Showing posts with label internet companies. Show all posts
Showing posts with label internet companies. Show all posts

Friday, September 20, 2019

The U.S. Justice Department and Facebook: Secretly Mining Personal Information

Collusion between business and government has hardly been a rarity; the extent of secrecy regarding it , however, may be a surprise. Whereas business-government economic partnerships (as well as university-government partnerships) have typically been made public, the extent to which government uses businesses to get information on citizens has hardly been transparent. In spite of a U.S. federal law enacted in 2015, documents released in September of 2019 “show how far beyond Silicon Valley the practice extends—encompassing scores of banks, credit agencies, cellphone carriers and even universities.”[1] The documents, which cover 750 of the half-million subpoenas issued since 2001, reveal that more than 120 companies and other entities received subpoenas for information on customers, users, or students. F.B.I. could lawfully “scoop up a variety of information, including usernames, locations, IP addresses and records of purchases” without a judge’s approval.[2] A gag order keeps the businesses from divulging even the receipt of a subpoena. So much secrecy accompanying so much power is, I submit, dangerous to a republic. In fact, the subtle effects on citizens in the public square can easily be overlooked even if the negative impact on freedom is serious.
The documents reveal that the credit agencies received a large number of subpoenas, as did financial institutions like Bank of America. Universities including Kansas State University and cellular providers including AT&T and Verizon, as well as tech companies like Google and Facebook also received subpoenas. The public was kept in the dark, due to “several large loopholes” enabling the U.S. Justice Department to refuse even to review “a large swath” of gag orders.[3] Loopholes have been a common practice in legislation impacting business, given the power of large businesses or industries to influence lawmakers via large campaign contributions. I submit that the loopholes enabling secrecy on the subpoenas are even worse for a republic’s viability because of the extent of governmental power that is possible from mining private data on citizens. The potential uses—again in the dark—go well beyond reducing or preventing crime.
Political uses, for example, should not be discounted. Even as Facebook’s CEO, Mark Zuckerberg, was assuring users that they had control over what data is shared, the company’s COO had devised a business model that would substantially raise Facebook’s revenue by secretly allowing third-party “app” companies access to user data. The practice enabled Cambridge Analytic to influence users politically without the users’ knowledge. In the case of the F.B.I. subpoenas, partisans in governmental roles could conceivable gain access to the data through political pressure (e.g., from Congress or the White House).
Moreover, I submit that a government with a lot of information on citizens is totalitarian with respect to information, and such a near-totality can easily breed a totalitarian state in the sense of control over citizens. They in term could be expected to increasingly fear sharing personal data with businesses. In 2018, for instance, I tried out Facebook. After just weeks with an account, I was surprised when the company demanded that I send a photo in which my face is recognizable. I had read that the company had been working on facial recognition technology, and the explicit demand for a recognizable face seemed strange to me. I also knew that Facebook regularly shared user information with third-parties, whether business or governmental in nature. I had nothing to hide, but I did not like feeling invasiveness even in the demand itself. So I experimented by taking a picture on a public sidewalk of a poor person not likely to have an account. Facebook deleted my account without explanation. I would have deleted the account anyway rather than use a fake picture. I wanted to see whether Facebook would use its facial-recognition technology to assess the picture. Either the person whom I photographed had an account or Facebook already had access from an external entity (such as my web-site) of my face. Even just the use of secret software to assess the photo I had submitted struck me as excessive, and I would not have been surprised to discover that Facebook had access to more personal information that what I had shared on my account. Facebook itself could be said to be a private totalitarian state. Given the compromised ethics in the company’s brief history, I felt uncomfortable with Facebook having any of my personal information and, moreover, concluded that such a company with a totalitarian approach to information as a means at the very least of raising revenue is major problem. Sadly, given the susceptibility of the Congress and White House to political influence from large campaign-contributions,  the company’s wealth and thus political pull could keep a law from being enacted that would force Facebook to permanently remove all information pertaining to me at my written request. It would be interesting if any U.S. citizen could have access to any data collected by the F.B.I. from businesses and other external entities unless deemed classified by a judge in the Judiciary. The purpose would obviously not be to help criminals.
With personal data being provided on “social networks,” as well as to other companies, banks, phone companies, and internet providers (including universities), and with the U.S. Government having unlimited access to that information, a person could be expected to feel that he or she has a contracted personal space. Even in one’s home, if a cell phone or computer is on (and even if it is off, I have read), the government may have a way to look in. Not even a personal conversation on a cell phone can any longer be regarded as private. The sphere of a sense of freedom of expression has likely come to be feel very restricted. I suspect that Americans have resisted this encroaching de facto sense of limitation on their personal freedom by being in the illusion that an actual phone call is private and that neither a government agency nor Facebook is keeping tabs on which sites are being visited or what is being said or done on a phone. Yet the diminishment of the sense of freedom, especially when a person is in public but also on private property, is real, which a decrease in the quality of life going along with the masked fear. The People can regard this constriction of freedom as being subject to the Will of the People rather than merely something that can evolve by means of vested interests inside and out of government. In other words, an electorate need not be passive.
Moreover, a government’s totalitarian approach to gaining information on the citizenry is contrary to the notion of a limited government wherein the People are the popular sovereign. A limited government is a key part of a republic, whereas a totalitarian government is vital to a dictatorship wherein the People have no power. Adding to the concern is a private company’s totalitarian approach to information-gathering, especially if such a company has lied to its users about it. Interestingly, the third-party commercial app makers can be considered the company’s clients, whereas the users supplying the data are suppliers. In other words, the users are not the customers. The suppliers are not paid in monetary terms; rather, Facebook pays those bills by allowing the suppliers to use the company’s platform—activity that increases the supply of information!
In supplying something, a supplier transfers a commodity to a buyer; the supplier cannot claim ownership or control of the commodity once it has been supplied. Obviously if the buyer lies to the supplier regarding the contract, the supplier has grounds to take back the commodity supplied. The suppliers did not agree (and thus were not “paid”) to allow Facebook to contract with Cambridge Analytic, a client, to use the commodity to manipulate the suppliers themselves. To be sure, ordinarily a supplier would not expect to have any say as to what a buyer does with the commodity, but Mark Zuckerberg made oral promises that the company’s user-suppliers would continue to have a veto over how Facebook uses the commodity, including with whom the said commodity is shared. Because the CEO lied, it is important for the suppliers to realize that what had begun as a social network for college students became a business model. Unfortunately, the typical user is not even aware that he or she is actually a supplier. 
Government use is of course different; it can legally be done secretly, thus without the knowledge of Facebook’s suppliers. So it becomes a political question of whether the People should allow their government, assuming it is a republic, to have access. Citizens would be wise to remember that absolute power corrupts absolutely, and that with great power comes a huge responsibility even if the powerful may tend to shrug off the responsibility as they seize even more power.



