How Movie Studios Shoot Themselves in the Foot

In 1975, Sony released Betamax, a video cassette recording device that could be attached to a television set and could record television programs onto its Betamax cassettes.

In 1976 Walt Disney and Universal Studios sued Sony for copyright infringement. They argued that these video cassette recorders (VCRs) could be used to copy and distribute their movies. They also argued that most people would record movies for later viewing and, when this viewing occurred, they would skip over the commercials, thereby depriving the studios of their source of revenue. The case dragged on, through various courts, until 1984, at which point the supreme court ruled in favor of Sony.

Interestingly, the movie studios failed to realize that in a few short years a market for videotapes of each of their movies would provide huge revenue streams. Needless to say, had the court ruled in their favor, movie videotapes, and therefore companies such as Blockbuster and Hollywood videos, would not have existed for many years to come, and the whole VCR market would have been pushed back by years.

Fast forward to 2004, and MGM, along with 27 other entertainment studios, is suing Grokster (remember them?) over copyright infringement for their P2P software. Much like the Betamax case, Grokster argued that their product could be used legitimately or illegitimately and, just like Sony Betamax, they were not liable for what their users chose to do. More to the point, the studios should have noticed the parallels and realized the potential for future profits in this new medium.

Unlike the Betamax case, however, the courts ruled in favor of the studios in 2005. Now, half a decade later, we are at much the same point as we were then (except other companies have taken Grokster’s position). MGM could have tried selling movies online, encoding them, providing a monthly access fee, advertising the fact that movies available through their websites were legitimate and virus-free, among many other revenue generating schemes.

Instead they chose to set back the online movie industry by years.

What Porn Can Teach Us

The movie industry is finding itself at a crossroads. This is a multimillion dollar industry staring nervously at the music industry, the file sharing that swept it up, and the industry’s abysmal response to it all. Now Hollywood is wondering what will happen to them. Will they lose returns because of illegal sharing? Will this mean they won’t be able to afford to make new movies? Will all our actors be out of work?

We think it would help if these Hollywood execs, rather than looking at the music industry, followed millions of internet users and looked at the porn industry. This is an industry that, not many years ago, had movie directors, released movies, had well-known actors and actresses, and could be a lucrative career for many. These days, however, there are countless online providers of free or cheap videos and websites. Amateurs are quite literally posting videos from their bedrooms and competing with the professionals.

So what has happened? There are still plenty of sites that make much money (otherwise you wouldn’t be bombarded with spam about it), but they do so by differentiating themselves. Whether it be a specific niche (we won’t get into specifics) or a performer who has created a name for her/himself, certain people have found ways of standing out by providing the customer with what they want.

What does this mean for the movie industry? Hollywood will usually say that without their big budgets (and therefore their grasp on the industry) expensive movies like The Matrix would never have been made. We believe this will be less and less true as time passes. With the equipment that can be bought on credit card advances, people are increasingly able to film and edit video that looks more and more professional. So special effects will be more and more mainstream. Of course, hiring big name actors might become harder, which would mean The Wachowski brothers might have had to hire someone other than Keanu Reeves to play Neo.

On the other hand, actors who differentiate themselves will still be in very high demand. Likewise, freelancers who have real talent will find funding for their movies. Movies will be more niched, more targeted and provide more of what customers want, and an industry that once had extremely high barriers to entry will be giving everyone a shot at bat. And those who are able to keep with the times will benefit enormously. Much like has happened with the Porn industry.

What worries us is when other states start emulating some of California’s models. 10 years ago more than two thirds of all big studio films were filmed in California. Now less than half are. This is because other states have started offering tax incentives and perks for studios to film in their state. The argument is that having a film crew in the area and gaining the publicity will be good for the economy in the long term. Unfortunately hard numbers are difficult to come by, but we’d be surprised to learn that any state has made a profit for this. Having the film crew in the area creates, at best, temp jobs. The publicity is minimal and a crapshoot (New Zealand was helped by Lord of the Rings, Detroit has hardly been helped by the 137 movies filmed there in recent years).

