The Audit
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May 25, 2012 02:26 PM
The private-equity problem with Romney and GS Technologies
Loading up a company with debt to ensure Bain's own profits
It's seriously grating to see an Eton and Oxford-educated ambassador's son who works for the Council on Foreign Relations rant about Obama's "populist" attack on private equity.
That's Sebastian Mallaby, who takes to the Financial Times to defend Mitt Romney and Bain Capital's honor, as well as the honor of the private-equity industry at large. Here's the top:
Having hit the rich with the promise of a Buffett tax, the Obama campaign is rolling out its next populist gimmick: an attack on private equity. A series of lurid campaign commercials goes after Mitt Romney for his record at Bain Capital, a company that, in the advert’s telling, behaves like a “vampire”. “They came in and sucked the life out of us,” a steel worker says in the first commercial. “It was like watching an old friend bleed to death,” says another.
Never mind the emotional manipulation; the ad is factually wayward. In 1993, when Bain bought the steel plant in the commercial, it was a saviour: in the absence of a buyer, the plant would have closed. Bain provided a transfusion of $100m to update the plant’s machinery - it was a blood bank, not a vampire - and its investment succeeded for a time. Only in 2001, two years after Mr Romney had left Bain Capital, did the plant succumb to foreign competition and go bust.
It's Mallaby who is factually wayward. He fails to mention private-equity critics' major beef with Bain's behavior here: It borrowed scads of money against GS Technologies (the company referred to in the ad) to ensure its own profit—at the expense of GST.
The big problem with private-equity is when firms make profits off companies that go bust, particularly when those profits directly contribute to the companies going under.
Bain bought control of GST for $8 million in 1993. Within months, it had borrowed $61 million to pay off shareholders. Bain itself got most of that—$36 million—more than quadrupling its initial investment (though it would later put about half of this back into the company to acquire another one).
Mallaby insists GST was in serious trouble when Bain and its partners purchased it. So it makes it even more problematic that Bain & Co. to put GST in more trouble by levering the firm up to pay Mitt Romney et al. a dividend.
If you own a struggling business and you're not a leech, you don't use cashflow for special dividends that could be used to pay down debt or to reinvest in the business. That's why it's so egregious that the Washington Post Company has handed shareholders more than a billion dollars in the last four years even while its namesake business collapses. The New York Times Company, by contrast, has suspended its dividend, which is what responsible companies do when facing a life-threatening rough patch.
GST had very little debt when Bain purchased it in 1993, according to SEC filings. By the end of Bain's first year of ownership, it had roughly sextupled GST's annual interest payments. Within three years, and after borrowing to merge with another company, GST's interest payments had exploded, up 27 times more than the pre-Bain era, while revenue was just 2.3 times 1993 levels and operating profits quadrupled.
GST's outstanding debt rose from $13.2 million when Bain acquired it in 1993 to $385 million in 1996, and the company went from paying $1.6 million a year in interest to paying $42 million. Taxpayers would eventually get stuck with $44 million pension tab when the company filed for bankruptcy.
So it's misleading for Mallaby to claim that "Bain provided a transfusion of $100m to update the plant’s machinery - it was a blood bank, not a vampire." Bain didn't provide anything. Bain's banks did. Bain loaded that $100 million onto GST's balance sheet. It didn't put its own capital into the company, and it had nothing at risk. It had already paid itself back big time for its original, puny $8 million equity investment.
David Brooks of The New York Times also makes the Bain-as-savior mistake in a wildly wrongheaded column on how leveraged buyouts and corporate raiders supposedly saved American capitalism, an incorrect argument his colleague Paul Krugman, as usual, debunks.
Bain made money while its investment went bust—in no small part because of the debt piled on it to ensure Bain made money—and hundreds of people lost their jobs (this isn't to mention that the industry games the tax code to make its money and that its profits are taxed at less than half the rate of other workers via the absurd carried-interest tax break).
That's why elitist (cough) defenses like Mallaby's and Brooks's are so flawed.
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May 25, 2012 06:50 AM
Sorkin’s Glass-Steagall straw man
Of course its repeal contributed, directly and indirectly, to the financial crisis
Here's the headline for Andrew Ross Sorkin's column on Tuesday about Glass-Steagall and the financial crisis:
Reinstating an Old Rule Is Not a Cure for Crisis
No kiddin'. Let's see what else isn't a "cure for crisis":
— Breaking Up Too Big to Fail Banks Is Not a Cure for Crisis
— Stronger Capital Requirements Are Not a Cure for Crisis
— Quintupling Regulatory Budgets Is Not a Cure for Crisis
— Hauling Executives to Jail Is Not a Cure for Crisis
There is no single "cure for crisis." Period. And nobody anyone pays attention to is actually saying there is. Here's the nut of Sorkin's argument:
A meme around Glass-Steagall has been created, repeated so often that it has almost become conventional wisdom: the repeal of Glass-Steagall led to the financial crisis of 2008. And, the thinking goes, has become almost religious for some people, that if the law were reinstated, we would avoid the next crisis.
Just because something isn't a cure doesn't mean it isn't a critical component of a plan to reduce the risk and ramifications of a future crisis. Sorkin himself admits this, as Audit contributing editor Felix Salmon writes:
A true classic of the straw-man form from Sorkin, here. He spends an entire column arguing against the people arguing for the return of Glass-Steagall. But then he concedes that the return of Glass-Steagall would actually be a good thing. He just doesn’t like people saying that it’s “the ultimate solution”. Except, he doesn’t name any such person. Grr.
There's a broader lesson for journalists here. As NYU's Jay Rosen says on Twitter: "'Not a panacea' is not an idea for a column." It's sloppy, simplistic thinking.
But this column is even more wrongheaded than that. Here's Sorkin (emphasis mine):
But here’s the key: Glass-Steagall wouldn’t have prevented the last financial crisis. And it probably wouldn’t have prevented JPMorgan’s $2 billion-plus trading loss. The loss occurred on the commercial side of the bank, not at the investment bank.
That's just not right. The whole purpose of Glass-Steagall, as David Dayen notes, was to prevent commercial banks from engaging in Wall Street-style speculation.
In other words, Glass-Steagall would have prevented JPMorgan from owning Chase, but it would have also prevented Chase from making those bets. We all know now that the bank wasn't hedging its portfolio of loans. It was using its taxpayer-insured deposits to make $100 billion bets for profit—on synthetic credit-default-swap indexes no less.
Sorkin's opinion matters more than most because he's a power center at The New York Times who helps direct Wall Street coverage for the paper. When he "parrots the argument made by Wall Street's elite," in the words of Reuters's Cate Long (as is not infrequent), it's worth watching closely.
As Elizabeth Warren tried to explain to Sorkin, who tries and fails to make it seem like he's caught her in a "gotcha" moment, Glass-Steagall is not the end-all be-all of crisis prevention. It's an important piece of it, as well as a potent symbol of the ascendance of Wall Street's political power and of the destruction of the New Deal regulatory apparatus that kept the financial system relatively safe for fifty years.
The demise of Glass-Steagall is part and parcel with the Commodity Futures Modernization Act, Gramm-Leach-Bliley, Riegle-Neal, the preemption doctrine, the revolving door, the Christopher Cox-style regulators, the death by a thousand cuts, and all the laws that were needed but never passed to update the regulatory system over the last three or four decades, like, say, changes to the tax code to eliminate the perverse tax incentives that favor loading up with debt over building equity.