1. Jennifer Valentino-DeVries, “Secret F.B.I. Subpoenas Scoop Up Personal Data From Scores of Companies,” The New York Times, September 20, 2019.
2. Ibid.
3. Ibid.

Thursday, June 27, 2019

Ownership and Compensation Conflated: The Case of Bill Gates and Paul Allen at Microsoft

Paul Allen claims in his memoir that Bill Gates tried on more than one occasion to reduce Allen’s relative ownership interest in Microsoft. Of course, the veracity of Allen’s explanation can be questioned even if the ownership changes in percentage terms are a matter of public record. Whereas The Wall Street Journal focused on Allen's credibility in making his claim, I see a case study on the difference between ownership and compensation for labor.

Allen claims in his book that in the mid-1970's, when he and Bill Gates were two college dropouts based in New Mexico, Gates asked for 60% of their partnership because of his greater contributions to the creation of software for running the BASIC programming language on an early PC, the MITS Altair 8800. Allen insists he had assumed that the partnership was evenly split, but he agreed Gates' request anyway. Several years later when the two men established Microsoft as a formal partnership, Gates asked to change their respective shares in the business to a 64-36 split, a demand to which Allen again agreed. However, in the early 1980s, Gates rebuffed Allen after he asked for an increase in his own Microsoft shares because of his work on a successful Microsoft product called SoftCard. Allen writes that he was deeply disappointed in Gates’ response; after all, the two men had known each other since they were students at a prestigious private school in Seattle. "In that moment, something died for me," Allen writes in his memoir. "I'd thought that our partnership was based on fairness, but now I saw that Bill's self-interest overrode all other considerations. My partner was out to grab as much of the pie as possible and hold on to it, and that was something I could not accept." Allen recounts that he sucked it up and thought, "OK…but one day I'm out of here."[1]  Gates had put money above not only friendship, but also a stable, enduring partnership. 

In 1982, Allen eavesdropped on a discussion between Bill Gates and Steve Ballmer, who would go on to become the company's CEO, in the Microsoft offices in Bellevue, Washington. Allen claims in his memoir that he heard the two men talking about his recent lack of productivity and how they might dilute his equity in the company by issuing options to themselves and other shareholders. Allen said he burst into the room and confronted the two men, both of whom later apologized to him and backed down from their plan. "I had helped start the company and was still an active member of management, though limited by my illness, and now my partner and my colleague were scheming to rip me off. . . . It was mercenary opportunism, plain and simple."[2] To be sure, Allen admits that his work was limited by an illness. Gates's attempts to lower Allen's stake in the company reflected Gates' concerns that Allen wasn't working hard enough and wasn't committed to the company, say people familiar with the relationship.[3] That was one reason, those people say, why Gates had put a provision in the first partnership agreement that would allow him to buy out Allen if Gates thought there were irreconcilable differences. In his memoir, Allen refers to the provision but does not include a reason for it, or why it was not mutual. 

The link between productivity or work accomplished and ownership stake may, however, not sufficiently distinguish between compensation and ownership. To be sure, additional ownership shares can be part of a compensation package, but Gates sought to change the founding ownership agreement by reducing his partner's share of ownership, which attends to founding the company. In other words, Gates should arguably have gone after Allen's salary and additional stock options, for those are more oriented to the quality of work and productivity. If a person owns a business, he still owns it if he performs badly for a year; of course, what he could take out as salary might be less than the prior year. 

1. Nick Wingfield and Robert Guth, "Microsoft Co-founder Hits Out at Gates," The Wall Street Journal, March 30, 2011.
2. Ibid.
3. Ibid.

