Category: Technology

Hollywood in Extremistan

In The Black Swan, Taleb originally explained Mediocristan and Extremistan to describe how many pundits, scholars, and participants had mistakenly believed that the finance industry followed a Gaussian distribution when it actually followed a Zipf-Mandelbrot power law.

Physical measurements in the world tend to have Gaussian distributions, “to live in Mediocristan,” but other domains, like finance, follow power laws, and “live in Extremistan.” In Mediocristan, the average weight of 100 random Americans won’t change much by adding the heaviest American into the sample as the 101st observation. Conversely, in Extremistan, the average income of 100 random Americans would change drastically by adding Bill Gates into the sample as the 101st observation.

Although it’s not commonly understood or discussed, Hollywood also lives in Extremistan. Successful studios, production companies, and freelancers all adopt barbell strategies.

In financial investing, a barbell strategy is a strategy in which an investor places a majority of the portfolio, maybe 90% to 95%, into extremely non-volatile assets like T-bills, CDs, cash, etc., and a minority of the portfolio, maybe 5% to 10%, into highly risky assets like stocks, venture capital, or futures.

In the financial domain, Taleb advocates for the barbell as a way of dealing with Black Swans–unexpected yet highly impactful events–by both hedging against negative Black Swans and profiting from positive Black Swans. In an extreme barbell strategy, the non-volatile majority of the portfolio might sustain small and steady losses in a bull market because T-bills wouldn’t beat the rate of inflation. T-bills are also insulated from recessions and will outperform bear markets. In both bear and bull markets however, some of the assets in the risky, volatile portion of the portfolio will sustain losses, but such losses are bounded and acceptable. The upside on the risky assets is effectively unbounded, so the highly profitable bets cover the losses for the rest of the portfolio.

What does all this mean for Hollywood? The barbell strategy is widespread.

Errol Morris, even after having won an Oscar for The Fog of War, still enjoyed and continues to enjoy working on commercials.

It’s very typical in Hollywood for client work to serve as bread and butter. Invoicing for client work is usually fee-for-service, and filmmakers don’t expect, require, or depend on any particular clients’ product enjoying runaway success.

Specialists in Hollywood are creatives though, and join the industry because they love creating. The scrounge, toil, and pull favors to make their passion projects, some of which do enjoy runaway success.

Hollywood lives in Extremistan because the physical inputs–development, pre-production, production, post-production, and marketing and distribution–are only very tenuously related to the outputs–tickets, views, à la carte VOD purchases, subscribers to subscription VOD services, etc.

Even though Hollywood’s finances are severely obfuscated, assume that the Pareto principle is in play, that 20% of films and shows generate 80% of the revenue. Matthew Ball and Prashob Menon explain that revenue has been stagnant and fragmentation of the industry has intensified.

In Vanity Fair, Nick Bilton explains how the inefficient Gaussian aspects of the industry are about to get squeezed. Silicon Valley is about to make Extremistan even more extreme.

Brands, product consistency, and the ascent of television and subscription-based VOD

One economic explanation of why brands proliferate is that brands provide consumers consistency of product. A classic illustration is a national restaurant chain. A traveler who’s passing through an unfamiliar town doesn’t know local restaurants, and the variance in quality among the mom-and-pop shops is high. Even though the quality of a chain might not be the highest in any given town, a risk averse consumer might prefer eating an average meal at a chain, rather than risking a low-quality meal at a mom-and-pop shop.

In Hollywood, it’s exceedingly difficult and rare for film studios to establish such consistency across their different marquee offerings. There are some mechanisms for doing so: moviegoers will often select films based on specific directors or actors. For more formulaic movies, sequels provide consistency for established demographics.

In the past decade, television has exploded with a vast amount of content. John Landgraf, the CEO of FX, has even worried that there is too much television. There’s more dreck, like reality television, but there is also more high production value television. Such high production value television competes with 2-hour theatrical feature films.

Story arcs are fractals. An audience will follow characters in a good story through a not only a 2-hour film, but also through a 12-episode television season, a single 45-minute television episode, or even just a 2-minute scene.

