases.

I suspect that as the world moves increasingly towards digital and mobile forms of payment, these issues are going to be key in determining how popular those forms of payment become. People are naturally resistant to change, and they still worry much more about spending money online than they do about spending money in much less secure real-world transactions. So long as headlines about digital and mobile payments continue to frame the issue as one of “consumer protection,” the payments industry is going to have to take such things very seriously, even if they run counter to the anarcho-utopian leanings of the geeks developing the underlying technologies.

The tension, of course, comes with regard to anonymity: while cash is perfectly anonymous, other forms of payment are not. And it’s pretty much impossible to create a reversible payments system if the users are completely anonymous.

But that’s OK: if I’m making a payment by swiping my phone, I don’t really feel the need to be anonymous at all. In fact, if the payments system knows not only my identity but also my location when the payment is made, there are lots of ways that it can use that information in ways I could find extremely valuable. We’re seeing this already: various payments companies are putting together systems whereby every time I walk into my local coffee shop, say, I can just pick up my regular order and walk out, and the payment will happen automatically. As will the free coffee I get after paying for ten at a regular price. All I need to do is have my phone in my pocket.

The future of payments, then, is likely to be highly personalized and reversible — exactly the opposite of the anonymous and irreversible protocols built into Bitcoin. And that’s one big reason Bitcoin is not going to be a long-term success.

Andy Zaky at Bullish Cross has a great post on Apple’s valuation, showing the astonishing degree to which the market is discounting the value of a dollar of Apple’s earnings today, compared to just two years ago. Back then, it was worth $32; now, it’s worth just $13. In the eyes of the market, Apple earnings are worth less than those of Cisco, Comcast, IBM, or AT&T, and are worth just 13% of the earnings of Amazon.

All of which raises the obvious question: why is Apple trading at such a seemingly depressed level? I have a few ideas, none of which are particularly compelling.

1. It’s run out of buyers. The Apple bull run has been going on for so long, at this point, that anybody who wanted to buy it has bought it already. And they’ve done pretty well by doing so. If they want to rebalance so that they keep their Apple holdings constant as a percentage of their total portfolio, they’re more likely to be selling than they are to be buying.
2. We’re all long Apple already. Apple is now firmly ensconced in its position as one of the two most valuable companies on the US stock market, in a world where ETFs and index funds are only getting more popular. As a result, if you’re long the S&P 500, you’re long Apple in quite a big way. And a large amount of the trade in Apple is going to be index-arbitrage trading. This is inevitably going to increase the correlation between Apple and the S&P 500. And when the S&P 500 has much lower earnings growth than Apple, that’s going to act as a drag on Apple’s share-price growth.
3. The headline share price is high. This shouldn’t matter, but it does. Small investors feel a bit weird about spending $2,500 on Apple stock and getting the grand total of seven shares in return. And the high share price sends a message to bigger investors, too: it says that Apple isn’t in the business of managing its share price, and is not about to engage in shenanigans like stock buybacks. Indeed, the market shouldn’t even expect a dividend any time in the foreseeable future, despite the fact that Apple clearly has more cash than it knows what to do with.
4. The headline market capitalization is high. When a company is worth $340 billion, a 10% rise in the share price means that the stock market has created $34 billion of new wealth. Which is harder than creating $3 billion of new wealth.
5. The appeal of the mean-reversion hypothesis. Apple can’t go on increasing its rate of earnings growth forever; indeed, it can’t even sustain its current level of earnings growth very long. It’s so big, and has come so far, and is making so much money, that at some point the only way to go is down. This is true on a conceptual level, but I don’t think it’s true on a practical level: Apple’s market share is still pretty small in the US, and positively tiny in the rest of the world. There’s a lot of growth potential left in this company, as smartphones increase their global penetration and as more people move from Windows to Macintosh.
6. Steve Jobs is dead. Apple’s p/e ratios started shrinking at about the same time that Jobs did, and all the hagiographic attention on how unique Jobs was only serves to remind us that he’s not around any more. If the next generation of Apple products is a success, people will still give Jobs the credit, and worry that Tim Cook won’t be able to replicate Jobs’s achievements. It’s going to take a long time before Cook can truly own the company and come out from Jobs’s shadow; in the meantime, investors are naturally going to worry that the glory years are over.
7. Apple’s earnings come from the frothiest, most disposable part of consumer income, which is the first part of consumer spending to go away if and when the economy heads south. As such, Apple’s more vulnerable to an economic downturn than most of its peers.
8. There isn’t a real bear case for Apple: the closest thing I can find is all technical-analysis astrology. And the way that markets work, stocks are much more likely to rise when people are bearish than when they’re bullish. No one seems to think that Apple is actually overvalued; indeed, analysts are ratcheting up their earnings forecasts at an astonishing pace. Here’s a table from Bill Maurer:

Estimates are up 12% over the past 90 days for the first quarter of 2012, and they’re up 7.5% over the past 90 days for the full year. This also helps explain the compression in forward p/e ratios.