Thursday, May 16, 2019

Facebook: Holding User Accounts Hostage

A Facebook “challenge” asking users to post a current photo and one from a decade earlier went viral in early 2019. Even though it is unlikely that the company was behind the “challenge” going viral, that the company had been working on facial recognition technology had users being suspicious on the motive behind the “challenge.”[1] A writer for Wired wrote at the time, “Imagine that you wanted to train a facial recognition algorithm on age-related characteristics and, more specifically, on age progression (e.g., how people are likely to look as they get older). Ideally, you’d want a broad and rigorous dataset with lots of people’s pictures. It would help if you knew they were taken a fixed number of years apart—say, 10 years.”[2] Why would Facebook want to track how a person is likely to look years later? Some users may put up an old picture of themselves or simply not update the existing photo, but why would Facebook want to know what those users are likely to look currently? Perhaps Facebook wanted to be able to identify those users in current pictures uploaded by others. So why did the company deny using the “challenge” for such a legitimate purpose as connecting people socially? Nonetheless, the company insisted that it had no benefit from the “challenge” going viral. This statement seems suspicious, especially given the company’s earlier lapses on user privacy. I contend that an even more toxic subterfuge existed at the time at Facebook—a cloak that held user accounts hostage until a clear facial picture could be supplied.

Perhaps because of the company’s track record since Cambridge Analytica on user privacy, the company’s statement also sought to reassure users by reminding them that they “can choose to turn facial recognition on or off at any time.”[3] While technically true, the company could freeze any user’s account supposedly for security reasons—to protect the user—until a current picture that clearly shows the face is supplied.

In spite of the fact that no legitimate security concerns could be raised a month or so after I created a user account, I discovered one day that Facebook’s computer had blocked my account until such time as I could verify the phone number I had used in setting up the account (when verification on the number was successfully made). I followed through nonetheless the second time, only to find days later that a current picture clearly showing my face was needed “for security reasons.” Until then, I could not use my account to protect my security. That I had not used the account for anything remotely suspicious, not to mention trolling or spam, led me to view the “security” rationale as fake, or at least as excessive. In demanding a face picture from me, the company indicated that the picture will not go on my profile, but this differentiation makes no difference in the company being able to use facial recognition software on me for the company’s internal uses (and even those of external stakeholders like the FBI) from then on. Facebook’s work on facial recognition AI for the previous two years had included such uses as tagging users in other users’ photos even if the photographed user does not know the photographer. Under the subterfuge of a “security need” for a current picture that other users will not see, the picture can still be used in tagging the user without his or her awareness.

I contend, therefore, that Facebook’s demand for a clear face photo is unethical. Besides the company’s horrendous track record on safekeeping user privacy, having users’ accounts held ransom nonetheless can seem presumptuous, like a bad child nonetheless demanding that his parents take him to Disneyland. The unethical verdict is also due to the felt-vulnerability that is natural (even among innocent people!) in handing a face picture to unknown people, even if they have a good reputation in securing privacy. For a company to dismiss the vulnerability and go so far as to demand a clear face picture can be reckoned as a harm (even as passive aggression) that is unjustifiable ethically.  Furthermore, the lying, such as in Facebook’s claim that it had no benefit from the treasure-trove of before-and-after pictures, and the subterfuge that a user can always turn facial-recognition off (even as the company uses it under the lie of a security need to connect a face to an account) are themselves unethical. Anticipating the future revelations on the privacy breaches, I wrote a booklet, Taking the Face off Facebook, on the unethical management at the company. It may therefore be that I’m on a “make problems for” list at Facebook, but other users have complained of having their accounts held hostage too, so I suspect the problem was still with the company’s managers, including its CEO. 

2. Ibid.
3. Ibid.

Saturday, February 2, 2019

Facebook Defies Markets: No Accountability for Unethical Managements

When Facebook announced a record $6.9 billion profit for the final quarter of 2018, up 61% from the last quarter of 2017, the company’s management could also boast of an estimated 2.7 billion users of Instagram, WhatsApp, Messenger and Facebook each month, 1.52 billion of whom used Facebook every day.[1] This was particularly surprising at the time because the company had “earned the ire of users and regulators [in the E.U. and U.S.] for a growing list of privacy issues, including the Cambridge Analytica data scandal and a massive security breach.”[2] Cambridge had improperly used information on tens of missions of Facebook users, and hackers had accessed the telephone numbers and email addresses of 30 million users. Even though Facebook’s CEO, Mark Zuckerberg “touted the steps taken by the company [in 2018] to deal with the missuse of the platform,” his company had been criticized on the eve of the announcement for being in violation of the agreement with Apple regarding an iOS app (Facebook Research) distributed to employees and customers through Apple’s “Enterprise Development Program.”[3] That program prohibited distribution to customers and accessing “information such as private messages, web searches and location data.”[4] How could users not have reacted negatively, hence bearing on Facebook’s stock-price and profit-level? How could a company’s unethical management—a point I had documented in Taking the Face Off Facebook in 2015, prior to the scandals—not be punished by the market?
Interviewing Facebook users and industry insiders at the time, I learned that the evolving norm among Facebook users was not to share so much personal information, including opinions. Some went from active users to keeping the social network to keep in touch with contacts, and of course business reasons still existed. In spite of knowing that using Facebook could help my book sales, I kept away. It does not seem that many other people walked away before or even during the scandals. So it was difficult for me to comprehend the herd-mentality and thus why Facebook numbers had improved in 2018. Why should I continue to boycott Facebook? I asked myself at the time of the announcement.
Moreover, if financial markets do not take account of unethical conduct it could be expected to spread because of the lack of financial accountability. Economic accountability may necessitate that people have an active disgust for excessively self-seeking, unethical managements, especially in cases in which users or customers have been the primary victims. In the case of Facebook, apparently billions of people did not care, at least enough to go beyond protecting themselves by limiting the personal information they would share on the site. Just as a viable republic requires an educated and virtuous citizenry, according to John Adams and Thomas Jefferson of eighteenth-century America, so too do markets that can act to weed out companies with unethical managements. In other words, perhaps we get what we deserve.



