:: The Park Paradigm ::

Markets for the Digital Generation

I certainly hope not but as I commented on Eric’s blog, I must admit to being disappointed and somewhat anxious upon hearing that they have sold themselves to CBS. This anxiety comes both as a customer and as an admirer and believer in the paradigm-changing potential of their platform. Ironically, after having used last.fm over the last year or so, last week I purchased a 12 month premium subscription, primarily to have access to “my radio station” (to listen click the big red button on the right sidebar.) And although it has proved to be a bit rough around the edges, I began to see that if they got their links to buy music and tickets (to events) right (api with iTunes store please?) it would become the natural way for me to purchase live and recorded entertainment - the revenues stream was starting to look potentially very real. Now let me say straight off that I have no visibility or view on the valuation, but it seems intuitive that it is likely to look generous based on current financials, and in absolute terms it is hard to argue with last.fm’s founders and backers taking the money; or put another way, I admit it is easy for me (with no financial exposure) to sit here and second guess their choice. However, if the motivation was financial security, locking in the win so-to-speak, I would posit that in today’s world there are a myriad of innovative financial options generally available to provide liquidity for owners beyond the traditional digital choice of IPO or trade sale…

However, putting financial considerations to the side and coming back to my two sources of anxiety…

As a customer, I just hope that in the medium term they are allowed to continue to innovate and especially that they are able to continue to treat their customers with respect. As partners. That may seem self-evident, but the track record of the music industry in this regard does not inspire much confidence. Indeed it is testimony to the compelling and real value of creative artists and their product, that the industry continues to function at all. If music truly was a ‘discretionary’ good, I suspect the industry would have collapsed on itself as customers disgusted by the convoluted and adversarial service they are asked to endure simply said ‘enough, I’ll take my money elsewhere…’ There is also the more universal (non-sector specific) issue of the inability of large organisations to avoid suffocating innovation.

That said, if last.fm can at least avoid going backwards, I’ll continue to be a happy customer ‘as is’, at least until something (much) better comes along. More disappointing from I guess what could only be described as a philosophical point of view, is the risk that the potential I thought was embedded in their approach to really change the way the music (and possibly other forms of art and entertainment) business worked. (Which also is the reason I think this post is germane to The Park Paradigm just in case you thought I was wandering ‘off script’ yet again!) The line of thinking I want to pursue probably originated with a series of discussions a couple years ago with Malcolm, who helpfully articulated Malcolm“>some of this on his blog:

As I have mentioned before I think the future of the industry as well as obviously being digital in nature is in the collaborative and personal spaces around such as last.fm and myspace. I think this particular future inexorably leads to new artists being initially funded by members of the collaborative communities who will, for their funding, be returned a share in future profit streams. This particular vision of the future is clearly not in the best interests of EMI: distribution will be handled by these spaces and the online music stores (distribution becomes essentially free as does the cost of production of each unit) and PR is also free as it is handled by the members of these communities and will be handled in their own interests. (PP note: viewed from this perspective, a cynic would say the CBS deal is defensive in nature: buy them before they can hurt you. A cynic. Not me.)

Clearly I have markets on the brain - for better or worse - but the potential I saw in last.fm was to use it’s brilliant organizing and community building software to ultimately allow the fans - the consumers of music - to become owners as well. And I’m not talking about CDs or MP3s, I’m talking about equity in the artists themselves. Creating a more efficient market in which to deploy capital (production, promotion, creation…distribution (digital)) backing artists, capital that in the current paradigm is effectively only available via a small-ish cabal of music companies. Think of it in terms analogous to replacing turn of the (20th) century JP Morgan (big universal banks with an oligopoly on capital allocation) with the turn of the (21st) century securities markets and you might see what I’m driving at. Too late tonight to go into detail, hopefully the point is somewhat clear.

In any event congratulations to the last.fm team on creating a fantastic product and here’s to hoping I’m sadly mistaken on their future prospects in their new home.

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Is embodied by the culture which produces this:

It’s not that IT is unaware of these new tools and methodologies. The networking folks in attendance at Interop certainly are well aware of Web 2.0/E2.0 and the collaborative powers the technologies have to offer. The biggest challenge is attaching hard-dollar business value to the solutions.

As Tom Marcin, director of global telecommunications at DuPont, put it at one panel discussion:

“We’re now being asked to build social networks and self-forming networks to solve business problems. We’re expected to transform businesses. But guess what, we’re expected to reduce costs. Collaboration tools are of value to us. But we can’t sell a project on migrating 60,000 employees, based upon the soft benefits associated with it. I need to show demonstrable savings directly linked to the solution we put in. One month of data on a pilot would not cut it.”