What’s certain here is that the market simply isn’t rewarding Apple for its astonishing level of earnings growth of late. Which is weird, since that kind of earnings growth really wasn’t priced in a couple of years ago. Zaky’s convinced we’re seeing a market failure here, and I’m not convinced he’s wrong. But I’d be happier if someone could persuade me that there’s actually a good reason why Apple earnings seem to be worth so much less than so many of Apple’s less-successful peers.

Apple products have always cost more than the equivalent products elsewhere. It’s one of the reasons that Apple has historically had very high brand loyalty and very low market share — a classic luxury-good combination. But now that Apple has become a mass-market brand, it’s reaching millions of sensible people, who like to save money. And that, in turn, causes an interesting tension.

Back when Apple sold widgets, things were easy: you paid through the nose for your widget, and then you were happy. But now Apple makes mobile devices like iPhones and iPads, an that means it has no choice but to get into bed with the much-hated wireless companies. It tries to control the experience as best it can — but people still end up being faced with ludicrous charges like $30 a month for text messaging. And then, on the perfectly reasonable grounds that $360 plus tax per year is a ridiculous sum of money to spend on a minuscule amount of data, they decide that they’re going to try to get around those charges.

It is indeed possible to get around extortionate wireless charges. Rather than buy a 3G iPad, for instance, you can use one with only wifi, and then connect it when you’re on the go to a tethered smartphone or some kind of MiFi device. And rather than spend lots of money on text messages, you can sign up for Google Voice, and do all your texting with that number.

These money-saving techniques are perfectly rational. And they don’t cost Apple any money — just the wireless carriers. But they’re still bad for Apple, because they defeat the elegant perfection which Apple puts so much effort into getting exactly right. And what’s more, these techniques are most attractive to people who are tempted by Apple products but can only just afford them, or can’t quite afford them. As it seeks to increase its market share, Apple has to sell its products to more and more of these people, who will often be buying an Apple product for the first time. And the last thing that Apple wants is for its carefully-crafted user experience to be sullied by something as banal as an attempt to avoid text-messaging charges.

Take the iPad, for instance: I can attest from personal experience that the 3G iPad is just miles better than trying to use a wifi-only iPad with a MiFi. It downloads emails automatically, even when you don’t ask it to; you can pull it out of your bag and look up anything you like instantly; there’s no waiting around for the wireless modem to get online and generate its wifi signal; you don’t need to worry about how charged up your MiFi is, or where you left it; you get all the advantages of real GPS; etc etc. An iPad + MiFi is adequate; it’s good enough; it’s “all I need”. But the 3G iPad is why people love Apple. And it costs $300 a year over and above the cost of the iPad, which is itself $130 more than the wifi-only version. There are definitely cheaper ways of getting your iPad online. But you lose a significant amount of elegance and ease of use in the process.

As for Google Voice, you can either just install it on your phone with a new number, or you can go through the rather convoluted process of transferring your current number to Google Voice. Either way, you’re going to be using the Google Voice app a lot — an app which is slower and buggier than the phone and messaging apps built in to iOS. And — to answer Ryan O’Donnell’s question — I can’t really recommend it.

Yes, you get to check your text messages on the web, which can be useful — although it’s not that useful. But you also break a lot of things which otherwise work seamlessly in iOS. There’s no MMS, for instance. There’s no iMessage. There’s also — this is big — no texting to anybody with an international number. You can’t text from Siri. FaceTime integration goes away. You can no longer just click on a phone number to call it, if you want to call people from your Google Voice number. And the whole thing becomes generally much less reliable, because you can’t get any text messages at all unless and until you have a data connection. And as anybody with an iPhone knows, there are many, many occasions when you have cell service but data service just doesn’t work at all.

On top of that, you might well be violating your wireless carrier’s terms of service.

