The Knowledge Economy

I was having lunch yesterday with Candice and Josh G. (I have to mention it's Josh G, because if it were Josh R the conversation would have been shorter and more definitive.) Candice brought up a company she knew that was building a marketplace for a certain type of information. The plan is to auction the information. We had a long discussion over whether this would work, after I asked if auctioning a non-rival good was the most efficient solution. I'm sure there's an analytical answer to this question, but that isn't my point here (although I'd be curious for any pointers to research, as always.) The interesting thing is that we could have the conversation at all. As all of you know, I'm an economics geek, but Candice and Josh aren't, and we're all primarily businesspeople.

I think it's fair to say that everyone who is reading this could have had that conversation, in some form. That's easy to say because there aren't that many of you, but I think it's also fair to say that 99% of the hundreds of people I have worked with in the past five years could have and would have been interested in having a conversation on this point. We're all steeped in information economics, it's become second nature to us.

It's been interesting for me to think about information products in a business context. When I went to business school, there were almost no information products. Music was a physical product, news was a physical product (unless you worked at an investment bank), etc. The few information products at the time (stock price information, sports scores, direct mail lists) were insignificant in the scheme of things.

I'm not going to argue the point that this is no longer true. It is, or it soon will be, depending on how you define significance. I like to apply standard economic thinking to information products. Write out the formulas and then drive the variable representing the cost of information transfer to zero and see what happens. As I've mentioned previously, marketing changes completely, for one thing. The media industry changes completely. Any industry that depends on innovation changes completely.

Information economics drives several other 'economics': the Attention Economy, the Entertainment Economy, etc. It drives them in the same way that physics drives chemistry or biology: in a fundamental but not very useful in practice sort of way.

I've been reading Advancing Knowledge and the Knowledge Economy edited by Brian Kahin and Dominique Foray. I'm finding Knowledge Economics a much more useful framework for dealing with the issues I'm sorting through. I'm going to be blogging about the essays in this book quite a bit in the next few weeks as I work through it.

It's Fine. Well, Not Really, but Let's Pretend

NEW YORK (Reuters) - Citigroup, Bank of America Corp. and three other top banks took the rare step of borrowing more than $2 billion total from the U.S. Federal Reserve ... in a bid to reassure markets and remove the stigma of getting short-term financing from the central bank...

Borrowing money directly from the Fed has historically been seen as a sign of weakness, but Bank of America, Germany's Deutsche Bank JPMorgan Chase & Co, and Wachovia Corp said they did it for the sake of the financial system. All five banks emphasized they have access to other, cheaper funds.

Translation: the Fed asked us to borrow from the discount window so people won't worry when banks do. But we want you to know we're just doing them a favor, because if we had to borrow from the Fed, you would be right to worry.

How convincing.

Free iPod Leads | Intentionality > Arb

Yesterday's Wall Street Journal had an article titled "Hot Online Marketing Niche Cools Fast" about the Valueclick earnings miss. Aside from proving my point about the NY Post being the only source of business news (their vastly similar article was published more than two weeks ago), the article tars everyone in the industry with the "incentive marketing" brush. Then it says:

...marketers [are] questioning the effectiveness of getting names through incentive offers--realizing these consumers want the prize and often have little interest in the marketer's product...

Do you think that marketers ever thought these people wanted their products? Of course not. They either:

• did not know how the leads were being generated;
• were paying almost nothing for the leads, so on a cost-per-sale basis the leads were still cheap; or,
• were paying on a cost-per-sale basis.
  

The problem isn't lead-gen, the problem is discriminating between good and bad leads. Quality pay-per-action marketing sells products more cheaply and at lower marketing dollar risk than pay-per-click, online display advertising and--even in this day and age of excess inventory--newspaper ads. The solution is more tracking of ROI by lead source.

If you could track your ROI and back into a cost-per-sale, then this whole brou-ha-ha becomes an opportunity. You could arbitrage the low-and-going-lower price of incentivized leads (and affiliate leads, which are cheap for a different, but related, reason) by buying more of them for less. For some products you don't care so much if you buy a lead for $20 and convert to a sale at a 5% rate or buy a lead for $2 and convert at a 0.5% rate (as long as the sale process itself isn't a cost: if you have to pick up the phone and call every lead, then that has to be factored in.)

Alternatively, and in the spirit of Monday's heuristic: buy low-cost leads, go one step down the process (by, for instance, calling the lead, having the lead fill out an application or otherwise verifying intent) and then sell the resulting better-quality leads. If you are relatively good at discriminating between just-bad and really-horrible batches of leads and can figure out how to weed the few good from the mass of bad leads cheaply, you can reap the arbitrage profits without a lot of fuss. Unlike most businesses, this is just a math problem.