Sorkin concedes that Glass-Steagall would have prevented or seriously mitigated Citigroup's bubble activities that led to its quasi-nationalization. But Citi was not just a footnote to the financial crisis, as Sorkin implies.
Recall that Citigroup was brazenly created in 1998 in violation of the Glass-Steagall restrictions. Those were repealed within months with major help from Robert Rubin, who went on months later to make $15 million a year at Citigroup. The repeal was like waving the green flag at a Nascar race—part of a culture of empowerment that encouraged Wall Street to get bigger and riskier and to eventually trash the rest of the economy.
But don't listen to me or Sorkin: Ask John Reed, Citi's former CEO, and Dick Parsons, its former chairman.
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May 24, 2012 05:59 PM
Audit notes: Buffett on newspapers, Times-Picayune, SEC lets Lehman go
A vow to invest in newspapers and protect them from interference
This is the most hopeful thing I've read about the business of newspapers in a long, long time:
I'll quote at length from Warren Buffett's letter to editors and publishers of his newly expanded portfolio of papers:
Berkshire buys for keeps. Our only exception to permanent ownership is when a business faces unending losses, a remote prospect for virtually all of our dailies. So let me express a few thoughts about what lies ahead as we join forces.
Though the economics of the business have drastically changed since our purchase of The Buffalo News, I believe newspapers that intensively cover their communities will have a good future. It’s your job to make your paper indispensable to anyone who cares about what is going on in your city or town.
That will mean both maintaining your news hole — a newspaper that reduces its coverage of the news important to its community is certain to reduce its readership as well and thoroughly covering all aspects of area life, particularly local sports. No one has ever stopped reading halfway through a story that was about them or their neighbors.
You should treat public policy issues just as you have in the past. I have some strong political views, but Berkshire owns the paper — I don’t. And Berkshire will always be nonpolitical. We have more than 600,000 shareholders of all stripes and I do not use Berkshire’s resources, directly or indirectly, to speak for them. I am 81, and many of you will outlive me as an employee of Berkshire. But I am sure my successors will follow the ideas I am laying out in this letter. (Indeed, letting them know of this hands-off principle is a secondary reason for my writing this letter.)
Your paper will operate from a position of financial strength. Berkshire will always maintain capital and liquidity second to none. We shun levels of debt that could ever impose problems. Therefore, you will determine your paper’s destiny; outsiders will never dictate it.
Our newspaper purchases are of smaller size, measured by dollar cost, than the businesses we normally consider buying. Nor will they move the needle in terms of Berkshire’s economic value, though I expect their contribution will likely be commensurate with our investment. But the papers are every bit as important to me — and, for that matter, to society — as other businesses we have purchased for many billions of dollars.
If Buffett of all people sees some economic value left in newspapers, maybe there really is some.
— Good thing I saw Buffett's note, because this other corporate letter is one of the more dispiriting things I've read about the business of newspapers recently. Watch Newhouse spin its gutting of the Times-Picayune with a digital smokescreen:
A new company - the NOLA Media Group, which will include The Times-Picayune and its affiliated web site NOLA.com - was announced today by Ricky Mathews, who will become its president. The change is intended to reshape how the New Orleans area's dominant news organization delivers its award-winning local news, sports and entertainment coverage in an increasingly digital age.
NOLA Media Group will significantly increase its online news-gathering efforts 24 hours a day, seven days a week, while offering enhanced printed newspapers on a schedule of three days a week. The newspaper will be home-delivered and sold in stores on Wednesdays, Fridays and Sundays only. A second new company, Advance Central Services, will print and deliver the newspaper. Both of the new companies are owned by Advance Publications.
Oh, yeah, down in the twelfth paragraph:
Mathews said details of the new digitally focused company are still being worked out, but the transition will be difficult. While many employees will have the opportunity to grow with the new organization, Mathews said, the need to reallocate resources to accelerate the digital growth of NOLA Media Group will result in a reduction in the size of the workforce.
The Times-Picayune is profitable, reports Jim Romenesko.
— Bloomberg scoops that the SEC will not ("probably") file charges against anyone for the collapse of Lehman Brothers:
Under a heading reading “Activity in Last Four Weeks,” the undated document reads, “The staff has concluded its investigation and determined that charges will likely not be recommended.”
In a 2010 report, Valukas said Lehman used transactions known as Repo 105s to hide billions of dollars in assets and artificially reduce the firm’s leverage. In a typical repo agreement, one party temporarily transfers a security to another as collateral for short-term cash. A Repo 105 transaction requires extra collateral, making it a more costly form of borrowing. Those deals were accounted for by Lehman as “sales,” as opposed to financing transactions, Valukas said...
In its final year, Lehman overvalued real-estate holdings, including a stake in U.S. apartment developer Archstone-Smith Trust, Valukas said. Lehman and Tishman Speyer Properties LP completed a joint acquisition of Archstone for $22 billion, including debt, in October 2007.
Valukas handed them a case or three, but they still come up with nuttin'.
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May 24, 2012 12:21 AM
Audit notes: No more daily in New Orleans, McClatchy, private equity
The NYT reports the Times-Picayune will print two or three times a week
If ever a town needed a newspaper, it's New Orleans.
But David Carr reports that Newhouse is preparing big layoffs at the Times-Picayune, which will no longer be a daily newspaper.
Newhouse Newspapers, which owns the Times-Picayune, will apparently be working off a blueprint the company used in Ann Arbor, Mich., where it reduced the frequency of the Ann Arbor News, emphasized the Web site as a primary distributor of news and in the process instituted wholesale layoffs to cut costs...
The plans have been kept under wraps, but the newspaper will likely cease to exist as a daily newspaper, and will publish two or three times a week, according to the employees.
My first newspaper internship was as a copy editor at a Newhouse paper in Alabama, The Huntsville Times, and I remember marveling at Newhouse's no-layoffs policy. It really had such a thing.
How times have changed.
— Despite a stock that's off 97 percent in seven years, McClatchy is still publishing daily newspapers (for now). And it's finally going leaky paywall, a la The New York Times.
Err... actually, it's going to kick the tires a bit more on the paywall thing:
The approach will offer readers a new print-digital subscription that will include access to multimedia editions for a relatively small increase of home delivery rates. We’ll also offer online-only users a digital subscription that will be prompted after a set number of page views. We’ve arrived at this combination after a lot of research, involving McClatchy papers and others, which shows that a thoughtfully crafted, opt-out digital subscription is a good fit with our overall readership and circulation strategy. In the coming months, we’ll begin a final round of testing with a handful of McClatchy papers (first up will be Sacramento, Fort Worth, Modesto, Biloxi and Columbus). The experiences of these papers will determine how and under what schedule to extend to all papers.
Our experiments with pay approaches, starting with Modesto more than a year ago and moving to several other McClatchy papers, have taught us a number of things. The pay model is a complex move that has to be part of wider plan for how we distribute and value our content. We’ve learned that many light online users are unlikely to become subscribers — but that our loyal print and online customers are willing to sign up in exchange for a multi-media subscription that would include the print edition, web, smart phones and the e-edition. Above all, we found that the impact of placing a clear value on our content is among the most important messages we can send as part of this transition.
Here's hoping McClatchy still has a stock price by the time it concludes this final round of testing.