[1] Seth Fiegerman, “Facebook Posts Record $6.9 Billion Profit Despite privacy Scandals,” CNN Business, January 30, 2019.
[2] Ibid.
[3] Kaya Yurieff and Ahiza Garcia, “Apple Says Facebook’s Controversial Market Research App Violated Its Policies,” CNN Business, January 30, 2019.
[4] Ibid.

Tuesday, March 20, 2018

Oligarchic Social Media Companies: Willowing the Internet Unethically

Too much power in a few hands is inherently dangerous. That goes for private as well as public, or governmental, power. In the world of social media, the companies that own and control the platforms are essentially governmental in nature in that the executives promulgate rules and, ideally, see that they are enforced. The downsides to too few platforms—each with an extraordinary amount of power—involve a constricting of ideas, or content, on the internet, and potentially unanswered violations of the rights of the social-networks’ respective users. The public policy repercussions, I submit, include applying anti-trust law to social media companies such that none gets to become as massively dominating as Facebook had been allowed to become.
In an open letter in March, 2018, Tim Berners-Lee, the inventor of the World Wide Web, proposed a regulatory framework to balance the interests of the social media companies and their users. In the wake of the Facebook scandal then involving the psychological-political manipulation of up to 50 million users by a third party, Cambridge Analytica, the obvious inference was that privacy rights were in dire need of being shored up by regulators as Facebook’s management had failed even to notify the users of the invasive  use of their data. Yet a single-minded focus on that problem risks missing a more subtle one.
Berners-Lee points in his letter to the “concentration of power” in a few social media companies that “creates a new set of gatekeepers, allowing a handful of platforms to control which ideas and opinions are seen and shared.”[1] As a result, the “Web that many connected to years ago is not what new users will find today. What was once a rich selection of blogs and websites has been compressed under the powerful weight of a few dominant platforms.”[2] The bloggers who can make good use of Facebook’s algorithm get to see their ideas (and blogs) popularized, whereas bloggers who eschew Facebook stand a greater chance of being relegated to a marginal position on the internet.
I am a case in point. I could have made use of Facebook for years to promote essays I have posted online, but I made a decision on principle not to use Facebook because of how that company had treated my attempts to create and use an account. On my first attempt, Facebook suspended my account because I had sent some text with a link to one of my academic articles to some scholars whom I actually knew. No one at Facebook bothered to ask me if my posts were spam. I was deemed to have sordid motives without much evidence to support the projection of distrust. I deleted the account. A few years later, I tried again. That time, Facebook demanded that I upload a clear facial picture of myself so I could be identified. Facebook had verified my phone number and email address, and thus my name, but strangely those were not enough. I had not yet even used the account and thus could not have violated any of the company’s use-policies, so the projection of distrust onto me was unacceptable to me. So I deleted that account rather than supply a picture of myself to be scanned. I was also concerned how the facial recognition software would be used, especially when combined with other basic information I had included in the profile. It turns out I had reason to be concerned, for even if my personality had not been construed and I had not been subject to political manipulation psychologically, the fact that Facebook failed to prevent the invasive actions by a political firm in 2015 means that other harvesting of data could have been going on without the users being informed. Even before that scandal broke, I did not trust Facebook’s staff.  
I suspect that the fact that I had written a booklet, Taking the Face off Facebook, had something to do with Facebook making it difficult for me to create and use an account. That the platform was at the time so huge means that keeping me off made it much more difficult for me to popularize my essays at The Worden Report. If so, Facebook was exploiting a conflict of interest by keeping off ideas critical of Facebook’s management. Although I made considerable use of LinkedIn and some use of Twitter, I felt as though I was swimming upstream in steering clear of Facebook as a possible means of publicizing my site. Even though business ethics was one of my areas of expertise, and thus of the essays on my site, I felt a strange feeling in actually making a stand ethically against my own use of Facebook even though I really could use the added publicity for my site.
A faculty member at the University of Chicago business school wrote me interestingly just after the Facebook scandal became public that if only I would get on Twitter and Facebook and attack the positions of other people, my essays would be picked up by the major media and I would no longer be making things harder on myself than need be. If only I “attack people.” Really? The University of Chicago must be quite a place! Another ethical line in the sand that I would not cross. Years earlier, I had stopped attending the Academy of Management “academic” conferences because the “scholars” had made a “blood sport” out of tearing apart scholars giving paper-presentations. I found that I could be helpful to the presenters by instead suggesting fruitful directions rather than trashing what had already been written. Any dead wood would eventually fall off from the tree anyway, whereas a useful insight would be sited and thus popularized. I had the same philosophy about my essays, sans any “facilitator” like Facebook. I suspect that Facebook’s culture might have been allowed to become akin to that of the Academy of Management. If so, vindictiveness could be added as a reason why the range of ideas on the internet has been narrowed, and why more attention was not devoted to enforcing policies on the third-party uses of user data. With great power comes great responsibility, so does the power remain when it has become clear that the responsibility has been lacking?
In short, social media companies like Google and Facebook had been allowed by the U.S. Government, and ultimately the American people, to get too big—too much coverage and control of the internet. There should have been another platform similar to Facebook’s that I could have used to reach more readers. Heather West of Mozilla stated at the SXSW conference in 2018 that people were “realizing the power that technology has in our lives and [were] asking technology companies to be more transparent and responsible.”[3] I doubt that, and, besides, I submit that something more than asking was needed. Social media companies like Facebook were clinging at the time to their mantra that they merely provide platforms rather than the content (or even curating it). That is similar to Goldman Sachs insisting in the wake of the financial crisis of 2008 that the bank merely puts markets together, rather than acts also as a proprietary player in them. At the SXSW conference, Kara Swisher of Vox Media and Christiane Amanpour of CNN mocked Twitter and Facebook for insisting, “We’re a tech platform that facilitates media.”[4] A conflict of interest is in even just that, for which media is to be facilitated and which relegated as problematic? Clearly, fake political ads are problematic, but are the social critics whose range includes critiquing social media companies also problematic? Perhaps Facebook’s actual role is a blend of public and private—a private sector government, one might say. If so, democratic accountability, and even that by stockholders, is problematic and thus not to be relied on.
The answer is more government regulation of companies like Facebook, essentially meaning that the public governance functions of Facebook should be overseen at the very least by public policy rather than corporate governance and pressure from users. But government regulation has its limits. Regulators cannot be everywhere, and they cannot get at the problem of the willowing of the blogs on the internet due to factors controlled by the social media companies. For there to be a true democracy of ideas on the World Wide Web, alternative platforms of substantial but not dominating scale  must be viable without being snuffed out by a bloated platform like Facebook’s. Breaking up that company could mean that potential upstarts would get a chance to grow without being bought out and shelved by the giant. Oligopoly is not good for competition, and whether or not an industry is permitted to attain an oligarchic structure is a matter for governments to decide, and ultimately electorates.