In the meantime, however, California is still messing up its own recovery. It has ranked 50th out of 50 states in terms of business climate. An example of this is Ms. Dashtaki, a Zoroastrian immigrant from Iran who came to the state in 1984. She is also an entrepreneur, making yogurt in the traditional “old country” way. As The Economist reports, she then received a letter from the “milk and dairy food safety branch” of the California Department of Food and Agriculture (CDFA) and was told to shut her business down. What ensued was a path down legalese to follow laws regulating yogurt that hadn’t been changed since 1947. For example, her milk needs to be pasteurized before she can use it, but she uses pasteurized milk, so was hoping for a waiver, but was told that wasn’t possible. So she was told to buy: “a “pasteuriser with a recorder”, a “culture tank”, and a “filler”, which apparently also required a “mechanical capper” to screw lids on jars.”. She pointed out this would change the taste of the yogurt substantially, but it didn’t matter. What did matter, however, was that the code doesn’t allow milk to be pasteurized a second time, so now she was at an impasse. Like any decent entrepreneur, she is contemplating leaving the state. We can’t blame her.

These two policies (along with our other article on Direct Democracy- link above) illustrate some of the main problems with California. But, lest this seem like a California-bashing session, we should mention what they have gotten right. As a response to gerrymandering, California has decided to redraw its election boundaries. While many might be cynical about how this can be done, we are happy to see that it has been accomplished by an independent commission who has access to no political information. Other initiatives, such as the Think Long Committee and a council of independent experts to review all initiatives, are also steps in the right direction, although the sharp partisan jabs created by direct democracy and gerrymandering are the main aspects that need to be fixed. Gerrymandering is a consequence of the “winner takes all” form of politics in the US (as opposed to proportional representation), and has existed since Elbridge Gerry gave it its name in the late 1700′s. If California’s initiatives put an end to this, and are thus emulated throughout the country, it could be momentous indeed.

But what happened? Why has a panel of academics been appointed to lead Italy, and what on earth is a “technical government”?

A “Governo Tecnico” arises during times of government crisis: sitting parliament decides to step back and give confidence to a temporary government made up of “technical experts” from outside the political arena. This temporary government must exercise its best judgment, free of political bias, to direct the country back to stability until the next general election, when a new political entity will be elected by the populace. This has also been called the “government of national responsibility”.

And herein lies the proof of Churchill’s statement about democracy being the worst form of government except for all the others.

Should not every government be exactly this type of government? Chosen from amongst the people best qualified to lead in their given roles, as judged by previous experience and outcomes, and making decisions based on their knowledge and best intentions for the good of the nation as a whole and in the long-run, rather than political affiliation.

Clearly Italy must justify why its people should accept to be led by a non-elected government, and this justification highlights exactly what the problem with elected government is: career politicians.

From the moment that we accept a “technical government” as an “other”, not the standard of government in general, then we accept that the role of government is to fulfill political bias. That we should elect politicians based on political affiliation, preferred sound-bytes, great hair we don’t mind looking at for the next few years; basically anything but their capability of making decisions for a positive outcome.

Maybe we should think once again as to how and why we select our national leaders.

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When most people think about inflation, they think about commodities such as gold and gas going up in price and currencies eroding in value.

As the speed of inflation picks up, the risk of hyperinflation occurs, with prices in supermarkets changing in front of your eyes as you shop and rotating strike cycles for workers struggling to keep up with those price increases. As workers salaries are raised by paralyzed goods producers, producer margins are squeezed, forcing producers to increase prices, and so it goes, a classic textbook economics case that that has been demonstrated, particularly in the 70s, and well studied. Recent world wide unrest is thought to be at least in part related to the inflationary commodity spikes, by analysts and economists of various stripes (i.e., it’s not meaningfully in dispute), although the Fed insists that such inflationary pressures are “transitory”.

But there’s a different way to think about inflation, and the best analogy is all around us, and it obeys well understood (or at least better understood) laws — it’s our inflationary universe. It may seem a stretch (pun intended), but it’s a great analogy. Once viewed in those terms, bubbles do in fact become more predictable.

How does the inflationary universe work? It’s expanding in all direction but, most of it,quantum foam aside, is completely empty. The interesting stuff tends to happen around sources of mass and energy, and the larger the object, the more interesting stuff happens around it, as it actually causes smaller objects, and space itself, to warp around it.

Back to the world economy. On a macro level, it’s been growing since at least the Sumerians, and just as space warps itself around sources of mass and energy, the economy warps around sources of money. This is perfectly normal, of course: a Walmart feeds over a million workers, numerous small businesses, a large range of medium size businesses, and finally dozens of large businesses (e.g. a Sony or a Kellogg). And, just like the physical universe has “unusual” objects where the laws of nature themselves get warped, such as black holes, or perhaps the even more exotic worm holes, so does the economy — the unusual objects in this case are governments with “fiat currencies”: http://en.wikipedia.org/wiki/Fiat_money.