JP would love this. Classic case of institutional coveryourass-itis, aka M.A.I.D. - mutually assured innovation destruction.

(via a great post on Web 2.0 ‘creep’ in the enterprise)

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…as the social and institutional framework fails utterly to keep up to the fast changing financial and technological reality…only in this case (any many others around the globe,) the result isn’t just unnecessary inefficiency or foregone growth but potentially the more pressing issue of survival.

Ok, that sounds more dramatic than I wanted but still…

Perhaps it is because I just finished reading Tim Flannery’s ‘The Weather Makers’ (after having read Jared Diamond’s ‘Collapse:How Societies Choose to Fail or Survive last autumn) but I get increasingly upset when I see attitudes rooted in the 19th and 20th centuries obstruct the natural power of freely traded markets to allocate precious resources efficiently. So when I saw Josh’s post on the Australian water debate (which I have been following for sometime as a fascinating story, given my interest in weather insurance, non-traditional markets (ie water-rights in this case), and climate change) I wanted to emphatically second his views as to the dangerousness (and lunacy) of the current situation.

I’ve only ever been to Australia once. For a day. (Long story, short trip.) So I have no obvious personal connection or reason for getting frustrated at what is going on there, nonetheless I have to admit it winds me up. I guess it is because I am convinced that an aggressive and forward thinking deployment of the modern market toolkit could make a real difference in mitigating the disastrous outcomes of the changing weather patterns. No - derivative markets in water rights won’t make the rain fall or make it fall in the right place - but they can make sure that water is used in the most efficient way.

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“Buy, buy, buy” is how the Economist headlined its timely briefing on financial exchanges this week:

TRADERS cannot resist a bet, even on their own fate. Amid a bidding war over Chicago’s derivatives exchanges, the US Futures Exchange, also based in the Windy City, has launched a “binary” contract which allows speculators to take a punt on whether the IntercontinentalExchange (ICE) can snatch the Chicago Board of Trade, America’s oldest derivatives exchange, from the grasp of the biggest, the Chicago Mercantile Exchange (CME). Until recently ICE, a fast-growing electronic upstart from Atlanta, had the edge. Then the CME upped its offer to $9.8 billion and its chances of success—as measured by the binary contracts—leapt to over 70%.

(But of course, trading on binaries based on the outcome of a possible merger battle is NOT gambling. And of course it is unlikely anyone is doing it in their BATHROBE…so Rep Frank Wolf needn’t worry…)

I’m going to keep this short and sweet - I wonder if today’s existing (and/or planned) mega-exchanges don’t resemble the giant incumbent telecom companies c. 1998?

(…and of course I’m not just talking about the share price…and are Reg NMS and Mifid analogous to the Telecoms Act of 1996?)

History never repeats itself - exactly - but if I’m right, there are fortunes to be made and lost over the next decade in this arena, and - more importantly - I’d suggest they aren’t the ones most people are currently discounting.

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Perhaps the current angst over the plummeting (relative) competitiveness of US financial markets is finally set to overcome traditional resistance to overhauling the outdated, parochial, archaic and innovation-resisting regulatory frameworks in the US. It would of course be fantastic news and perhaps hasten the arrival of the new (AmazonBay?) paradigm in financial services.

(from the FT:)

Pressure grows for insurance regulation

By Jeremy Grant in Washington
Published: May 27 2007 21:59 | Last updated: May 27 2007 21:59

Momentum is building in the US towards the creation of a more streamlined regulatory system for insurance and re-insurance with the reintroduction of bipartisan legislation to create an “optional federal charter”.

Let’s hope this initiative gets the support it deserves on the Hill. It will be interesting to see who - if anyone - comes out against this highly sensible proposal.

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If the Park Paradigm had a required (ok, recommended!) reading list - something that is on the “to-do” list (but don’t hold your breath) - the recent Economist Special Report on International Banking would be a recent addition. If you haven’t already, it’s definitely worth a read, especially for those of you that are from outside the financial services industry. Henry Tricks, the excellent Capital Markets Editor of the Economist, does a good job of framing and illuminating many of the key issues facing the industry today.