For more on this topic, 


See also the booklet, Taking the Face off Facebook





[1] Rob Pegoraro, “SXSW Takes a Skeptical Look at Tech,” USA Today, March 13, 2018.
[2] Ibid.
[3]Ibid.
[4] Ibid.

Wednesday, September 27, 2017

Did Pandora's IPO Eclipse Fiscal Gravity?

Pandora, an internet-based radio company oriented to music, sold its initial public offering at $16 per share late on June 14, 2011. The shares opened the next day at $20 and rose as high as $26, only to fall into the teens before market close. At $26, the company had a market value of $4.2 billion, more than the value of AOL at the time. Just two weeks earlier, Pandora’s management had been looking at the $7 to $9 range.  Despite offering only 9 percent of its shares to the public, the company raised twice as much money as it had expected.

Astonishingly, Pandora had not made a profit in its 11 year history. On June 15th  when the share price was over $20,  Pandora’s CEO, Joe Kennedy, refused to say whether the company would make a profit in the next five years. Instead, he pointed to the operating margin and cash flow, and to the business model, as reasons to invest long-term in the company. "Our focus has always been to build a great company. That’s our dream, that’s our passion, that’s our focus," he said, according to CNBC. It can be asked whether investors were engaging in irrational exuberance or on the rational expectation that it can take time for a company to begin showing profits.  

With all the attention typically paid to quarterly earnings, it is refreshing to hear a CEO stress the long-term nature of investing in his company. It would be nice if Pandora’s owners also had had a passion in Pandora as a going concern pushing along the technological wave by providing music tailored to individual listeners’ tastes. Such long-term investment would have bode well for corporate governance as owners take more of an interest in holding their management accountable through directors and stockholder referendums.

At the same time, Pandora’s reliance on advertising revenue even as an increasing proportion of use on smart phones may suggest a flawed business model. For internet companies in general (as well as bloggers!), it is difficult to turn non-paying users into subscribers. At the time of its IPO, Pandora had 94 million registered users, most of which were non-paying customers. "The excitement for Pandora is driven by people's usage of the service and the enjoyment of the service," said Richard Greenfield, an analyst with BTIG Research. "But in order to justify a high valuation, they need to get far more advertising, and they need to get more people paying for the service." But this can be difficult in a marketplace where users can simply switch to a free service. While a nice set-up for us users, I’m not sure the business model is viable, given how much internet advertisers pay for clicks of their ads (which in turn is a reflection of users being able to ignore ads).