— Josh Kosman writes for Rolling Stone on "Why Private Equity Firms Like Bain Really Are the Worst of Capitalism":
Here’s what private equity is really about: A firm like Bain obtains cheap credit and uses it to acquire a company in a "leveraged buyout." "Leverage" refers to the fact that that the company being purchased is forced to pay for about 70 percent of its own acquisition, by taking out loans. If this sounds like an odd arrangement, that's because it is. Imagine a homebuyer purchasing a house and making the bank responsible for repaying its own loan, and you start to get the picture.
O.K., but what about this much more virtuous business of swooping in and restoring struggling companies to financial health? Well, that's not a large part of what private equity firms do, either. In fact, they more typically target profitable, slow-growth market leaders. (Private equity firms presently own companies employing one of every 10 U.S. workers, or 10 million people.)
And that's when the fun starts. Once the buyout is completed, the private equity guys start swinging the meat axe, aggressively cutting costs wherever they can - so that the company can start paying off its new debt - by laying off workers and cutting capital costs. This process often boosts operating profit without a significant hit to the business, but only in the short term; in the long run, the austerity approach makes it difficult for companies to stay competitive, not least because money that would otherwise have been invested in expansion or product development - which might increase revenue down the line - is used to pay off the company's debt.
Kosman wrote The Buyout of America: How Private Equity Is Destroying Jobs and Killing The American Economy', which has a killer chapter on Bain Capital. Go read it.
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May 23, 2012 01:04 PM
Facebook fiasco
The well connected made out while retail investors got hosed
We're starting to get a better picture of what happened with Facebook on Friday and in the run-up to its IPO, and it's not pretty.
The repercussions have already begun, with a class-action lawsuit already filed against Facebook and Wall Street for misleading investors about the company's prospects. You can bet the recrimination from participants won't be too far behind.
It appears from what we know now that Facebook and its bankers selectively told big investors in the days before the IPO that the company's outlook had dimmed but failed to tell mom and pop investors. That would be a serious problem if true.
Reuters has been leading on this story, reporting Saturday that Facebook had lowered its guidance during the IPO roadshow, "a rare and disruptive move." Reuters followed that on Monday with a report that Morgan Stanley, the IPO's lead underwriter, had lowered its earnings and revenue guidance for Facebook, as had underwriters Goldman Sachs and JPMorgan Chase.
Henry Blodget seized on the potential importance of these reports story and has been following them with a mix of gossipy reporting and first-hand expertise from his years as an analyst (and one who had an infamous run-in with the law). He wrote this yesterday morning:
So the fact that these analysts suddenly all cut their earnings forecasts at the same time, during the roadshow, and then this information was not passed on to the broader public, is a huge problem...
Selective dissemination of this sort could be a direct violation of securities laws. Irrespective of its legality, it is also grossly unfair. The SEC should investigate this immediately.
Underwriters may say that they were just responding to Facebook's May 9 revision of its S-1 filing with the SEC. But while Facebook didn't issue any new numbers in the S-1 revision, the analysts' revisions were awfully similar.
Reuters reports now that four of the Facebook underwriters lowered estimates after the S-1 revision. Here's the new and old revenue estimates:
Morgan Stanley -- $4.854 billion (new)from $5.036 billion (old)
Bank of America -- $4.815 billion (new) from $5.040 billion (old)
JPMorgan -- $4.839 billion (new) from $5.044 billion (old)
Goldman Sachs -- $4.852 billion (new) from $5.169 billion (old)
I suppose it's just coincidence that these four analysts all ended up revising within 0.8 percent of each others' revenue estimates.
Which is why Blodget's reporting, though thinly sourced, makes sense. He writes that "One of the underwriter's analysts has said he was told by a Facebook financial executive to cut his estimates."
Who might that have been? The Wall Street Journal reports this morning that Facebook CFO David Ebersman micromanaged the IPO in an unusual manner.
The problem here is that institutional investors may have been getting one, relatively bearish message from inside the company while mom and pop investors (aka the dumb money) were still getting the bubble utopia message. One interesting but thinly sourced piece of Blodget's report says:
Institutional investors, having digested the news of the underwriter estimate cut, were comfortable buying Facebook stock at $32 a share.
Retail investors, meanwhile, who were presumably unaware of the estimate cut, were comfortable buying Facebook at $40 a share.
Under this version of the story, it turns out, retail investors were rushing to buy Facebook shares. It was the institutional investors who had inside information who balked at the high price and sold.
If it turns out that Facebook told analysts about its weakened prospects without telling the broader public in its S-1, it should be in big-time trouble. CNBC's John Carney:
If someone at Facebook did whisper in the ear of the underwriters’ analysts about the earnings, and those analysts then used this material, non-public information for the basis of rethinking their estimates, and the clients of the banks then altered their orders for Facebook shares while in possession of this information, we have the makings of an insider trading case.
The New York Times reports that Facebook held a conference call with analysts at its underwriters to "update their banks’ analysts on the business. Analysts at Morgan Stanley and other firms soon started advising clients to dial back their expectations."
Regardless of whether anyone committed a crime, much less gets charged for one (don't hold your breath), this ugly episode has shown very clearly how Wall Street, tech companies, and the venture capitalists who back them have been trying to inflate another bubble to enrich themselves. They were too incompetent this time to pull it off cleanly, as Audit contributor Felix Salmon shows in his "List of Incompetents," but they did end up gouging plenty of folks.
If you were one of the suckers who bought at the open on Friday, you lost more than a quarter of your money in less than three trading days.
But the pace of the decline is what's unusual about Facebook's launch, not the decline itself. Here are the other major social-media (or social-ish) IPOs of the last year:
— Groupon: -55 percent since Novemeber
— Pandora: -43 percent since June
— Zynga: -28 percent since December
— Yelp: -28 percent since March
Only LinkedIn is trading above its bankers' price level, up 7 percent since last May. And it's not exactly a discount purchase with a price-to-earnings ratio of 627.
The rest of the above companies (except Facebook) don't have P/E's. They lose money.
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May 23, 2012 11:03 AM
How Gawker wants to monetize comments
Denton’s vision for Gawker Media’s editorial product moves away from posts
Back in November, I grappled with the fact that online display ads in general, and banner ads in particular, are clearly not working very well; my suggested alternative was for brand advertisers to embrace the power of the external link. That was one suggestion; there are many, many more. But what they all have in common is that they’re attempts to go beyond the ad, and to leverage the interactive power of the internet.
Over at Tumblr, David Karp is being characteristically vague about what he’s offering to potential advertisers: all we know for the time being is that he “wants brands and marketers to use Tumblr as a way to tell stories that they can’t otherwise tell on other social networks”. Which sounds great, but doesn’t even come close to answering the obvious first question, which is “how?“. I understand that the idea is to sell space on the right hand side of the screen, and that clicking on one of those units will take Tumblr users to the advertiser’s tumblog. But this seems uncomfortably close to the idea that advertisers buy a banner ad and that clicking on that banner ad will take users to the advertiser’s website. The tumblog itself might well tell a story — but then again, so might the advertiser’s website. The difficult thing is getting users to click on things, especially when those things look like — and are clearly labeled as — ads.
Similarly, Facebook’s revenue problems are based on much the same underlying issue: Facebook itself is highly interactive and immersive, but the ads you find there are not. And while there are one or two companies I will follow on Facebook, they’re invariably companies which are run by my friends. Facebook is a great place to keep up with what your friends are up to, but it still hasn’t cracked the nut of working out how to make itself valuable to brand advertisers.