To create warps in the economy, such governments can go way beyond printing money. They can create incentives and regulations that then rapidly attract (or divert) smaller entities (i.e. people, small businesses, large businesses and even giants). But there’s a price to be paid: this mass of people and companies, instead of being distributed “evenly”, or among naturally occurring gravity wells, streams quicker and quicker towards the source of “free lunch”, or, as another common phrase would put it, OPM or Other People’s Money. Eventually, unless the incentive is eliminated or reduced, a bubble is formed. And, since even governments must obey physical laws, the free lunch eventually ends, and poof, supernova, or worse, everything gets sucked into a black hole.

OK, so far we have a fancy analogy, what are some real world examples?
Here’s a quick list:

1. Housing bubble. Started forming on a combination of artificially low
interest rates and pressure and incentives to lenders to issue
unprofitable loans. The housing deduction in the US is a major
distortion of the market.

2. Student loans. Government mandates and participation in the market
distort the real value of loans. When you open a business and borrow
money from a bank, the rate you get (if you get the money at all) is
based on the risk of your business actually generating sufficient money
to pay it back. How can a degree in English Literature, with an average
starting salary of $30K, be worth the same, to the bank, as a degree in
mechanical engineering which might result in a starting salary of $100K?
The availability of loans, out of proportion to ability to pay,
continues to direct students to more expensive schools and academic
pursuits with dubious employment opportunities, instead of saving $100K
or more by going to a local community college

3. Medical costs. The government ostensibly tries to contain costs by
regulating prices, or at least the rate of price increases. But since
buyers are divorced from the financial impact of their choices, costs
continue to go up.

Numerous other examples abound. Bubbles (and the business cycle) cannot be wished out of existence, or repealed. Fear and greed drive the markets, and speculative excess (early notable example being the Tulip Mania during the Dutch Golden Age) will occur even without fiat currencies. But markets work. When people talk about “free markets failing” in 2007, they didn’t — what failed was the set of economy warping incentives and regulations and the Fed, which inflated the bubble. We continue to be in the “try to tear the Band-aid off slowly” phase now. It’s not going too well, because we have not let markets work.

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Arthur is a a venture investor, inventor and alchemist. His early stage investment fund, @venture.us, turns ideas jotted down on napkins into gold, and he is building his latest company, Surre.al to give the entire world rose colored glasses.

He hails from suburban New Jersey, where he arrived by way of lucky marriage, Brooklyn, Haifa and Tiraspol, Moldova, which he is quite confident he does not remember. His solid credentials as a card carrying member of the Bourgeois class are cemented by his personal twitter handle, @iamthepoint99pct and his obsession with words and ideas is best exemplified by his Halfbakery account http://www.halfbakery.com/user/theircompetitor, where he is nearing 300 posted inventions.

Yeah, so: that all sounds wishy-washy of us not to take a stand, so as a cop out we’ll show you where we stand by means of Remy‘s Youtube video. Enjoy!

Also, an interesting tidbit added today: Wall Street Doesn’t Dominate the Top 1% (HT @vgr, although the Yahoo video has little to do with the article.).

No, the reason they find the patients worse off is their lack of will to survive. One doctor talks of how patients in Africa with heart failure walked 50 miles “in the broiling sun, with panting breath and swollen legs, to obtain treatment—and then walked home again.” In London, on the other hand, people let their yards become overridden with trash and then complain that social services does nothing about it. They then go in and out of the hospital due to alcohol, drugs and being beaten by spouses, all the while cursing the doctors and complaining about the system.

This argument is interesting, because it can be applied to countries as well. Let’s say that the more people are handed benefits (house, food, livelihood) the less they cherish them and therefore the worse they are at managing them. How can this apply to countries? Well, what are many countries handed that others aren’t? A clear example is Natural Resources, such as oil. For example, Venezuela has much oil, while Chile has none. Nigeria has huge amounts, while Ghana has none. So do countries who have oil manage their gains worse than countries who have to earn their money (via trade and commerce)? We can answer this because we aren’t the first ones to come up with it. Fareed Zakaria, in The Future of Freedom, says the same thing, claiming that natural resources can be a curse. Without them, a government has to provide equal laws that provide a framework for wealth generation and legal recourse, but all bets are off if there is a constant access to oil.