In a sidebar entitled Les fleurs du mal, the author highlights the emerging new risks and assets that are being traded and managed via markets, and comments on the increasing blurring of lines between banks and insurance companies in this context:

Now that technology and financial engineering have made it possible to isolate and trade all manner of risks, the insurance industry is marching ever more eagerly into the capital markets. Last year AXA, a French insurer, issued so-called mortality catastrophe bonds to protect itself in the event of large death tolls caused by, say, avian flu or terrorism. The bonds were put together by Swiss Re, a reinsurer, which had hired Jacques Aigrain, a former JPMorgan Chase investment banker, as its chief executive. It expects the market for insurance-backed bonds to leap from $25 billion now to at least $150 billion by 2015.

(I think this number will be much higher (than $150 billion) but is unlikely (only) to come in the form of a linear extension of today’s business, ie many new instruments and mechanisms for disaggregating, repackaging and distributing multi-faceted risks will emerge and contribute to this growth.)

The article goes on to speculate:

But the principle could be extended to all walks of life. Perhaps farmers will be able to buy weather products at their local bank as a hedge against a poor harvest.

Ahem…actually…farmers are already able to do that today (and do, as some of the early adopters and first customers) via Weatherbill. Indeed they have recently announced the addition of (quotes on) 170 new weather stations in the US improving even further the granularity of coverage on offer. (Here is my quick and dirty summary of Weatherbill.)

The article however finishes on a sceptic note, hightlighting the fact that the concept of

…”particle finance” in which every form of risk could be isolated and sold to the buyer with the biggest appetite for it…

had been first developed by Charles Sanford (Chairman of Bankers Trust from 1987-1996) and that it hadn’t worked out too well for Bankers. Entertaining and clever writing perhaps, but the greed and ethical vacuum that eventually brought down Bankers was not the inevitable result of smart, forward thinking on risk (but rather imo the result of insufficient and poor middle management overwhelmed by a gold rush mentality.) Indeed the number of Bankers Trust alumni that have driven innovation and risen to senior positions across the financial firmament is a more apt illustration of the importance of these ideas. I was also curious to learn that Mr. Sanford had first developed the concept of particle finance, I had not encountered this metaphor before first using it myself a few years ago (and I have to admit it made me smile to see a Park Paradigm post at the top of the “particle finance” Google search, just ahead of Mr. Sanford’s 1993 article ‘Financial Markets in 2020′, reprinted in the Federal Reserve Bank of Kansas City Economic Review!) but it is nice to see that this way of looking at the (inevitable) evolution of risk management has other significant champions. The vision he articulated in 1994 (when I was just a young whippersnapper of a bond trader, flinging around the front end of the French yield curve) is remarkably clear and insightful, and all the more so for having been written before the financial/technological boom of the late 1990s. I only wish I had first read it in 1993! And if any readers out there know Mr. Sanford, please let him know that I’d love to buy him a coffee and find out what he thinks now that we are halfway to 2020…and talk of risk quarks,

Of shoes—and ships—and sealing-wax—
Of cabbages—and kings—
And why the sea is boiling hot—
And whether pigs have wings.”

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Stumbled on to this post as it mentions Weatherbill. Anyhow the rest of the post - in particular the bit on bears - had me laughing out loud. So a bit of a fun distraction at the start of a long weekend and a break from the usual stuff on markets, derivatives, mobile phones and stuff. So introducing TV Guy…Enjoy!

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Please reconsider your archaic paywall policies in favour of a more modern, enlightened, and - dare I suggest - more profitable paradigm. I refer you to Doc Searls:

So here’s a challenge to the daily papers: stop giving away the franchise. Make daily editorial available online only for subscribers. Charge for the fresh stuff, online as well as off.
But give away what’s stale. Free the fishwrap.
There is lots of advertising money to be gathered just by opening the archives, linking to them, letting Google’s spiders index them, and watching as the AdSense ads start appearing on them and bringing in money from click-throughs. Most papers have enormous archives that, once exposed, will vastly raise their profiles on Google and other search engines. There’s lots of good will to be had as well, from everybody who ever wants to know anything about a town or a city that only newspapers have kept up with, for decades. I can’t think of a better way for a paper to expose vast legacy advantages than by opening its archives.

Your value lies in your reputation and ubiquity within the community. Now I’m not suggesting that this will disappear overnight, inertia is your friend (for now), but sooner or later your walled fortress mentality will cut you off from a real-time interconnected world of digital information. Because it is impossible to search and link to your archives (dynamically, automatically, algorithmically) they will lose their value. Become irrelevant.

I doubt however that the markets will allow truly valuable financial newspapers to continue on their current path of slow suicide. If current management persists, I’m sure there will be (private?) capital available to sweep up these tarnished assets and transform them into successful digital age enterprises.