Step 1: Be Absurdly Wrong; Step 3: Prosper!

I know everyone else is pointing to Dan Lyon's stupid article about bloggers now that he's been unmasked as Fake Steve Jobs. Personally, I think it's an unusual coincidence that the Forbes writer I associate most with being a cheerleader for SCO's ridiculous legal shakedown of Linux vendors has managed to change the subject just when a judge finally determines that SCO has absolutely no case.

It's not a bad career strategy to take a gamble on a contrarian position: if you're right you look like a genius and get rewarded for it, if you're wrong you look like someone who would push an unfounded idea for potential personal gain despite the harm it might do to your company, colleagues or customers, and you get dinged or maybe quietly fired. The upside is often more personally rewarding than the downside.

In journalism it seems that the price for being wrong when you take sides on a story you just don't know enough about to know who is right is... nothing. No wonder our business press is so freakin bad.

Instead of taking Lyons to task for being so wrong on the SCO story (and, no doubt, convincing some readers of Forbes to put their money into SCOX; look at the five year chart and check out the price when the Lyons story was published--about $12 per share--and the price at open today--$0.40... yes, 40 cents.) Lyons will, instead, reap the benefit of the media's short management attention span.

Heuristic of the Day

I am back from vacation and was immediately immersed in work (why did I write that in the passive voice? Hmm.) I'm too scatterbrained from sun and sea to really write anything, so I'm taking the lazy man's way out. The Heuristic of the Day.

Well, at least it's not as lazy as the quote of the day. (Which, btw, is "if you can't solve a problem, make it bigger." My morning meeting attributed it to Eisenhower. I believe it was recently uttered by Donald Rumsfeld. Regardless, sheer genius. Of course, I just use it in my personal life, not in international relations. I'm not sure how wise it is in international relations. Actually, it hasn't worked so well in my personal life, either, but I still think it's genius.)

In my life as venture capitalist, I had several rules of thumb. I liked to think of them as primary drivers and limitations of business change, but same difference. Here's one on market evolution.

As markets get bigger, companies that specialize in each piece of a process chain replace end-to-end players.

There are a lot of reasons for this and a complete proof (such as it is in economics) would have to take into account the rationale for the firm itself, the economics of the knowledge economy and producer-consumer learning, etc. But the easy reason is that you can be better at something if it is all you do.

Well, duh, you say. Isn't that the theory that made Adam Smith famous, when applied to pins? Yes it is, grasshopper. I didn't say I made them up, I just said I used them.

But, you know, it's something that entrepreneurs forget all the time. After a while I got tired of successful entrepreneurs--especially marketing entrepreneurs--thinking that because they've become good at one thing (marketing, that is) they should immediately branch out into their customers' business. The old "I've sold a lot of soda for that guy, so maybe I should get into the soda business." We've all heard it, and it's a seductive idea. If you provide a product you want to provide a service also, if you provide a service, you want to provide a product also.

Sometimes it works. Everyone has a success story to point to. I've never seen it work, personally, and I've seen lots of people try it, but that's me. It just seems to me that if you're really good at something, the best business strategy is to do more of that.

And with that...

OK. That post was incredibly long. I need a vacation.

Actually, I figured I'd start blogging when noone was around to try and get the hang of it. Now I'm off to Cape Cod to eat fried food take a long-planned vacation. I doubt I'm going to attempt to post from my Blackberry, so have a good beginning of August and see you in a couple of weeks!

Win a Free iPod!

So which newspaper has the best business news? The New York Post, of course. In fact, the New York Post is the only New York newspaper that seems to have business news. Everybody else has analysis. Plus, they delight in covering the media, marketing and internet business in New York. No one else really does. Every morning I open to the business section of the Post with trepidation. I never know what I'm going to find. Anyhoo, just had to say that.

From their article today on ValueClick's missed earnings:

ValueClick's revenue from so-called lead generation business, which includes online sweepstakes, fell during the quarter after the Federal Trade Commission started investigating the practice in May, Chief Executive Officer TomVadnais said.

The FTC is investigating whether promises of free gifts violate U.S. laws.

I have no idea if this is what ValueClick said on their call. I didn't listen to it. But it's a perfect illustration of what is going on in the "so-called" lead generation business. (What's up with that "so-called"? Is Google a "so-called" cost per click business? Weird.)