Now, Gawker Media’s Nick Denton has a new idea:
In an internal memo on Thursday, Denton announced the formation of a new sales unit that will focus on helping advertisers and brands take part in the new commenting system…
According to the memo, Gawker is creating a new content unit within the sales department that will be headed by Ray Wert, formerly editor of the Gawker-owned automotive blog Jalopnik. This new unit will take over responsibility for all of Gawker’s branded content functions, as well as marketing communications and events — and the purpose of the unit will be to promote the new Gawker discussion platform as a way for marketers and brands to engage with customers in an open forum. Says Denton:
We all know the conventional wisdom: the days of the banner advertisement are numbered. In two years, our primary offering to marketers will be our discussion platform.
Last Friday, Denton gave me, along with a few other New York digital-media types, a preview of his new commenting system; yesterday, I had a pretty geeky conversation with Wert about how he intends to turn it into dollars.
At Gawker, as at most other popular sites, the number of people reading the comments is vastly greater than the number of people writing them. But the way they’re presented, they’re not easy to read, there’s far to many of them, and the signal-to-noise ratio tends to be extremely low.
So Gawker’s new commenting system is based around threads, with the default view being the main, most interesting thread. It’s possible to click through to other threads, and every thread — indeed, every comment — has its own unique URL; what’s more, the person who starts a thread has quite a lot of control over which comments in that thread will get featured.
What that means is that if an advertiser buys a sponsored post — and sponsored posts have been part of Gawker’s menu of offerings for some time now — then once the new commenting system is in place, the advertiser will have a reasonably large degree of control of the conversation that most people see in that post.
Denton’s vision for Gawker Media’s editorial product is very much moving towards comments and away from posts, and he reckons that advertisers will follow him in that direction if he blazes the trail. Expect Gawker’s blog posts to get shorter, in future, and sometimes just be a headline, at least in the first instance, so that the conversation can get going before a pretty post can be put together. And if Denton’s scheme goes according to plan, when you follow a link to a Gawker website, it will often — or maybe even usually — be a link to a comment, rather than to an original post. Eventually, it’s possible to envisage a world where the distinction between the two is erased completely.
This is a very ambitious vision. Historically, Gawker has been pretty weak with respect to technological innovations, and so it’s reasonable to take an I’ll-believe-it-when-I-see-it approach any time that Nick Denton claims to have invented a revolutionary new technology. As Wert said to me, forums have been around on the internet since the 90s, and no one’s managed to reinvent them yet. But a few companies like Reddit and Quora have pointed in interesting directions, and Wert was quite open about wanting to ape Reddit’s AMA (“ask me anything”) feature for his new advertorial conversations.
The idea is for these things to be more a PR/marketing product than a brand-advertising product. The idea is to get challenger brands, in particular, to take part: they tend to be very open and transparent about what they’re up to, and they love the idea of engaging with the public as much as possible, if they can do so in a reasonably controlled environment. When that kind of a brand has some kind of news they want to share, doing so through a Gawker Media sponsored post will be a pretty effective way of getting the news out to a large number of people while at the same time sending the message that they’re trying to be as transparent as possible and are happy to answer lots of questions in a friendly and conversational and open manner. The metric for success, says Wert, isn’t going to be the number of pageviews they get; rather, it will be the amount of earned media they get — the degree to which other media outlets pick up on the initial announcement and the rest of the information that the company reveals in the comments section.
The conversation will probably only go on for a day or two, but after that the post — and all its associated comments — will live on in perpetuity, a much more open and accessible record of the announcement than any press release could be.
The problem here, for Denton — and the reason why he got an editorial guy to run this new project — is the old one: how to persuade his websites’ readers to read the sponsored posts and to engage in their comments sections. Wert’s stated ambition — and you can hold him to this — is for his sponsored posts to be so well written and newsworthy and generally high quality that the editors of Gawker’s websites will love to be able to feature them on their home pages. There have been very high-quality sponsored posts in the past, but Wert is going to have to work very hard, I think, to turn boring PR announcements into something of Gawker-level juiciness.
What’s more, this move of Denton’s is to a large degree a reversal of his stated aim back at the end of 2010, when he did his big network-wide redesign. Back then, I explained the departure of sales chief Chris Batty, now at Quartz, as being a function of the fact that Batty was a huge fan of the sponsored post, while Denton’s redesign “essentially sacrifices the idea of having a sponsored post on the home page—something Batty was almost religious about—and replaces it with interstitial videos which aren’t nearly as sharable, aren’t extensible, and quite possibly won’t even have permalinks.” This move of Denton’s, then, is a step backwards, in many ways, towards the Batty vision which he rejected two years ago.
Still, I do like the fact that Denton’s constantly trying new things, constantly trying to reinvent what an online media company can and should be. Really ambitious brands, indeed, won’t need Wert’s help at all: they’ll have the ability to dive straight into existing non-sponsored editorial posts and respond to commenters directly, much as they’re already responding to people who talk about them on Twitter. But I suspect that the brands which do that will actually be more receptive, rather than less receptive, to Wert’s sales pitch — they will already understand the power of conversation.
And in general, I like Denton’s bigger idea of building a comments system designed more for the majority of readers who don’t comment than it is for the minority of commenters themselves. I don’t believe for a minute that the new system will attract the big-name commenters — Dov Charney, Brian Williams — that Denton really wants. But I do think that the new system will make very high-end comments threads much more common. And when those things do appear, they’re wonderful.
I used to help run a site, back in the early days of the blogosphere, called MemeFirst. The posts were short; the comments threads were long, and generally very high quality. We didn’t have much of a signal-to-noise problem, because very few people knew we existed. We were basically just a group of friends using the web as a discussion aid. But the fact is that even though there are many more readers than there are commenters, there are also many more commenters than there are posters. And collectively, those commenters are faster and funnier and more knowledgeable than the staff of any website.
Nick Denton wants to be the first publisher to develop the ability to effectively tap into that collective wisdom. And then, he wants to try to sell his new-found ability to advertisers. If — and only if — Denton can do the former, I suspect that Ray Wert has a decent shot of being able to do the latter.
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May 22, 2012 05:58 PM
Audit notes: Facebook disclosure, Facebook value, soft corruption
Business Insider's Henry Blodget, who knows a thing or two about analyst/IPO scandals, writes that Facebook and/or its bankers could be in trouble for not disclosing material information to the public about its financial health.
Reuters has been reporting for several days that analysts at three of Facebook's bankers cut estimates for the company during the roadshow leading up to the IPO. But the banks didn't tell the public.
Now, regardless of why the analysts cut their estimates (and this will be important), estimate cuts of any sort are material information, so if this news was given to some institutional clients, it also obviously should have been given to everyone.
That's the first problem.
The second potential question and problem is whether Facebook told the underwriters to cut their estimates—either by directly telling them to, or, more likely, by "suggesting" that the analysts might want to revisit their estimates in light of the new disclosures in the prospectus.
If there was any communication at all between Facebook and its underwriters regarding the analysts' estimates, Facebook will likely be on the hook for this, too.
This is one to watch.
— Reuters looks at how overvalued Facebook, which started trading at $38 a share on Friday, looks to be (emphasis mine):
As bad as the declines have been, though, a view persists that the stock remains overvalued.
Thomson Reuters Starmine conservatively estimates a 10.8 percent annual growth rate -- almost exactly the mean for the technology sector -- which would value the stock at $9.59 a share, a 72 percent discount to its IPO price.