Now for some people — specifically people who are very comfortable with iOS, who know their way around an iPhone, and who value the ability to save money — a switch to Google Voice still makes sense. Text-messaging plans are ludicrously expensive, and I support anybody who comes up with a way of avoiding having to pay those bills. (Including, it must be said, Apple, whose iMessage platform, if it catches on, neatly circumvents existing text-messaging systems.)

But it does seem to me that so long as Apple has to deal with the hated wireless providers, people will always be voluntarily accepting a subpar user experience because they want to save on monthly charges. Apple has always hated it when its customers have a subpar user experience, but this problem isn’t going to go away: in fact, it’s only going to get worse.

And in the meantime, if you buy a wireless Apple product, it’s a good idea to be aware that the premium you’re paying for the hardware is not the end of the story. You’re going to be feeling the monthly bills for as long as you use that thing. And they’re going to add up.

Here’s something I haven’t seen before: an IPO roadshow appearing online for the world to see. (Click the link on the left; the link on the right basically just takes you to a copy of Groupon’s S-1.) In fact, I’ve never seen an IPO roadshow pitch before. They’re boring! And, they feature senior executives looking uncomfortable wearing ties in front of a dark-grey background, talking to slides!

But, this roadshow is also very helpful indeed for people looking to understand Groupon’s business. And it includes cohort information which has never been made public before, and which is rather more bullish on Groupon’s prospects than the analysis we’ve had to make do with to date from Yipit.

First, though, it’s worth taking a look at the price tag on this company. As Anthony Hughes reports, the price range indicated here values Groupon at no more than $11.4 billion, with Groupon itself getting a maximum of $540 million in cash. These are big numbers; the valuation is essentially double the amount that was reportedly offered by Google for the company in December, and is 2.3 times the $4.875 billion valuation at which Groupon raised money that month. (Interestingly, Groupon is actually raising less money in the IPO than it did in that round.) Still, the valuation’s nowhere near the $25 billion or even $30 billion numbers that were being whispered a few months ago.

Andrew Ross Sorkin is very critical about all that $30 billion number, talking about known issues surrounding Groupon, and writing:

How did so many Wall Street firms desperate to underwrite the Groupon I.P.O. miss these warning signs when pitching such a sky-high valuation? …

A deep dive into the numbers should have raised alarm bells at the outset about even talking about the possibility of a $30 billion valuation…

If it were to really slow its marketing spending, it is possible Groupon could turn a profit.

Even so, it does not fully explain how Groupon’s underwriters, whose endorsement of the company is supposed to be considered the Good Housekeeping Seal of Approval, originally came up with Groupon’s questionable $30 billion valuation.

Sorkin, here, is saying that Goldman Sachs and other banks, when pitching their IPO services, told Groupon that they could bring the company public at a $30 billion valuation — indeed, that they “originally came up with” that number. And, frankly, I don’t believe him. All conversations about these matters are off the record, of course, so it’s hard to be definitive. And Sorkin certainly talks to many more bankers than I do. But going public really isn’t about the IPO — it’s about being a publicly-listed company in perpetuity. And Groupon has very little incentive to launch at a bubblicious valuation which can only exacerbate volatility over time.

I think that the $30 billion number was never something that bankers seriously pitched to Groupon as a launch-valuation possibility. Instead, it was a number thrown out by people looking at LinkedIn’s first-day pop, and was intended to reflect not the IPO price but rather the level at which Groupon shares might trade in the secondary market, if the market remained frothy. (And even today LinkedIn is worth more than $8 billion, which makes $11 billion for Groupon seem pretty reasonable in comparison.)

As for Groupon’s business, I do still like the model — with the proviso that I have no idea how to place a present value on such a thing, so I take no position at all on what a sensible valuation for the company might be.

And in the light of the numbers Groupon released today, it’s no stretch at all to say that “Groupon could turn a profit”: the company’s total loss in the third quarter was a tiny $239,000 — essentially, the company broke even.

One thing which makes me look more favorably on Groupon now that I’ve seen the roadshow is the company’s cohort data. One of my biggest concerns about Groupon, up until now, has been the idea that its subscribers suffer from “deal fatigue”. You sign up in a fit of enthusiasm, you buy a few deals, and then the novelty wears off and you go back to your old life. That thesis was supported with charts like this one, generated from some of the relatively sparse information that Groupon provided in its S-1.