What does this mean for television? Filmic shows might contain long story arcs that follow characters across six seasons, but episodes often function as standalone short films. Episodes of The Walking Dead in later seasons often have self-contained, coherent stories that can draw in new viewers without requiring that they watch earlier seasons. Characters come and go from season to season. No additional context is required. This is a highly successful mechanism to actually create a consistent product across tens and tens of hours of entertainment content. This is more successful branding than any traditional movie studio could hope for, even one that specializes in zombie horror.

Subscription-based VOD services like HBO, Netflix, and Amazon, through their original content, have been able to establish brands in a way that film studios never quite could. Sophisticated audiences understand what it means for a show to be “an HBO show” or “a Netflix original.”

Is the brand loyalty to these subscription-based VOD services merely an artifact of their captive audiences? Subscribers who have already opted into particular subscriptions might actually be receptive to mere feature-length films, and not just entire television seasons. Economies of scale nudge subscription-based VOD services toward the production of entire television seasons rather than two-hour films, because consumers who have opted into a subscription want the most bang for their buck. There are exceptions, however—the Netflix feature film “Beasts of No Nation,” HBO documentaries like “Going Clear,” or even just shorter miniseries like “Oliver Kitteridge,” “Angels in America,” et cetera. Perhaps, insomuch as content producers own distribution channels, they can maintain attractive brands for their subscribers.

Invasive monitoring for discounted health insurance policies

What is often called “health insurance” in the United States often isn’t actually health insurance, but a kind of imperfect prepayment plan for medical services.

If “insurance” companies were ever again to become actual insurance companies, seeking profit by assessing and pricing risks of payouts, how much producer and consumer surplus might be available through invasive health monitoring? If insurance companies could more comprehensively and invasively monitor their customers’ risk factors by, for instance, requiring monthly blood tests, or requiring shared access to a 23andMe profile, how much economic surplus might be available?

Surely there’s potential producer surplus, because insurance companies would be able to keep more money if they knew certain kinds of healthy customers would require fewer expenditures. Surely there’s potential consumer surplus, because healthy customers would be rewarded with lower prices for their good health. Pricing could even be dynamic, depending on the particular monitoring technology.

Aside from gains in producer and consumer surplus, there would be an even greater benefit. Prices would serve as a kind of check on biased medical research. Medical academics politicking for research money might continue to make wild and untrue claims about different pathologies, but insurance companies would have skin in the game to evaluate medical research.

As far as I know, privacy regulations and price regulations make this idea completely impossible today.

Why is Netflix implementing user profiles?

Netflix has now implemented different user profiles for streaming accounts. By doing so, they’re finally acknowledging that users have been sharing accounts. Even if they had been interested in maximizing the number of paid subscriptions, they never really had any mechanism to prevent account sharing.

Before user profiles, sharing a streaming account did impose costs to users. Though users were able to share access to content, their taste profiles and suggestions were irrelevant, and the shared app wasn’t able to keep track of individualized progress for users watching the same shows at different rates. Such inconveniences might have been an incentive to prevent some users from sharing accounts, but not a significant incentive.

Netflix could have tried to squeeze more revenue from users by charging a dollar or two per additional profile, but they’ll profit a different way, by fostering customer loyalty through better user experience. They’ll also be able to more reliably quantify their audience to charge higher prices to advertisers for product placements.

AT&T’s weak default security provides a huge security hole for Google 2-Step verification

Mat Honan’s article from November of last year about the weakness of using passwords for online security details a terrifyingly easy method to crack Google’s 2-step verification:

On the consumer side, we hear a lot about the magic of Google’s two-factor authentication for Gmail. It works like this: First you confirm a mobile phone number with Google. After that, whenever you try to log in from an unfamiliar IP address, the company sends an additional code to your phone: the second factor. Does this keep your account safer? Absolutely, and if you’re a Gmail user, you should enable it this very minute. Will a two-factor system like Gmail’s save passwords from obsolescence? Let me tell you about what happened to Matthew Prince.

This past summer UGNazi decided to go after Prince, CEO of a web performance and security company called CloudFlare. They wanted to get into his Google Apps account, but it was protected by two-factor. What to do? The hackers hit his AT&T cell phone account. As it turns out, AT&T uses Social Security numbers essentially as an over-the-phone password. Give the carrier those nine digits—or even just the last four—along with the name, phone number, and billing address on an account and it lets anyone add a forwarding number to any account in its system. And getting a Social Security number these days is simple: They’re sold openly online, in shockingly complete databases.