Similarly, the company's price-to-earnings ratio remains lofty, even after the selloff. The $31 price implies a forward P/E of 60, compared with Google's 13.3 forward price-to-earnings ratio (for a similar rate of growth).
— Matt Stoller has a must-read piece on how Big Money corrupts how at least some politicians (and I would add: regulators and journalists) think and act. It's not just campaign donations for their re-elections.
Most activists and political operatives are under a delusion about American politics, which goes as follows. Politicians will do *anything* to get reelected, and they will pander, beg, borrow, lie, cheat and steal, just to stay in office. It’s all about their job.
This is 100% wrong. The dirty secret of American politics is that, for most politicians, getting elected is just not that important. What matters is post-election employment. It’s all about staying in the elite political class, which means being respected in a dense network of corporate-funded think tanks, high-powered law firms, banks, defense contractors, prestigious universities, and corporations. If you run a campaign based on populist themes, that’s a threat to your post-election employment prospects. This is why rising Democratic star and Newark Mayor Corey Booker reacted so strongly against criticism of private equity - he’s looking out for a potential client after his political career is over, or perhaps, during interludes between offices. Running as a vague populist is manageable, as long as you’re lying to voters. If you actually go after powerful interests while in office, then you better win, because if you don’t, you’ll have basically nowhere to go. And if you lose, but you were a team player, then you’ll have plenty of money and opportunity. The most lucrative scenario is to win and be a team player, which is what Bill and Hillary Clinton did. The Clinton’s are the best at the political game - it’s not a coincidence that deregulation accelerated in the late 1990s, as Clinton and his whole team began thinking about their post-Presidential prospects.
He notes that Bill Clinton gutted financial regulation in the late 1990s and, weeks after signing the infamous Commodity Futures Modernization Act, cashed a quarter-million dollars worth of checks from Wall Street for speeches and has since raked in $80 million.
Meanwhile, Russ Feingold, a Senator who did go after Wall Street, is a professor in the Midwest. Eliot Spitzer is a struggling TV host and writer.
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May 21, 2012 05:03 PM
Audit Notes: Facebook IPO edition
I'm happy to say I was wrong (and Felix was right) in guessing that retail investors would jump into Facebook shares and push it significantly higher. The stock stayed even on Friday only with the massive support of its underwriters, and it plunged 11 percent today.
What happened? The company was overpriced, as many press stories suggested, and Facebook and its bankers unloaded too many shares all at once, The Wall Street Journal reports:
The greater issue, they said, was that the company and its bankers overestimated demand. In particular they pointed to a decision disclosed Wednesday to raise the potential pool of shares to be sold to 484.4 million shares from 388 million.
With that shift, many investors received far more shares than they had expected, said people familiar with the matter. That is unusual for an IPO, and it spooked investors...
t $34, Facebook would have a price-to-earnings ratio, a measure of how expensive or cheap a stock is, of about 57 times projected earnings for the next 12 months, according to FactSet research. That's still a much richer valuation than other tech titans, such as Google, at 14. Those ratios mean a Facebook share is more than four times as expensive as a share of Google.
Facebook is worth "just" $73 billion tonight, but that is still awfully high for a company with declining earnings that made just a billion dollars last year and whose revenue growth, while still fast, is slowing.
— TechCrunch's Alexander Haislip writes that "Silicon Valley Can Do Better Than Facebook."
Facebook isn’t bad. It is just a low-value use of time that doesn’t contribute much to the economy beyond enriching the rich. What more valuable things could be done with the time, energy, effort, creativity and capital invested in its making and daily usage?
There are startups doing amazing things here in Silicon Valley still. Sure there are the electric cars, robot butlers, space rockets and a bunch of hyper-ambitious projects. But you can have a positive contribution to the economy and the world without curing cancer or feeding starving people in Africa (there is a venture firm in San Francisco working on sustainable agriculture if you do want to make a difference in the subcontinent). I’m often impressed by people working to prevent outbreaks of nasty viruses with rapid vaccination development or others creating systems to radically improve the energy efficiency of large buildings. These companies’ goals are obtainable, their achievement would be beneficial and the products would be the world’s envy.
With Facebook public, perhaps the past half-decade of social networking, casual games, virtual worlds, MMORPGs, app stores, avatars and “pokes” will give way to a renaissance of startup companies that make real products of tangible value that employ regular people. Such a return to Silicon Valley’s roots could reinvigorate the American economy and once again put this unique place at the heart of human progress.
I'm not sure I'd go all utilitarian on Facebook, but it's good to point out that despite the utopian rhetoric, this is basically an entertainment company trying to get you to click ads about the gout.
— And speaking of Felix, don't miss this post he wrote last month deflating the Marc Andreessen bubble a bit—and pushing back on a silly <i>Wired cover deeming the Facebook investor "The Man Who Makes the Future":
But Andreessen has never really been a public intellectual. His single greatest achievement — the creation of the world’s first web browser, Mosaic — took place under the auspices of the National Center for Supercomputing Applications at the University of Illinois. But ever since then he’s been a red-blooded capitalist, founding and funding a long series of for-profit companies, and becoming one of the wealthiest and most powerful men in Silicon Valley in the process.
And when you look at Marc the capitalist, rather than at Marc the ideas guy, the hero-worship becomes a bit more difficult. I certainly like the way that he’s dragging Silicon Valley into the world of philanthropy, where it’s historically been very weak. But a lot of my own Wired story, last month, can be read as a push back against the IPO culture which Andreessen, almost more than anybody else, has managed to create.
“Silicon Valley is full of venture capitalists who have become dynastically wealthy off the backs of companies that no longer exist,” I wrote in that piece, and Andreessen is Exhibit A if you want to look for such a person. His first company, Netscape, lost the Browser Wars and ended up getting sold to AOL. His second company, Loudcloud, was (to be charitable) too far ahead of its time, so it “pivoted” into something called Opsware; eventually Andreessen managed to sell it off to HP. His third company, Ning, was even less successful, and ended up buried somewhere in Glam Media. None of them exist today in any recognizable form; none of them ever made much money; and none of them even really made it as far as building anything approaching a permanent income stream.
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May 21, 2012 11:07 AM
The Chicago Tribune lights up the flame-retardant industry
An outstanding investigation show how chemical companies preserve a toxic cash cow
A tremendous Chicago Tribune investigation into flame-retardant chemical manufacturers shows how they push their poisons on an unsuspecting public despite repeated findings that their products do nothing to prevent or delay fires. It's a sordid tale of powerful corporations, paid shills, and legislative and regulatory impotence—one of the best examples I've seen of how private special interests dominate the public interest.
The Trib's series is a devastating piece of muckraking that shows how the chemical industry misleads lawmakers and the public to protect a cash cow.
This is how newspaper journalism ought to be done. The paper hits the chemical industry and the folks on its payroll hard, comes to a clear conclusion, and uses pointed language that amplifies the impact.
The Tribune calls the chemical industry's push "a decades-long campaign of deception" that "manipulated scientific findings" with "flaws so basic they violate central tenets of science," and created a "phony consumer watchdog," a "front" that has "misrepresented itself." It doesn't futz around with he said/she said. It just out and out says that flame retardant in household products "doesn't work." The paper calls it like it sees it and makes a convincing case that it has it right.