My understanding is that the phenomenon wherein a very high proportion of customers can use a product for free is pretty much limited to the internet. Tangentially, free wifi at coffee shops and even some restaurants (e.g., McDonalds) has given rise to customers “camping out” for hours to use the free service long after finishing their drink.  Incidentally, as I write this essay, I’m using Starbucks’ wifi long after my ice tea and slice of coffee cake. I’m watching the 100-minute full lunar eclipse live (just showed the video feed to the store’s manager and another customer—both of whom are amazed) as I contemplate Pandora’s business plan relative to fiscal gravity here on earth. It is just such amazement at the marvels of technology that a long-term investor in a company like Pandora can have while participating in the innovation; but lest we lose too much perspective, it is well to observe that a business model is trite, artificial and even profane next to the translucent liminality of the eclipsed rock otherwise known as our moon.

If Pandora’s advertising revenue is not sufficient to pay for the rights to the music the station plays, then not being allowed by the market to charge most users can mean eventual financial ruin for the company, especially given the extent of the competition facing the company. According to Msnbc.com, “Pandora is going up against traditional radio companies, satellite radio provider Sirius XM, music services such as Rhapsody, not to mention services from Apple, Google and Amazon that allow users to access music from anywhere.” The internet platform itself can mean not only relatively low advertising rates, but also low barriers to entry for future competitors.

According to The New York Times, Pandora had just 3 percent of the market at the time of the company’s IPO and had lost $92 million cumulatively since it began. In 2010, revenue of $137.8 million was more than double from the previous year, but the company’s 2010 loss was at $1.8 million. Most significantly, the company had never earned a profit and yet investors were rushing to invest in the company’s IPO. "I think it's heavily overvalued," Anupam Palit, an analyst with GreenCrest Capital, said according to Msnbc.com. "It's a great company but what we're seeing right now is incredible investor demand for Internet IPOs and a lot of dollars chasing very little supply." In rushing to invest, investors may have been ignoring a fundamentally flawed business model—in effect defying fiscal gravity.

An unsustainable imbalance between relying on on-line advertising revenue rather than subscribers and having to pay labels substantial fees for content mean that Pandora may never earn a profit. According to The New York Times“the fees [Pandora] pays to record labels for songs remain its largest expense. The cost to acquire content more than doubled last year to $69.4 million. ‘As the volume of music we stream to listeners increases, our content acquisition expense will also increase, regardless of whether we are able to generate more revenue,’ the company warned.” According to The Wall Street Journal, “The company faces hefty payments to music labels and publishers, similar to traditional radio companies, and has yet to offset such expenses with advertising revenues and user fees.” It would seem that the labels and publishers were not making a sufficient allowance for the discounted nature of internet-advertising revenue relative to that of brick-and-mortar radio stations.

I would be remiss if this business analysis did not place Pandora in historical context. In the closing years of the twentieth century and during the first decade of the twenty-first century, managers of “dot.coms” grasped at how to monetize the internet wherein the norm was free content. That norm had such gravitas and the internet itself was so new that business practitioners had trouble simply grasping how to get a handle on the platform. Indeed, the internet itself was changing—prodded along by the likes of companies such as The New York Times that led the way to confining their internet-users to a subscription-basis. At the time, no one knew whether the momentum would shift to this basis across the internet; no one knew whether the free access to stuff on the internet would continue unabated or suffer a decline.

Theoretically, a movement toward “subscription-only” access could pass a threshold-point beyond which businesses (and bloggers) could discount the impact of alternative free vendors and the monetization trend would be irreversible. The more traditional, more financially-solid business model could then be applied by internet companies. By the end of the first decade of the twenty-first century, internet-company managers could not even be sure that such a threshold would be crossed. At the same time, relying on advertising revenue seemed to be an insufficient basis for sustained profitability.
In other words, the uncertainty in the air at the time of Pandora’s IPO was not limited to the company. Fundamentally, the world was still grappling with how to make money using a completely new platform. It takes years for such novelty to be understood and thus ably used, even if in hindsight it seems simple. The human mind is indeed quite finite, particularly as it struggles to make sense of a new environment.

 Those people willing to invest in Pandora in its IPO on the ides of June 2011 were indeed taking a risk, and the CEO was correct to stress the long-term (which is the best perspective for stock-ownership anyway). Unless or until the monetization threshold point is hit on the internet as a whole, Pandora’s management (and investors) ought to have been taking seriously the possibility that the company’s business model was not in balance. Content should be in balance with ad revenue, and negotiating with labels and publishers ought to reflect such a balance as even the suppliers cannot earn money from defunct distributors such as Pandora. A viable business model is indeed possible for internet companies before the threshold point unless they face an overwhelming amount of free-content by competitors and ad revenue is tiny (e.g., blogging). The question at the time of Pandora's IPO was whether the company would go down this route or be able to adjust its business model even without the internet itself reaching a monetization threshold-point. 



Sources:

Margo D. Beller, “Pandora Soars, Then Falls in Market Debut,” CNBC, June 15, 2011.

Pandora Shares Surge at Their Debut,” msnbc.com, June 15, 2011.

Lynn Cowan and Don Clark, “Pandora IPO Is High Note,” The Wall Street Journal, June 15, 2011.



Evelyn M. Rusli, “Pandora Prices Its I.P.O. at $16 a Share,” The New York Times, June 15, 2011.