So, if you are handed things on a platter there is more chance that you squander it than if you have to work hard to earn it, whether you are human or a country. What other parallels can be drawn between people and countries?

Let’s start with the War of Troy, probably the most famous war of antiquity. We admittedly know very little about this war (we’re pretty sure a war happened, but that’s about it). However, if you see the position of Ancient Troy on a map, you’ll see that it occupied a very strategic location: right on the sea, at the edge of Ancient Greece and on the way to the Caucuses and the East (and therefore the Silk Road). We also have evidence that, at this time, Troy gathered pretty much all of its income from tolls it charged to people passing through its ports and city. Might it be that, rather than a beautiful woman, the war was fought because Greeks grew tired of being taxed more and more whenever they tried to gain access to the East?

We should also add that the Greco-Persian wars took place around the Dardanelles, islands which controlled access of the sea during those times.

Let’s move a bit closer to home now, with World War 1. The commonly accepted causus belli is the assassination of Archduke Franz Ferdinand of Austria, but in actuality the causes of this war are some of the most disputed there are among historians. Ultimately, Austria-Hungary, Serbia and Russia were all competing for control of the Balkans. There had been recent breakdowns of power (the ottoman empire was gone, Russia was considered weak, and Serbia had gained power), and the last big empire in the region was the Austro-Hungarian one. While many factors and poor decisions are what made everything spiral out of control, the spark was dissatisfaction with his Habsburg rule. At the time the Balkans were the gateway from middle Europe to the newly liberated Eastern European countries and Turkey. Had Serbia been located somewhere North of Minsk, chances are there would have been no spiraling.

What about World War II? Despite being one of the most brutal wars in recent history, its analysis isn’t too hard. After World War I all the winners wanted to punish the main losing country, ie. Germany, and decided to give it onerous taxes and force it to make huge repayments despite the fact that it was devastated. Finding no way out, the Germans turned to extreme measures. Hitler and Nazism were a product of extreme economic hardship with no way out.

Let’s look at more recent memory, however. The September 11th attacks on the US seem pretty clear cut. Islamic extremists wanted to commit destruction on the US, which they called “The Great Satan”. It sounds very clearly religious in nature. Yet if that’s the case, why did they not target the vatican, or some other religious center? Not one church or religious icon was targeted. Rather, New York and Washington DC: the financial and political capitals of the US, the economic powerhouse of the world at the time. One cannot ignore the economic factors of these attacks, and how closely the economic consequences were monitored (stock market activity, the economic downturn, etc.)

The US, by raising its debt ceiling, has basically extended its own line of credit. This is as if you had maxed out your credit card but then raised the spending limit (don’t expect VISA to offer that option anytime soon) so you could keep on buying. This is good if the money you then spend earns you more money, so you can start paying back what you owe and you never have to default on your monthly payment. Likewise, if the economy picks up the US can use future gains to pay back what it owes. If the economy doesn’t pick up, however, the US will just accumulate more debt and will have the same problem (albeit more severe) in the near future.

So the US needs to earn more money. What would you do if you needed to earn more money? Well, you could start by cutting down on lattes at Starbucks and other measures. Maybe you could eat in more often. Or maybe you could trade in your car for a bike. These are what is called Austerity in economics. The US decides to cut back on its spending. The most affected sectors are usually welfare benefits and development projects.

But, of course, cutting down on spending only takes you so far. You will also have to start making more money. You could do this by getting a second job, a part time job, freelancing, etc. The US tends to do this by raising taxes and public transport fees.

Here is the problem, however. You new job is across town, but you sold your car for a bike. Your freelance job requires a flipcam, but you can’t afford to buy one. Or you have to network more to get that new project, but you don’t have a budget for eating out. Likewise, the US took away benefits and raised fees for its citizens, while asking for more taxes.

There is one other option, however. This is exports. It’s as if you took all your belongings and had one big garage sale (or sold them on eBay or Amazon), or you decided to sell cakes or become someone’s personal assistant. This, too, is good. Except you discover that all your neighbors and the neighboring towns are going through the crisis as well. This is what the US finds when it tries exporting to Europe, which is going through its own economic turmoil. In other words, the US could try to rely on exports, but other countries are going through a process of debt reduction.

So you can turn to other towns further away. The problem here is that they tend to have much lower incomes than your neighborhood. In fact, what if their income and spending were tied to yours? This isn’t common for people, but more common with countries when they peg their currencies, as China did with the US.