The entire series is fantastic, but let's focus on one piece, about how a prominent burn surgeon has pulled heartstrings for the industry with stories of burned children who could have been saved if their furniture had contained flame retardants. The Tribune shows that the surgeon’s stories are fabricated and false. Here’s the lede:
Dr. David Heimbach knows how to tell a story.
Boy, does he. The Trib tell us five paragraphs in flatly that one anecdote in particular “wasn’t true”—that critical elements of the story, and others Heimbach told in similar testimony, were invented.
Heimbach was testifying (though not under oath, as the doctor explains in his fumbling attempts to excuse his falsehoods) for an astroturf group called Citizens for Fire Safety. It goes to show that if a group calls itself “Citizens for” something these days, it’s almost certainly a fake grassroots organization whose real purpose is to lobby and propagandize for powerful interests. The paper points out the similarities (and connections) between this campaign of deception and Big Tobacco's decades-long effort to claim its deadly products were safe.
The Trib reports that these flame retardants are everywhere—stuffed into couches and pillow and mattresses by the pound, despite scientific evidence that they can cause a range of health problems, including cancer, mental problems, and infertility.
A critical part of the problem here is that our laws tie make it extremely difficult for regulators to police the chemicals industry. This is from another story in the series, on the law and how the EPA let a toxic fire retardant replace another toxic fire retardant:
Unlike Europe, where companies generally are required to prove the safety of their chemicals before use, U.S. law requires manufacturers to submit safety data only if they have it. Most don't, records show, which forces the EPA to predict whether chemicals will pose health problems by using computer models that the agency admits can fail to identify adverse effects.
The EPA can require studies of new chemicals that it anticipates could affect people's health — as it did with Firemaster 550 — but this step is rare, and the research doesn't need to be completed before the chemicals are sold.
To ban a chemical already on the market, the EPA must prove that it poses an "unreasonable risk." Federal courts have established such a narrow definition of "unreasonable" that the government couldn't even ban asbestos, a well-documented carcinogen that has killed thousands of people who suffered devastating lung diseases.
This is one of those series that is so damn good and so infuriating, you'd like to think we'd wake up tomorrow and everything has changed. The EPA would have banned the chemicals in question, the surgeon would have been hauled in for misleading testimony, the front organization would have been disbanded, the chemical companies responsible would have gone broke, and the law would have been changed to require remaining chemical companies actually prove their products are safe before selling them.
You'd have to be a hopeless optimist to bet that real change will be effected, and if anything does, it will take years. The calcification of the political system is too complete.
But if there's a piece of journalism that could force it to happen, it's this one.
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May 18, 2012 03:00 PM
A game of telephone fools the Times
And the newspaper-of-record short-arms the correction
The New York Times posts a nasty correction on its Sunday op-ed by William Deresiewicz, who asserted that a study had found that 10 percent of people on Wall Street were "clinical psychopaths."
That 10-percent-psycho baloney was the lead anecdote—critical framing for the whole op-ed. The Times has since re-written the lede paragraph almost entirely, disappeared the errors, and attached a correction at the very end of the story:
An earlier version of this article misstated the findings of a 2010 study on psychopathy in corporations. The study found that 4 percent of a sample of 203 corporate professionals met a clinical threshold for being described as psychopaths, not that 10 percent of people who work on Wall Street are clinical psychopaths. In addition, the study, in the journal Behavioral Sciences and the Law, was not based on a representative sample; the authors of the study say that the 4 percent figure cannot be generalized to the larger population of corporate managers and executives.
That's not good enough. Here's the original lede, which I snagged via Factiva:
THERE is an ongoing debate in this country about the rich: who they are, what their social role may be, whether they are good or bad. Well, consider the following. A recent study found that 10 percent of people who work on Wall Street are ''clinical psychopaths,'' exhibiting a lack of interest in and empathy for others and an ''unparalleled capacity for lying, fabrication, and manipulation.'' (The proportion at large is 1 percent.) Another study concluded that the rich are more likely to lie, cheat and break the law.
Here's the lede, as rewritten:
THERE is an ongoing debate in this country about the rich: who they are, what their social role may be, whether they are good or bad. Well, consider the following. A 2010 study found that 4 percent of a sample of corporate managers met a clinical threshold for being labeled psychopaths, compared with 1 percent for the population at large. (However, the sample was not representative, as the study’s authors have noted.) Another study concluded that the rich are more likely to lie, cheat and break the law.
The NYT is effectively saying, "We originally said a study found 10 percent of Wall Streeters were psychopaths. But that was false. It really said 4 percent of executives are psychopaths. But even then, the study was not based on a representative sample, according to its own authors, which means that it's just bullshit, which means that this op-ed is fatally flawed."
But rather than say something like that, the paper just rewrites the false part—without noting it has done so until and unless you get to the very bottom of the piece. The Gray Lady doesn't do strikethroughs, you know.
The "study" the original NYT piece linked to was an article in CFA Institute magazine, as Edward Jay Epstein writes at The Daily Beast. Actually, Epstein writes that the Times linked to an aggregated version of CFA's story that ran in The Week, which itself was aggregating the story via other aggregators.
In other words, the Times's false information was sourced from The Week, which sourced it, via aggregated posts at master aggregators Business Insider and Huffington Post, from CFA Institute magazine which sourced it, erroneously, from "Studies conducted by Canadian forensic psychologist Robert Hare."
This is telephone, press style. The Times was at least four derivative sources removed from the original source of the information. If anyone along the way messed it up, as the first reporter did, the whole chain was vulnerable. Some editor at the Times should have noticed that the column's most eye-opening claim, one on which it hung its whole thesis, was sourced not to the APA or some academic journal, but to The Week, which in turn was sourcing it on down the line.
This isn't to say that columnists and bloggers have to re-report everything that has already been reported elsewhere. But editors have to fact check the lede graph of a provocative, edited column in your paper of record that accuses a big chunk of people of being "clinical psychopaths."
The worst part of this is that the 10-percent-psycho claim spread by CFA and aggregators was debunked more than two months ago by John M. Grohol, the editor of Psych Central, who thought the number sounded fishy and called up the author of the study.
The viral nature of this error shows why corrections, prominently displayed, are so critical. None of the articles in the telephone chain above have been corrected—even after the Times's fix—and the Times itself has yet to correct its error in print.
That's how misinformation becomes conventional wisdom.
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May 17, 2012 06:11 PM
Audit notes: Questions for JPMorgan, hindsight journalism, Ticketmaster
Jesse Eisinger asks what and when Dimon & Co. knew about the bank's big loss
ProPublica's Jesse Eisinger, in his NYT DealBook column, writes about what the press and the authorities should be asking about JPMorgan's $3 billion (and counting) loss:
The first lesson of the financial crisis is not that the capital markets were poorly regulated or that the banks were too leveraged or that the government needed better processes for taking over failing institutions.
The first lesson is that when they are in trouble, banks will mislead the world about their financials. And some will lie. Richard S. Fuld Jr. of Lehman Brothers, E. Stanley O’Neal of Merrill Lynch and Charles O. Prince of Citigroup all played down their banks’ exposures before their institutions took vast losses. Were they deliberately misleading? Because of the failures to investigate the financial crisis adequately, we still don’t know...
Perhaps JPMorgan was a model of probity, but so far these questions have been given only glancing treatment. The news coverage has largely focused on how the bank took the losses, what went wrong with its risk management and what it’s doing now. The commentary has mostly gone straight to discussing the implications for banking reform.
