Cable Internet: What is the Problem?

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Felix Salmon writes,

Americans really love their TV. They love it so much that cable-TV penetration is still substantially higher than broadband penetration. As a result, any new broadband company will not be competing against the standalone cost of broadband from the cable operators: instead, they will be competing against the marginal extra cost of broadband from the cable company, for people who already have — and won’t give up — their cable TV.

If you’re a cable-TV subscriber, the cost of upgrading to a double-play package of cable TV and broadband is actually very low; what’s more, there’s a certain amount of convenience involved in just dealing with one company for both services.

And yet Salmon argues that the lack of competition in offering broadband Internet is a problem. I am not sure why.

It has always seemed to me that what holds back penetration of broadband Internet is that there are a lot of “want-nots” among American consumers. The penetration rate for cable TV is somewhere north of 90 percent, and as Salmon points out, the marginal cost of adding broadband is low. So if more Americans wanted broadband Internet, they could have it.

The other technology that Americans really love is cell phones. My guess is that going forward the marginal value of bandwidth is much higher in wireless than it is in cable. Worrying about cable monopolies reminds me of the days when the government pursued an antitrust case against IBM for its monopoly in mainframe computers. In hindsight, that monopoly does not appear so formidable.

Pointer from Tyler Cowen, who is on my side, but for somewhat different reasons.

More on WhatsApp

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1. From Sarah Lacey.

Facebook has grown into such a huge thing that we forget what the core always was: Photos. This was the reason Instagram was such a threat to its dominance. It was the next social network where the primary organizing and viral mechanism was photos. That’s why Facebook had to own it.

Read the whole thing. She points out that WhatsApp was valued at 10 percent of Facebook, which is a much higher share of the acquiring company that YouTube was relative to Google, for example.

2. From Peter Schiff.

It’s very easy to get customers when you don’t charge them, it’s much harder to keep them when you do.

Thanks to a commenter for the pointer.

I look at it this way. I would value WhatsApp at about $200 million. Like Schiff, I believe that it will start to bleed users rapidly as (a) it attempts to monetize them and (b) as competitors take them.

If $200 million is 10 percent of Facebook, then Facebook is worth $2 billion. Have a nice day.

What I’m Saying

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I am a last-minute fill-in for Brink Lindsey at this event discussing the new book by Megan McArdle. The book is about failure, which is a fascinating topic. My talk should begin shortly after this post goes up. I will try to say that the best way to deal with failure depends on the institution.

An individual needs to fail with a fallback position. Megan discusses this in terms of job search and in terms of living within your means so that you can deal with illness or loss of a job. She also discusses the forgiving nature of the U.S. bankruptcy code.

A small startup firm needs to fail quickly. Find out that you need to rethink your concept after you have test-marketed a prototype that you built in three months, not after you have spent two years in stealth mode trying to implement your grand design.

A large, established firm needs to fail gracefully. Be able to kill the project without killing the company. You might think of Coca-Cola’s recovery from New Coke, but the real graceful failures are the ones we never even hear about. A large firm that fails ungracefully is denying that it is in trouble (Megan uses the example of Dan Rather and Mary Mapes of CBS News, who put out a story based on a forged document and just refused to back down from the story.)

Government cannot do any of these things well. Think of Obamacare. Fallback position? None. Quick failure? No, it is going to be long and drawn out. Graceful failure? No, it is a big, ugly failure.

At one point in Megan’s book, she writes,

There is a scientific name for people with an especially accurate perception of how talented, attractive, and popular they are–we call them clinically depressed.

For government, I think that the only solution is clinical depression.

Scott Sumner on the Fed Transcripts

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He writes,

Note that on the very day of the September 16 meeting, the meeting at which the Fed refused to cut rates due to fear of “high inflation,” the TIPS spreads were showing only 1.23% inflation over the next 5 years, well below target. The Fed should have ignored its own worries about inflation, and instead relied on the wisdom of the crowds. The crowd is not always right, but they are more reliable than the Fed, especially when conditions are changing rapidly. Market participants saw the bottom dropping out of the economy using millions of pieces of highly dispersed information, while the clumsy Fed waited for macro data that comes in with long lags.

The idea of relying on market forecasts is what puts the “market” in market monetarism. An interesting question is how much the Fed would have had to do to cause both actual and expected inflation (or nominal GDP) to change. My inclination is to believe that a lot more M would have merely resulted in a lot less V.

I Do Not Understand

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Joshua Gans attempts to explain WhatsApp, the small text messaging service that was acquired by Facebook for a combination of cash and stock reported as $19 billion. He writes,

WhatsApp experimented with various paid models from a paid up to a paid subscription to its now, try before you buy, option. Basically, after a year you pay $1 per year. It is dead simple and quite lovely. There are no gimmicks there either. You have to initialise the paid version. It doesn’t just kick in. There is something so refreshing in a service that just gets people to pay for it if it is worth something to them rather than exploit some failing in their rationality.

Among the things I do not understand.

1. I agree that the business model is refreshing. But I think that in this case it is also self-extinguishing. The service has value to people who are otherwise charged for sending text messages. As more people adopt the service, cell phone companies will obtain less revenue from charging for text messages. The end game is for them to obtain revenue in other ways and drop the charges for text messages (a lot of us in the U.S. already have plans with unlimited text messaging). At that point, the rationale for paying even $1 a year to WhatsApp will have evaporated.

2. I do not understand why, in a bidding war between Google and Facebook, if Google bids $10 billion, Facebook has to pay $19 billion. I would think that the minimum raise in this game would be a little smaller.