So you could maybe move to a cheaper part of town, or a cheaper town. Except if your potential buyers’ income and spending are tied to yours, this means they can suddenly buy less regardless. In fact, when they are going through hard times, they try to find more ways to raise your income and spending so theirs can go up. In other words, the US could try to have the dollar depreciate, and therefore increase its exports, but America’s second largest trading partner, China, has its currency pegged to the dollar, which means the dollar won’t be cheaper for them. In fact they’ll resist a dollar depreciation. On top of this, when investors worldwide seek a safe base, they buy US treasuries and debt, thereby strengthening the dollar further.

So what do you do? The more you cut back, then less you can invest in your career. You can try to sell your goods or offer your services to neighbors, but they’re going through the same problems you are. Moreover, neighboring towns have their salary and spending levels tied to you and your town, so they suffer when you try to cut back as well. At a certain point you run out of a market to sell goods to, and suddenly your credit card is maxed again. Time to raise the spending limit once more?

So what is the solution? Well it looks as though the US government wants to propose regulating the amount of time that can be spent on the tarmac, while the UK want to punish airlines that aren’t adequately prepared for such emergencies. We don’t believe these will be very effective and just add another layer of unneeded regulation (also it might be possible that these government actually like using weather-related delays for their purposes).

Let’s remember that once upon a time every new airline, every fare, and flight across state lines had to be approved by the federal government. This changed in 1978, with deregulation (under Jimmy Carter, which may surprise some). This deregulation dramatically lowered the prices of airline flights and the number of flights, and it allowed low cost airlines to enter the market as well. The savings of these deregulations to consumers have amounted to billions of dollars per year. For this reason, we think further regulation should not be taken without much consideration.

So what is a viable solution? Well, some are already being seen. The inefficiencies of sites like Kayak, Expedia and Travelocity, etc. are quite apparent. If a flight costs even a dollar more many times the flights won’t even show up on the first page (or couple of pages) of the flight results, even if that one dollar can result in a much shorter flight with fewer stops and a more reliable airline. Websites like Hipmunk are able to deal with issues such as this, while sites such as Seatguru let us deal with flight details (like making sure we’re in a good seat while we’re waiting on that tarmac).

This still leaves delays. The airlines have no incentive to deal with these, since they can usually blame ‘external factors’ and not get penalized. Also, by cramming their airlines with passengers they will rarely have an extra plane available if any of their flights get canceled. A solution to this could be a search option taking into account the average wait time of each airline company and each route (this can further be whittled down to likelihood of delay based on time of year, time of day, etc. etc.)

In fact, airlines could even be offered various spots (at a price) for priority in case of an emergency. These “preferred flights” will be able to leave earlier in case delays do occur. Passengers may be willing to pay more for the guarantee that they can arrive on time. And this extra income could help make flights cheaper for the other passengers. Michael Levine, of New York University, thinks this would be the optimal solution.

Unfortunately, most politicians see greater chances of reelection by building new airports in their districts, even if completely unneeded. Also no politician would want to risk asking the TSA to ease on their tedious and mostly useless security measures, for fear of looking “soft on terror”.

It might help if they saw that most voters aren’t as simplistic as they’d like to think, but this might be putting too much faith in politicians, who would rather decide for themselves how long airplanes can wait on tarmacs and call it a day.

Unfortunately, the ultimate factor will be the driver. If the driver is in a hurry, he or she will learn where the cameras are to avoid them, cover up the car’s license plates, and realize the behavioral games that are being played (or at least believe to do so). In other words, these are all punishments that will tend to put drivers on the defensive so they can “find a way around the system” to arrive at their destination earlier and get the good parking space. The town of Swindon recently removed their speed cameras claiming that they did nothing to prevent crashes. In fact the first year after they were removed the collision rate decreased slightly.

Following this line of reasoning, Sweden has come up with a novel way to deter fast drivers. They have set up speed cameras which not only fine those who speed, but then use this money to reward those who don’t. These cameras take a picture of the license plate of every car that passes in front of them. Those that are speeding are fined, while those that aren’t are entered into a lottery. Every week a lucky winner receives the funds collected so far. This means that, far from trying to avoid these roads or cover up their license plates, drivers have a positive incentive to drive slowly.

So will reward be more effective than punishment? Or is this akin to rewarding people any time they don’t steal money from someone else? It will be interesting to see how this works and if it expands. And, if it works, might it not be worth searching for more “carrot” incentives over “stick” incentives for other matters such as recycling, saving money, etc.?