Sunday, June 18, 2017

Apparent Gains in Corporate Governance Accountability as the U.S. Economy Shifts

In 2016, Sacred Heart University purchased G.E.’s headquarters in Fairfield, Connecticut for $31.5 million. Gone were the Persian rugs and lavish artwork. The property acquired included the “Guest House,” the company’s 28-room hotel “to serve visiting executives and others, with no expense spared on the parquet floors, wood-burning fireplaces and a Steinway piano.”[1] Jack Welsh oversaw the ornate construction, leading to the obvious question of just what his sense of fiduciary duty to the company’s stockholders was. An artificial distinction between managers—only some being styled “executives”—was doubtless behind the luxuriant excess only for those certain employees “in the club.” From the standpoints of a board and its stockholders, “executives,” managers, and other employees are all employees. Why then should some of them be associated with luxury while they are at work? Historically, the aristocratic luxuriated precisely because those people didn’t have to work, and more importantly, they viewed work (and even their own money) as not worthy of much attention—there being finer things in life. “Executive” employees are not aristocratic, for they labor even when they could live off their accumulated wealth and pursue loftier aims, such as aiding humanity, furthering knowledge, or engaging in the arts with an eye toward advancing civilization. Bill Gates got this memo; Warren Buffett did not.

The presence of extremely rich people in the executive ranks of large corporations interferes, I submit, with the accountability that corporate governance is designed to deliver for stockholders. Lavish business expenses run counter to such governance and the very notion of a corporation as the stockholders’ combined wealth.  In the era of American industrialization, the huge profits in the industrial sector gave cover to managers such as Jack Welsh, who felt free to exploit the obvious conflict of interest in spending lavishly for the upper-echelon managers themselves, as if the company were their own country club rather than a business. Doubtless managers themselves assumed that paid country-club memberships were necessary to get and even retain (well qualified?) fellow “executives.” The underlying conflict of interest was somehow invisible to sycophantic boards and even large stockholders who looked the other way. In the succeeding high-tech era, the same obliviousness has surely existed in that sector in spite of the rise of activist stockholders.

To be sure, indications can be found that suggest more activist pressure. Even as stockholder activists’ assets were increasing from 1997 to 2015, the number of publically traded U.S. companies decreased from 7,507 to 3,766.[2] Meanwhile, the activists were getting more, well, active, and they were finding it easier to win board seats as fewer companies staggered their elections over three-year cycles. More than 300 U.S. companies were targeted in 2015, up from about 100 in 2010.[3] Boards were better positioned, at least formally, to hold C.E.O.s accountable as the percentage of joint C.E.O.-Chair positions decreased. “In 2001, more than half of new C.E.O.s also assumed the position of chairman when they took over. By 2016, only 10 percent occupied both roles.”[4]

Yet the actual impact from activist stockholders may have only been in decreasing the average tenure of the C.E.O’s. Boards were “still willing to dole out huge golden parachutes to C.E.O.’s, even if they fail.”[5] Furthermore, even though G.E.’s swanky executive suites went from 44,000 square feet in Fairfield to 7,800 square feet in Boston, C.E.O.s of high-tech companies were under less activist scrutiny in spending from soaring profits and stock prices.[6] A study looking at shareholder proposals from 2003 through 2015 concludes that “managers often seek to avoid the implementation of legitimate shareholder interests.”[7] In 2017, the U.S. House of Representatives passed the Financial Choice Act, a deregulatory bill that would require a shareholder to own at least 1% of a company’s shares for three years to get a proposal on a proxy ballot. At the time, a stockholder needed to own only $2,000 worth of stock for at least a year. Clearly, the power of activist stockholders was quite far away from Congress, whereas that of corporate managements was very close by.

Even the increased power of activists to pressure the firing of a C.E.O. of an underperforming blue chip company may actually be a manifestation of frustration over stagnant revenue and profits in the sagging industrial sector; the real question, still unanswered in 2017, is whether activist stockholders would ever go after the lavish spending of “executives” of profitable companies. Even those managements, such as of Amazon, Apple, Google, and Facebook were obliged even in their hay-day by the legal doctrine of fiduciary duty to not be profligate, and to authorize spending for legitimate business reasons because cost management is in the stockowners’ financial interest. This interest, rather than those of “executives,” is legally hegemonic, rather than to be dismissed or even rebuffed. Luxury, in other words, does not go with the work inside a corporation, but, rather, with the ownership of wealth, even if some of the employees are themselves extremely rich. Their independence and association of themselves with luxury does not fit with the corporate model, especially as concerned the ability of corporate governance to exert accountability in the interests of stockholders. As for the apparent strengthening of corporate governance in the industrial sector, the alleged improvement may actually have been a function of a major sectoral shift within the American economy. It is only natural that the old guard would be frustrated at the shift, so what looks like better accountability may only be infighting. To gauge real accountability, we would need to look at the newly hegemonic sector: Are the “executives” in it taking liberties at their stockholders’ expense?  


[1] Nelson D. Schwartz, “The Decline of the Baronial C.E.O.,” The New York Times, June 17, 2017.
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] Ibid.
[6] Ibid.
[7] Gretchen Morgenson, “Meet the Legislation Designed to Stifle Shareholders,” The New York Times, June 16, 2017.