3. Reihan Salam reproduces some analysis by Tariq Krim that indicates that WhatsApp has a faster-growing user base than Twitter, which is valued by the market at $20 billion. (a) I think I understand what makes Twitter’s market advantage seem defensible, but I do not understand what is defensible about WhatsApp’s user base. (b) As an investor, I would not go anywhere near Twitter at its current valuation.

4. Reihan points to Ben Thompson, who writes breathlessly,

Still, it’s only recently that the killer app for this era, when the nodes of communication are smartphones, has become apparent, and it is messaging. While the home telephone enabled real-time communication, and the web passive communication, messaging enables constant communication. Conversations are never ending, and friends come and go at a pace dictated not by physicality, but rather by attention. And, given that we are all humans and crave human interaction and affection, we are more than happy to give massive amounts of attention to messaging, to those who matter most to us, and who are always there in our pockets and purses.

I do not understand why Thompson is so confident of this. I teach in a high school, so I think I have a bit of sense of what teenagers are up to these days. They are the natural market for this stuff, and a few students are really into messaging. There also are a few of them who are really into games. A few of them are really into music. And a lot of them are perfectly content to leave their phones in their pockets for the whole day.

Late in 1999, I started my first blog, which I called The Internet Bubble Monitor, to make fun of the stock valuations of that era. I shut it down about six months later, because there was nothing to make fun of any more. I think I might have to start it up again.

The Phelps Contention

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A few nights ago, a number of us met over dinner to discuss Edmund Phelps’ book, Mass Flourishing. He contends that starting around 1970s, America’s commitment to modern values started to recede, and we began reverting to traditionalism. That in turn leads to reduced innovation and slower economic growth.

The reaction to this hypothesis from several Baby Boomers and younger discussants ranged from skeptical to apoplectic. Not modern? Us? Civil Rights! Women’s Equality! Four-letter Words! Gay Marriage! Smart phones!

Against those, here are some counterpoints, some of which Phelps has noted:

–decline in the propensity of young adults to move far from their parents (or even out of the house!)

–increase in NIMBYism (often masquerading as environmental concern), blocking development, for example, of airports.

–lower rate of new business formation

–stifling safety regulations (in nuclear power and in drug development)

–resistance to innovation in food production (GMOs)

–demonization of the 1 percent

–hostility to energy production and consumption

What Phelps means by modern values are individualism, self-reliance, and striving for individual excellence. By his standards, he would argue that those values are on the decline. This is a topic that is a bit squishy for economists to try to grasp, but I am not certain that Phelps is wrong.

By the way, I reviewed Phelps’ book here. He says that, contrary to my review, he is an anti-Schumpeterian. I am not sure what he means by that. In any case, he believes that innovation consists much more of small, everyday innovation than it does of dramatic examples such as the internal combustion engine. I tend to agree, and that is one reason that I have been unwilling to side with stagnationists who complain that we have not seen anything Really Big in the most recent two decades.

Trifurcation?

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Richard Reeves writes,

say, the top decile, or 10%, of the income distribution.

This stratum is not only prospering economically. For the people on this top rung, education levels are high and rising. Families are planned, marriages strong, neighborhoods safe and rich in social capital, networks plentiful, BMIs low and savings rates high.

Below these are what Reeves calls “the squeezed middle” and then the “entrenched poor. Reeves later writes,

Data recently unveiled by my colleague Gary Burtless, showing income growth since 1979 across the distribution, shows that in terms of after-tax income, those at the top have done really well since 1979; that’s perhaps not a surprise. What might be more instructive is the relative performance of the lowest quintile and the middle – ie. a 49% rise compared to a 36% rise. Income growth has clearly been weakest in the middle of the distribution.

Pointer from James Pethokoukis.

Government and Failure

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Megan McArdle writes,

the way that people and groups respond when they’re told that their plan is not working out as intended. Basically, there are three responses you can have:

  • My plan was defective: I should change something.
  • The world is defective: The plan is great, but we clearly need to do even more of this.
  • The information is wrong, and my plan is actually working very well.

The first answer is rarely the one that people go to.

Pointer from Tyler Cowen.

This can be as true of people in business as it is of people in government. But in business, you face what Eamonn Butler calls in The Best Book on the Market the World of Truth. If you do not fix what is broken, you lose money and go out of business. In government, you just keep telling people that Obamacare won’t cost jobs.

Follow-up Questions

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On this post. I will summarize the questions as (1) don’t marginal costs really fall when a sector goes through a structural shift, which should lead to a drop in prices? and (2) why don’t investment booms cause dislocation?

1. In microeconomics, I tell my high school students that price discrimination explains everything. Almost every real-world business case finds firms facing very low marginal costs but needing to recover fixed costs. So you see many efforts to segment the market and charge a higher price to the customer with less elastic demand. For your question, the relevant point is that firms always face very low marginal costs–in either booms or recessions. They choose their price structure so as to maximize revenue. A recession does not fundamentally alter their pricing problem.

As a side note, you give several examples of industries that you argue have mostly production workers. I am not convinced. Take health care, for example. If a hospital or a medical practice experiences a 15 percent decline in demand, which workers become expendable? You still need all the administrative staff–accounting folks, the insurance-billing folks, the IT folks. You can lay off some of the folks who touch patients, but that is not an overwhelming proportion of the health care work force.

2. In the Schumpeterian story of PSST, an investment boom is what you observe when the new opportunity arrives but the legacy industry does not recognize it. So Borders keeps investing in stores while Amazon undertakes expansion. This is unsustainable, since the market is not big enough for both of them. When Borders closes, investment declines. The causal factor is technological change. In the short run, investment and employment rise, because the legacy industry is in denial. When they get the memo, investment and employment fall. It seems to me that the pattern in the legacy industry is for firms to hang on as long as possible, and then crash. You might think that they would decay gradually, but that does not seem to be the pattern.