That’s already a victory for bankers — including Mr. Dimon. The first question on everyone’s mind should be whether any existing laws were broken.
— Josh Stearns has some good thoughts on what he calls hindsight journalism, the tendency to piece stories together after the fact, when it's way too late:
Some of the blame for the rise in hindsight journalism can be laid at the feet of journalists who have gotten too cozy with the the powerful, or too embedded within the industries they are supposed to be covering. In these cases, the hard questions aren’t being asked ahead of time because doing so would risk a journalist’s access or imperil some sense of false objectivity.
In reality though, we should look at the overall culture of newsrooms, not at individual journalists. A key factor in the rise of hindsight journalism is structural, rooted in job cuts and budget cuts. Many news organizations don’t have the resources, or won’t dedicate the resources, to investing in long-term stories that need to be tracked or developed over time (think for example of the Guardian’s dogged coverage of the News of the World hacking scandal over the course of years). It is risky for a newsroom to invest in a story that might go no where. There are no page views in the hypothetical. The FCC Information Needs of Communities report touches on how this has “shifted power away from citizens to government and other powerful institutions, which can more often set the news agenda.” Instead of breaking news, our newsrooms are too often waiting for news to happen and then trying to explain it...
It is not enough for journalism to simply report and explain where we have been. We are at a moment in history when we need journalism that also forges ahead, scouts the possible paths forward. We need a journalism of exploration and investigation, a journalism not afraid to wander or to fail. For in those forays into the wild, the complex, the unknown, we may find something that we need to know now, not after the fact
— The New York Times writes about how the String Cheese Incident is taking on monopoly Ticketmaster's fee gouging, but leaves out a critical piece of information: How much telling us how much Ticketmaster is actually charging.
Consumers seeking tickets to all sorts of events have become increasingly frustrated — and sometimes enraged — by ticket fees, which can add 30 or 40 percent to the cost of an order, as well as by the lack of other options for buying tickets. But while the brunt of that anger is usually directed at Ticketmaster, other players in the business, like theaters and promoters, collect, and depend on, their share of fees.
We learn that the band's tickets to one show cost $49.95 apiece, that the band bought four hundred of its own tickets at a loss to sell back to fans without Ticketmaster fees, that the band charged $12 to UPS the tickets to fans, and that it was still cheaper for fans than buying from Ticketmaster. But we never learn how much Ticketmaster's service fee actually is.
I looked on Ticketmaster's site myself. Ticketmaster fees turn a $49.95 ticket into a $67.40 hit—a 35 percent markup.
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May 17, 2012 11:00 AM
The Facebook frenzy
Retail investors prepare to jump on a richly valued IPO
The Wall Street Journal's page-one Facebook IPO story does a good job of capturing some uncomfortable parallels to the dot.com bubble.
The Journal profiles three investors to give us a feel for how people are thinking about the most buzzed about IPO since Google.
The headline on the story tells us that, "In Facebook IPO, Frenzy, Skepticism." But the story shows a lot more frenzy than skepticism.
Most of the skepticism comes from a very bullish retail investor shaking his head at the hubbub surrounding the IPO.
That mania is too much for a guy who got the idea to invest in Facebook from his 11 year old back in January and tried to use his kid's college fund, his IRA and his 401k to put $100,000 into Facebook shares on the private market.
One of the trademarks of the 90s mania was the influx of retail investors (aka dumb money) into get-rich-quick stocks with vaporous business plans. The difference with Facebook is that it actually makes money, and lots of it—but not nearly as much as its $80 billion to $100 billion valuation would imply.
If the differences are stark, the similarities are clear. Sky-high valuations unsupported by revenue and growth trendlines. Mom and pop investors in a frenzy to dump their savings into dot.com stocks marketed in a quasi-messianic manner. People buying because other people will surely be buying.
The Journal finds a high school investing club that's trying to buy a few shares of Facebook. Their adviser went to his broker to see if he could get an in:
At the end of their hour-and-a-half meeting, he told the broker that he had one more question. He said the broker slumped his shoulders and said one word: "Facebook?"
While you shouldn't draw conclusions from a few anecdotes in a newspaper story, it seems to me that the Journal is on to something here. I'd bet something fairly dramatic will happen when Facebook IPOs tomorrow—a surge that will blow past that eyebrow-raising $100 billion valuation.
So would The New Yorker's John Cassidy, who calls Facebook the "ultimate dot.com" and says he wouldn't be surprised to see it close at least one-third above its starting price. That's not a compliment coming from someone who wrote Dot.con: How America Lost Its Mind and Money in the Internet Era back in 2002.
Cassidy:
In Silicon Valley, many people view Facebook’s Web site, and its trove of user data, as the next key technology platform, something akin to Microsoft Windows and Apple iOS, which the company will leverage to create its own economic ecosystem—one that generates huge monopoly rents. Perhaps this will happen. For now, though, Facebook is basically an online media company, and there are some legitimate questions about its prospects. In purchasing its stock, as with buying the original dot-com stocks, investors will be laying out their cash primarily on the basis of hope and optimism rather than a clearly defined and firmly established business plan.
To me, at least, that has echoes of the past.
These enormous numbers are hard to justify based on the company's revenue, income, and growth trendlines. Revenue growth, while still high, is slowing. Earnings growth is slowing. User growth is slowing. The company hasn't proven—at all—that it can monetize its creepy, giant pile of user-supplied data.
CJR contributing editor Felix Salmon wrote yesterday that "this seems to be the point at which the smart money is getting out of Facebook," though he disagrees that the Journal story is really on to something.
We'll see.
But Felix is right that the smart money is getting out of the stock. Another Journal story reports that a huge amount of the float will come from insiders:
The change means that 57% of the offering will be coming from current holders, rather than from the company, an unusually high percentage for one of the most sought-after IPOs in years.
In comparison, when Google Inc. went public in 2004, existing holders represented 28% of sales, according to Dealogic. Private holders sold no shares in the public offerings of Yahoo Inc. and Amazon.com Inc. in the 1990s.
That really doesn't bode well for the folks lining up to buy Facebook on the pop Friday. And it's worth being extra careful about how we cover any huge run-up in the share price.
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May 16, 2012 11:00 AM
What’s the right price for ebooks? (updated)
It's probably not 99 cents
Author Chuck Windig, GigaOm's Mathew Ingram, and TechDirt's Mike Masnick all took on the question of ebook pricing recently, arguing that production costs (you know, minor details like advances, editors, etc.) don't or shouldn't factor into the end price.
Ingram writes that "It doesn't matter what e-books cost to make," and Masnick follows with "Nobody Cares About the Fixed Costs Of Your Book."
But nobody cares about the fixed cost of your car, either. And yet, it matters, in theory as well as in practice.
But as author Chuck Wendig notes, what e-books cost to manufacture or distribute is irrelevant to everyone but the publishers themselves. All that matters is what book consumers are willing to pay for an e-book — and the same principle applies for any form of digital content.
In fact, an ebook’s production cost is directly related to the decision to make it at all. Just as buyers may decide that a $12.99 ebook is too dear, sellers may decide that any price below that level doesn’t justify the cost of writing, editing, and publishing it.
If demand were all that mattered—reader heaven—ebooks would cost 99 cents and you could impulse-buy them like an iTunes song. In book-business heaven, ebooks could charge some big number, and readers would have no choice but to pay up.
In reality, as in theory, the market for books is only so big—we only have so much time—so a 99-cent price point might move a lot of units but not enough to justify the cost of production. Obviously, a $50 price point would crush sales and also bring in much less revenue overall.