Lead gen, if you're one of the thirteen people in the United States who hasn't heard my lead gen spiel yet, is the next step in the evolution of marketing from being push to being pull. I vaguely mentioned last week something about lower search costs changing the nature of marketing. One of the ways this is happening is that consumers are now paying more of the search cost and marketers are paying less.

Wait! It's not like that. It's like this: marketers pay the same average dollar amount per customer, but take less risk. The media get paid the same dollar amount by the marketer, take more risk, but make the consumer do some work. The consumer 'pays' more of the search cost by providing extra information about themselves in exchange for finding a product that better matches what they are looking for.

Am I being obtuse? Take Google as an example. Instead of running banner advertisements, they show cost-per-click ads. A marketer who buys a CPC ad on Google pays the same amount per sale as running a banner ad but takes less risk that his money will be wasted. An auto dealer could run a display ad at a $25 CPM and expect one out of every 20,000 people who see the ad to buy a car from him. Or, he could buy a click-through from Google for $10 and expect one out of every fifty people who click on it to buy a car from him. He takes less risk with the second option because he doesn't pay unless someone clicks and people who click are more likely to become customers. (In the real, inefficient, world right now, the dealer actually pays quite a bit less with the second option, and we'll get back to ValueClick with that fact later, I promise!)

The consumer provides information to Google by typing in "Honda dealer NJ new car", or something of the sort. The fact that the consumer is looking for a new car Honda dealer in New Jersey is valuable information and she is giving it to Google in exchange for information about these dealers. Google is, in turn, using this valuable information to put up CPC ads that point to New Jersey Honda dealers. By only getting paid if the consumer clicks through, Google is taking the risk that it will squander the consumer's valuable information and not get paid by an advertiser. (As an aside, it would be interesting to know how much Google is getting paid for taking that risk, consumer shouldering of search cost aside; does anyone know Google's overall effective CPM? I guess it shouldn't be hard to figure out. Knowing that would, if you believe in efficiency, put a dollar figure on the value of the consumer search.)

Lead gen is the next stage in the evolution of product-consumer matching from being a cost borne mainly by the marketer to being a cost borne mainly by the consumer. CPC is to CPM what Cost-per-Lead is to CPC: a further outsourcing of customer acquisition risk by marketers and a further increase in consumers trading information about themselves in order to find more appropriate products. This process is as inexorable as the move from CPM to CPC, from Doubleclick to Google. The next Google will be in lead generation.

But yesterday's news says it won't be ValueClick. The problem with outsourcing your marketing, or with outsourcing anything for that matter, is the familiar principal-agent problem. If you are paying someone to provide you with something that looks a certain way, they will provide you with that in the cheapest way possible, even if providing it cheaply strips all the value from it. For Google this looks like click-fraud. For lead gen it often looks like incentive marketing.

Ever see the ads for a free iPod or a free flat screen TV? (Maybe not so much anymore because of the above-mentioned FTC investigation.) You are promised a free iPod if you fill out a bunch of personal information. Next thing you know, you have a mortgage broker on the phone, trying to get you to refinance your mortgage. You've been sold as a mortgage lead.

You are a bad lead, obviously. Not because you aren't a real person or because you don't have a house to refinance (those would be pre-requisites for selling you as a mortgage lead) but because you have no intention of refinancing. A lead has to have both personal information and intentionality. If the person who filled out the lead form does not have the intention to purchase, then they are a bad lead. A company that entices low-intentionality people to fill out lead forms is selling poor quality leads. Lead buyers can figure out a given lead's quality on a lot of dimensions: is the person real, does the name match the address match the telephone number, if the lead becomes a customer then how much will that customer be worth, etc. But determining the intentionality of a given lead is very difficult.

That's why some lead generators sell low-intentionality leads: they are cheap to generate and indistinguishable from high-intentionality leads for a long time. An extension of Gresham's Law holds: bad leads drive out good. And because leads are fungible (a low-intentionality lead generator can sell his leads to another lead generator to be sold to a marketer) the industry has accrued many bad, or at least cynical, actors and the marketers can't weed them out.

Now, I'm not pointing fingers at anyone. I don't know ValueClick. But incentive marketing creates low intentionality, almost by definition. The mortgage broker calls and the prospect say "yeah, yeah, where's my iPod." One reason marketers pay less, on average, for a customer acquired through lead gen than through display advertising is that marketers don't trust lead generators to not screw them.

This is a problem the lead gen industry needs to solve before our Google can push the last Google into Doubleclick-like obscurity. Any takers?