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Tech Industry

How to lose friends and alienate people

Law professor Tim Wu sees tech companies making wrong choices when it comes to their customers.

William Smith, the chief technology officer of BellSouth, recently said Internet service providers should be allowed to charge companies that want their sites to load faster than those of a rival.

Meanwhile, Sony distributed millions of CDs bundled with a dangerous copy-protection rootkit that made consumers' computers vulnerable to attack.

It is commonplace to say these companies have lost touch with their customers. That may be true, but there is something deeper going on here. Too many companies, with too little thought, have subscribed to a flawed product model.

The "control" or "value added" approach neglects the market values of neutrality and consumer choice. Companies sometimes are acting out of fear or are operating with a poor understanding of economics. Yet avoiding the kinds of errors BellSouth and Sony are making will make a key difference in companies' comparative fates.

Let's start with a basic proposition. The value of a product to a consumer (and its price) is directly related to what the consumer can do with it. This is a point Sony and the Bells once knew very well. The Sony Betamax sold because it enabled people to watch television when they wanted. In its golden age, AT&T became a common carrier; its customers could reach whomever they wanted and for whatever purposes--which is one reason people bought phone service.

Too many companies, with too little thought, have subscribed to a flawed product model.

Yet while this seems obvious, why did Sony want to sell crippled CDs that endangered its customers? Why does BellSouth want to make it comparatively harder for people to reach the sites they like best?

The answer is that these companies have fallen prey to seductive economic fallacy. The culprit goes by many names, but we can call it the "value added" business model.

The logic works fine on a PowerPoint slide. Today we sell an Internet connection for $50 a month. To make even more money, we should add a service (say, e-mail), give it preferential or exclusive rights, and charge customers an extra $10 per month. That means more money, right?

Wrong.

In the process of favoring your own services, you often cripple the underlying product--or at least make it less useful for the consumer than it might otherwise be. In the e-mail example, you need to block or disadvantage the e-mails of other providers like Yahoo. Immediately, the product as a whole--the Internet connection--is less valuable. The same logic works for search engines, operating systems and even toasters. Neutral products and neutral networks are usually more valuable to customers--a point too easily forgotten.

The e-mail example is an obvious case, and in the real world, things aren't usually so simple. Take Sony's case. By adding copy protection, Sony presumably thought that the incremental decline in piracy would add up to greater total CD revenue. But in the process, it was unthinkingly destroying an important value proposition--that the value of a CD today lies partially in its ability to be copied. A completely copy-protected CD is worth less, and a CD that infects your computer with spyware is worth less than nothing.

While I want to stress the value of neutral products, that's not to say it never makes sense for a firm to offer add-on services. Companies, for example, do very well competitively offering their own services, such as when Canon sells you great lenses for its cameras. And sometimes, though quite rarely, a service requires a kind of coordination that can only be offered by a single company(laptop repair, perhaps, being a good example.) The problem is that companies like BellSouth aren't acting carefully at all. They err by thinking that their customers want their services, as opposed to better access to an open market.

BellSouth's Smith made these logical errors abundantly clear. Surely, part of what makes Google successful, Smith said, is that it gives better search results to those who pay. But he was wrong. Google and Yahoo strive for neutral results, and that is why people find them useful.