With either, the ultimate outcome would be a hollowing out of the books economy. With far less prospect for making back their upfront costs, publishers would only bankroll sure winners, and even those would make less money than before. Writers would have less incentive and less ability to write books. Authors who are capable of producing quality books would do something else.
The fixed-costs-don’t-matter argument hinges on your conception of the nature of the product.
Wendig likens a book to fast food:
An e-book is a digital good. Ephemeral and intangible. Sometimes we don’t even have access to the e-book itself in the form of a file — in the case of Amazon, we’re just “renting” the e-book the same way you rent Taco Bell food. You bought it. It’s inside your device. But if Amazon decides you don’t need it anymore, one snap of the wizard’s fingers and the e-books are poof, gone, siphoned from your reader like gas from a gas-tank. E-books have no supply — if I buy one, it doesn’t reduce how many remain, because theoretically infinite copies remain. No cost to reprint. No cost to remake. It just… sits out there, attempting to be the very embodiment of the Long Tail.
This is what the audience sees and believes.
It matters little what the e-book actually costs.
It only matters what the audience thinks they should cost.
If you want to buy fast food, though, you have many options. If you want to buy The Big Short, there’s only one.
This is a fundamental disagreement over the value of cultural production, in the end. We think it’s intrinsically valuable and believe cultural consumers do, too.
Let’s take another example, this time in software:
If I want to buy a copy of Final Cut Pro X, for instance, Apple will sell it to me digitally through the Mac App Store for $299. The marginal cost of that copy—what Apple pays to shoot the 1s and 0s over the intertubes—is almost nothing. Apple charges $299 because it believes that's the sweet spot in the market and, presumably, because video editors actually buy it at that price. If you don't like it, you can go buy Adobe Premiere or Avid's Media Composer, steal the software and live with the potential consequences (and your conscience), or do without.
If "the pricing on the individual item is entirely about the marginal costs," as Masnick says, Final Cut would cost 99 cents. But it doesn’t, and it sells.
The marginal-cost-is-all argument also fails to take into account copyright law, which essentially grants each new work a sort of miniature monopoly. If I write a book about something, you can't republish it unless I give the okay, or unless it's 70 years after I kick the bucket and the copyright expires. You can argue about whether copyrights are too long or too restrictive, but we grant them so creators and investors do the creating and investing they otherwise would do much less of if anyone could profit off their work. Just because a product is digital doesn't mean it's infinitely abundant—as long as the law is enforced.
That doesn't mean it's right for big publishers to get together with Apple to fix prices in a market, if it turns out that's what happened. But it's worth noting, as I've written, that they were responding to Amazon's distortion of the ebooks market via its willingness to use predatory pricing to preserve its ebooks monopoly. Rather than ham-handedly setting prices at $12.99 and $14.99 (and, importantly, making less money than they did from Amazon's system), the book industry should have used the agency model to individually price books at their own price points and let readers' purchases help them decide where to end up.
At base, copyright holders have the right to ask what they want to get for their work (which is why they were so concerned about Amazon selling ebooks at a loss). If they set the price too high, nobody will buy the book and they will lose money. If they set the price too low, lots of people might buy it, but they will still lose money.
Marginal costs in the ebooks industry aren't even really about what it costs to produce a copy. In ebooks and other digital media they're actually about what it costs to produce the next entirely new ebook, not what it costs to send out one more copy of Harry Potter. The marginal cost to an airline, for example, of putting one more person on a plane is almost nothing, but it would go broke (or broker) if it did that. The real marginal cost is what it takes to get the next plane in the air, not the next passenger.
If readers don't want to pay $12.99 or $14.99 for an ebook, they won't. And the book industry will have to lower its prices. Until then, they can buy all the 99-cent ebooks they want on Amazon.
UPDATE: I should say that Masnick wrote this about why fixed costs matter: "That's not to say that the fixed costs aren't important -- they are -- but they don't factor into the pricing decision, they factor into the investment decision."
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May 15, 2012 11:15 PM
Audit notes: Commercialization, GM and Facebook, Saverin’s taxes
Conor Friedersdorf makes a nice catch on Tom Friedman's Sunday column bemoaning the commercialization of seemingly all aspects of American life:
For example, his column is bizarrely titled, "This Column Is Not Sponsored by Anyone," despite the fact that right above it on NYTimes.com there is a banner ad for a Citi/American Airlines credit card.
But Friedersdorf says Friedman is "analytically sloppy" in connecting the commercialization of the culture with inequality:
Advertising on school buses may be problematic. Outsourcing war to private military contractors definitely is - but for a very different reason. Shorter security lines for affluent air passengers are problematic for a third reason. Conflating those things makes no sense.
I'm hardly a Friedman fan and I hate to defend him on anything analytical, but the thread running through these anecdotes is the commercialization of everything—the encroachment of the private sector on the public sphere, as Friedman says.
Friedersdorf defends advertising, for instance, as a leveler of inequality, citing sports stadiums of all things:
But if we mean that a sports stadium can charge 15 percent less for tickets because it sold naming rights to the building itself, the scoreboard, the halftime show, and the cheerleaders? That's one of many times when the marketization of public life brings us together. And one day we may miss it.
I'd guess that naming rights subsidize gargantuan players' salaries and owner profits more than they do ticket prices for fans.
— General Motors is dropping a bomb on Facebook three days before its giant IPO, The Wall Street Journal reports.
GM is yanking its ads from the site because it says they don't work. Also, it can advertise for free on Facebook:
GM will continue to promote its products on Facebook, but without paying the social-media company, the GM official and other people familiar with the matter said. Many companies maintain free Facebook pages.
GM's decision raises questions about the ability of Facebook to sustain the 88% revenue growth achieved in 2011. Facebook said last month its first-quarter ad revenue was down 7.5% from the previous three months. Facebook blamed "seasonal trends" for the decline, as well as a greater number of users from outside the U.S., where ad rates are lower.
There was already almost no way Facebook would sustain an 88 percent annual growth rate.
GM was already skeptical, apparently. It only spent $10 million on Facebook ads last year. But, "GM is the third-biggest advertiser across all media in the U.S. after Procter & Gamble Co. PNG and AT&T, according to Kantar," the WSJ reports.
— What does Eduardo Saverin, the Facebook co-founder who's renouncing his American citizenship to lower the tax bill on his upcoming $3.8 billion IPO windfall, owe the U.S.?
"Nearly everything," writes Farhad Manjoo:
Yet if you study the trajectory of Saverin’s life—the path that took him from being an immigrant kid to a Harvard student to an instant billionaire to the subject of an Oscar-winning motion picture—it emerges as a uniquely American story. At just about every step between his landing in Miami and his becoming a co-founder of Facebook, you find American institutions and inventions playing a significant part in his success.
Would Eduardo Saverin have been successful anywhere else? Maybe, but not as quickly, and not as spectacularly. It was only thanks to America—thanks to the American government’s direct and indirect investments in science and technology; thanks to the U.S. justice system; the relatively safe and fair investment climate made possible by that justice system; the education system that educated all of Facebook’s workers, and on and on—it was only thanks to all of this that you know anything at all about Eduardo Saverin today...
Is this fair? No. It’s worse than that, though. It’s ungrateful and it’s indecent. Saverin’s decision to decamp the U.S. suggests he’s got no idea how much America has helped him out.
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