Wednesday, October 26, 2016

AT&T Buys Time Warner: An Expansive Strategy Amid Industry Uncertainty


After Comcast’s $30 billion takeover of NBCUniversal and Verizon’s acquisitions of the Huffington Post and Yahoo, AT&T agreed on October 22, 2016 to buy Time Warner for $85.4 billion. The ability to produce content and deliver it to millions of viewers “with wireless phones, broadband subscriptions and satellite TV connections was not lost on either board.[i] At the time, AT&T sold “wireless service in a saturated market, while Time Warner [was] a content company whose primary assets, networks like CNN and HBO, [faced] tougher times in a cord-cutting world.”[ii] Although AT&T’s board could be accused of empire-building, the stabilizing impact of combining wireless service and content could hardly be ignored in a business-environment so full of change and uncertainty. In other words, with the traditional television industry facing such dire threats to its revenue-structure due to the proliferation of high-tech substitutes, having the wherewithal to formulate and experiment with different distribution means and even content was at the time a fitting strategy.

Due to the internet and the smartphone, the way people paid for TV, the kinds of programming, and the devices to watch it on were “all undergoing transformational change.”[iii] Accordingly, consumer behavior was “neither settled nor predictable.”[iv] One thing was clear: the ability to avoid having to watch commercials was something that viewers prized, and this meant that the traditional television industry would very likely be transformed. “I think we’re all trying to figure this out — how technology and the consumer is going to change, and who are the winners and losers in this future,” said Walter Piecyk, who studies the telecommunications industry at the research firm BTIG. The best argument for the merger, he said, is that AT&T would be diversified in that the company would have both programming content and distribution channels, rather than just one or the other. When you face an uncertain future, diversity can be an asset. “If it turns out that in the future, content becomes more valuable than distribution, the new AT&T will have that; if the opposite happens, it’s covered there, too.”[v]

Randall Stephenson and Jeffrey Bewkes, the chairmen and chief executives of AT&T and Time Warner, argued, “the future of TV will depend on a lot of new ideas that are tested and deployed very quickly. These might include new business models for paying for shows, new ways to distribute and market that content, and new technologies and industrywide standards to make sure it all works.”[vi] Analysts, however, said a lot of these potential products and services could be created from licensing deals. A merger might actually slow down industrywide collaborations, they argued, because it sets up a new giant that others in the industry may not want to work with. “This appears to be about empire sustenance rather than economic efficiency,” said Brian Wieser, an analyst at the Pivotal Research Group.

Expanding a business empire is never without its ethical challenges, not to mention the possible economic hit on market-competition. In the case of the media, a lot of power in a few hands also presents political risks to democracy, especially when the electorate relies on the media for information concerning candidates and policy. In the case of the United States, where the First Amendment of the federal constitution protects media, giving such license to a few rather than many can result in distortions within the democracy. Not only could the few who control the "public airwaves" (an antiquated expression) influence elections and public policy; interlocking corporate board memberships could make it easy for the few private companies that control the media to act in the interest of corporations in other sectors at the expense of the public good. Rather than taking on these "macro" issues here, I want to suggest how the combined merger in this case can be optimized from a business standpoint. 

Moving to the company-level, a possible conflict of interest is involved in this particular merger. Specifically, would AT&T give priority in its distribution channels to its own content from Time Warner? Also, would AT&T restrict Time Warner’s content to the company’s distribution channels? It would not make sense economically “for Time Warner to offer most of its content exclusively to AT&T’s customers. Not only would that destroy its profitability (Comcast’s customers pay a lot for CNN and HBO, so why would Time Warner want to kill that business?), but it would also be out of step with the future. The notion of content tied to specific distribution lines is exactly what consumers [were] moving away from when they [chose] services like Netflix over cable bundles.”[vii] Clearly, maximizing both the types of distribution and the content would be in the combined company’s best interest, especially considering the tremendous uncertainty playing out in the industry after decades of traditional radio and television. 

So in this case, enlightened self-interest can obviate the conflict of interest that is inherent in having content and distribution channels that show others' content as well. Having the wherewithal to put large sums of money into research and development in new means of distribution and how they would impact the type of content is perhaps the foremost strategic advantage in the merger. With the industry changing so much and so quickly, at least as of the time of the merger, being and staying on the forefront both technologically and in terms of content is a prime advantage of this gigantic merger. 

The strategic standpoint at the company- and industry-level is of course not the whole story, particularly as the industry includes the media, which is very important especially in a large republic such as the United States. Weighing the strategic benefit to the firm and industry from the merger against possible costs including not only political ones, but also economic as well (i.e., diminished competition) is especially difficult because different levels are involved (i.e., society, industry, and company), and analysts reside at these various levels. A CEO talking about the case with a U.S. Senator, for instance, will face the problem of talking from one level to another (i.e., company to societal). Ideally, societal actors can work to create and sustain competitive industries and a free and open media, while CEOs still have enough space to situate their respective firms as best as possible strategically. The present case is interesting because the merger has the potential to facilitate the transformation of how content is delivered due to the combined financial wherewithal even as there are major ethical, economic, and political risks or downsides.


[i] Michael J. de la Merced, “AT&T Pledges $85 Billion To Acquire Time Warner,” The New York Times, October 23, 2016.
[ii] Farhad Manjoo, “AT&T-Time Warner Deal Is a Strike in the Dark,” The New York Times, October 24, 2016.
[iii] Ibid.
[iv] Ibid.
[v] Ibid.
[vi] Ibid.
[vii] Ibid.