Prince’s hackers used the SSN to add a forwarding number to his AT&T service and then made a password-reset request with Google. So when the automated call came in, it was forwarded to them. Voilà—the account was theirs. Two-factor just added a second step and a little expense. The longer we stay on this outdated system—the more Social Security numbers that get passed around in databases, the more login combinations that get dumped, the more we put our entire lives online for all to see—the faster these hacks will get.

It’s extremely easy to get someone’s social security number. I don’t know about other telephone providers other than AT&T, but the fix for this is easy. You can call AT&T’s customer support and lock your account with a password. The password you create should be strong and unique, and have absolutely no connection to anything else in your life, and thus unavailable for sale on the black market. Once your account is locked with a password, AT&T representatives will refuse to make any account changes whatsoever without the password. If you forget or lose your password, the only way into your account is to go into a brick-and-mortar AT&T store and present a government-issued ID.

Will this solution achieve perfect security? Of course it won’t. Nothing is 100% secure. AT&T representatives might not comply, and government IDs can be forged, but a hacker would have to be much more determined, and would have to conduct their entire operation in a very difficult time frame, before the targeted account holder is notified and figures out that something is amiss.

Marginal analysis debunks conflict theory

Intel is attempting to challenge the traditional television content distribution model, with a box that would provide cable channels à la carte. Netflix is starting to stream original content, having just launched their breakthrough House of Cards.

All of this exciting news raises the question of why television content has always been bundled up to this point. A while back, Megan McArdle explained that bundling occurs because the fixed cost of laying cable is quite high, while the marginal cost of providing an additional channel is quite low.

Applying calculus to truly understand marginal analysis is absolutely crucial to understanding cable companies’ behavior. Marginal analysis debunks the narrative that conflict theory would predict: that cable companies deliberately structure their services at the expense of their consumers.

Cable companies aren’t full-fledged monopolies, but they have indeed secured some monopoly power through regulatory capture, since they’ve had to cooperate directly with governments to lay cable on public land. Even so, they still face exogenous demand curves. Bundling isn’t some nefarious conspiracy indicative of limitless corporate power; it’s just the nature of the good itself.

Corporations have, up to this point in time, responded to exogenous demand curves, and now à la carte content is a logical outgrowth of widespread broadband. The proliferation of broadband drives creative destruction. Innovation is beautiful.

Do patents spur innovation?

In a new paper from the Federal Reserve Bank of St. Louis, Michele Boldrin and David K. Levine explain that there is no empirical evidence that patents serve to increase innovation and productivity. They recommend that the entire patent system be abolished.

They explain that although government-created Schumpeterian monopolies do provide incentives to innovate, those incentives are negated by political rent-seeking.

They argue that the current patent system in place is plagued by problems:

  1. Modern products have so many components from different sources that licensing costs are inefficient
  2. Patents do not function as a substitute for trade secrecy
  3. Patents in no way improve communication about ideas, as if submitting for a patent was somehow a news bulletin for new technologies
  4. The deadweight loss is quite large from patent monopolies, because social loss increases linearly with an increased price, but profits increase only quadratically
  5. The cost of litigation is quite high, and this is a waste of resources
  6. Patent trolling is destructive

Why don’t we need patents?

  1. In most industries, first movers have advantages, enough to extract rents
  2. In new, innovative industries, typically many competitive firms scramble for market share; it’s usually only mature firms that attack competition with patent claims

With the lens of economic analysis, the “patent puzzle” is no puzzle at all,

Increasing IP increases residual R&D expenditure at low level of protection… As IP protection is increased further the residual R&D expenditure levels off then falls. Note that at the lower levels we are probably observing primarily the effect of [foreign direct investment]: among poor countries with low IP protection, increases bring in more foreign investment and in doing so directly raise R&D. In richer countries with high levels of IP, foreign investment is not an issue, and increases in IP have little or no effect on innovation.

What would the world look like without patents? Failing monopolies would not be able to inhibit innovation from their last-ditch challenges to competition, and would close more quickly, thereby freeing up resources for other productive ventures.