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Ok … Fortune… And I’m probably showing my age - would they* get the reference?

Dr. Hook – The Cover of the Rolling Stone

*They, of course are the Digital Generation. Nadira Hira, the author of this Fortune cover story, calls them Generation Y, defined as those born between 1977 and 1995. She focuses more on the social and family environment in which this generation grew up (as opposed to my focus on the technological environment) in order to illuminate some of their behavioral and cultural traits. But the conclusions are similar - this generation will have a profound and transformational impact on the economy - both in the workplace and as consumers.

“This is the most high-maintenance workforce in the history of the world,” says Bruce Tulgan, the founder of leading generational-research firm RainmakerThinking. “The good news is they’re also going to be the most high-performing workforce in the history of the world. They walk in with more information in their heads, more information at their fingertips - and, sure, they have high expectations, but they have the highest expectations first and foremost for themselves.”

Anyhow, if you are over 40 and responsible for managing a team or recruiting young people, you probably should read this article (and perhaps also my thoughts on the subject and those of JP and Dave Morin.)

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Perhaps now that the idea has - albeit obliquely - appeared in the Economist, the legitimacy of hedging economic outcomes linked to sporting events will start, ever so slowly, to be accepted. The article talks about how the number of viewers - and thus the value to advertisers - evolves during an event as a function of ‘time until end’ and ‘uncertainty of outcome’, and then goes on to quote a researcher from London’s Tanaka Business school thinking aloud about ‘contingent’ pricing:

Broadcasters can capture some of this variation by charging advertisers on the basis of viewing figures. But ratings-based fees are retrospective and advertisers have to decide where to spend money ahead of time. Tanaka’s Stefan Szymanski thinks there is an argument for “contingent” pricing, whereby advertising slots for sporting events would be pre-auctioned, with bids depending on the score at each point in the game.

This is very much (part of) the point I was trying to make with the Google/World Cup/Sports Hedge vignette in the AmazonBay/Through the Looking Glass scenario I wrote two years ago, here is the relevant excerpt:

2014 (August) - Advertising rates for the World Cup final plummet as longshots Denmark and Iraq make it through to finals knocking out favorites Brazil and China. GoogleCorp’s stock sells off sharply until CEO Lachlan Murdoch reveals that they have hedged their exposure with €3.4 billion of payer positions on a basket of favorites in what is described as the largest ever single sports trade disclosed to date. The complex hedging strategy was designed by Allianz Sport Risk Solutions group and entirely executed using a proprietary algorithm on AmazonBay’s sports trading exchange.

The premise was that the ‘advertising infrastructure’ would be operating as a real-time dynamic market with GoogleCorp as the primary intermediary: buying and selling slots, balancing supply and demand in real-time, essentially performing a ‘market-making’ role for advertising assets. (As an aside, in this kind of world the pricing dynamics for advertising slots would be fascinating and resemble option pricing with similar issues especially wrt pricing close to expiry.) For the purposes of this example, I foresaw GoogleCorp having principle risk as well, more for the sake of simplicity (rather than adding another player to the scenario, say a hedge fund specialized in trading advertising slots…) So when both heavy favorites - each having vast and valuable home markets on their own, plus broad global followings - lose, say a 100-1 type outcome before the semis, the value of advertising slots for the final - now between two ‘minnows’ - plummets as both end users and speculators look to offload their positions. In the above scenario, GoogleCorp’s stock also sell off as the market believes it to be very long finals advertising slots and so exposed to the carnage in that market. However when the market finds out that this exposure had been hedged, the stock rebounds. The hedge in this case is decribed as a ‘payer’ on a basket of favorites; of course this is just swap market terminology for what would be called laying in the betting markets - essentially they have laid (or ‘bet against’ or ‘insured against loss’) a basket of favorites. As a simplified illustration, assume the hedge was just a simple bet that both China and Brazil would lose in the semi-finals and that the odds of this (as priced by the market) were 100-1. So for €3.4 billion of protection, GoogleCorp would need to pay €34mn of premium (their stake.)

So coming back to the idea of contingent pricing raised in the article, not only does this make sense (for both broadcasters and advertisers) but it can be enhanced considerably by bringing to bear the panoply of risk management techniques by using the liquidity and correlation provided by the underlying sporting market to create hedging instruments and incremental liquidity in the market for advertising itself (by facilitating arbitrage and speculation which should encourage additional ‘financial’ participants into the market.)

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