This chart could show that subscribers spend less and less money over time. On the other hand, it doesn’t necessarily show that. There’s an alternative explanation: basically, that there are diminishing marginal returns to marketing spend. Groupon picks the most valuable low-hanging fruit first, and then as its subscriber base grows, the newer subscribers spend less money than the older ones, bringing the average down. Even if the older subscribers keep on spending just as much as they ever used to.

And that’s what’s shown in two charts from the roadshow. They look at the numbers associated with the subscribers that Groupon acquired in the second quarter of 2010:

As Groupon CEO Andrew Mason explains with regard to the first chart,

This shows the repeat purchasing behavior of a typical cohort of customers; this one joined in Q2 of 2010. You can see that quarter after quarter after quarter, they continue to buy at the same pace.

The first chart shows the quarterly revenue from the customers that Groupon acquired in the quarter; the second chart shows the quarterly profit from those same customers. In both cases, the numbers are remarkably consistent over time — they’re not falling off.

My other big concern is about targeting — Groupon’s ability to differentiate between consumers based on much more than just what city they live in, and to show them deals they’re likely to love. Groupon product head Jeff Holden talks about this around slide 26. Groupon has something called Smart Deals, which tries to implement just that kind of targeting. One way it’s doing that is by getting its customers to click on categories called Deal Types, so that it knows what kind of deals that customer is interested in. And then of course given that customers keep on buying deals over time, it’s easy to see what kind of deals they’re buying, and what kind of deals they’re not.

Holden also gives the best explanation of Groupon Now that I’ve seen — the way it offers yield management for merchants.The idea is that the Groupon app on my phone is a great way for me to save money: I fire it up, and immediately see a list of deals nearby. Merchants can offer or not offer those deals in real time: they can make them better when business is slow, and turn them off when business is already overwhelming. That’s great for both merchants and consumers, who hate turning up to a Groupon-featured merchant and finding it overwhelmed with bargain-hunters.

There’s a rewards system, too. You know those punch-cards at coffee shops, where you get a free coffee after you’ve bought ten? That can now be built in to what the company is calling Groupon OS — all you need to do is allow Groupon to associate you with your credit-card number, and then every time you use that card to buy a certain item, it will automatically show up in the Groupon app. Eventually, you become eligible for a reward. It’s pretty effortless, for the consumer, and it brings an element of addictive gameplay into the shopping experience.

There’s a couple more slides which are relevant too, and directly address my concern that Groupon has to develop a reputation for high-quality deals. It can’t just let its salespeople maximize revenue, as sales people are wont to do: it has to delight its customers, by pointing them to great merchants. And it turns out that Groupon does actually attempt to do just that. One slide talks explicitly about “curation”:

And another (with the dreadful title “operational excellence”) shows the huge number of steps that need to be gone through before and after an offer appears on the site.

I love the way that under “Editorial” there are separate steps for “Humor”, “Voice Edit”, and “Copy Edit”. So there are systems in place here. But the really crucial step is buried somewhere in that “Deal Quality Assurance” circle. Groupon does not have the best reputation for picking only fabulous merchants; it probably needs to work on that a bit.

Overall, then, I think it’s pretty clear that people who think Groupon’s some kind of Ponzi scheme are wrong. There’s a real business here, with a real business model. The big question is whether Groupon can execute. Can it create a much-loved mass-market brand, which people and merchants trust and return to on a regular basis? We will always hear about bad experiences, of course — that’s a statistical inevitability, given the number of deals and employees going through the Groupon system. But will those significantly damage Groupon’s reputation? That’s a harder question to answer. (And it’s worth remembering, too, that for comparison reasons some small percentage of Groupon customers are going to have to continue to receive offers which are not targeted to them. If you’re one of those unlucky few, you might have a much worse experience of the company than everybody else.)

If I had to make a forecast, I’d say that Groupon is going to be around for the foreseeable future, but that the error bars on its future size are enormous. It could just slow down and lose its competitive advantage over its competition; it could, on the other hand, genuinely revolutionize the infrastructure of commerce and even become that thing everybody wants to be these days, a platform.

Like all fast-growing technology companies, Groupon is a risky bet from an investor’s point of view; it’s in no sense a widows-and-orphans stock. Like many consumer-facing companies, it’s probably better for most people to just take advantage of it as consumers. Individuals are much better at judging whether a money-off deal is a good one than they are at judging whether a particular stock is a good investment. But if Groupon’s sales continue to grow at anything like their recent pace, that’s an indication that a lot of individuals will continue to love what Groupon’s doing. And ultimately that’s going to show up on the bottom line.