Winter 2011

Cloud Cover

In the not so distant future, hard drives may become obsolete and all information - including entertainment - will be distributed to consumers by powerful global Web networks called clouds. It's yet another evolution of the Internet and presents a new business model, but still requires vigilance to make sure intellectual property is protected and creators are compensated.


Cloud Cover"The future," science fiction writer William Gibson once wryly observed, "is already here — it’s just not very evenly distributed." Today, Gibson’s words have a particular prescience for an American entertainment industry struggling, in the eye of the Internet’s seemingly perpetual destructive storm, to reinvent itself. The future has indeed arrived for the recorded movie and music businesses, but not only is it unevenly distributed, it is a future in which the very issue of distribution — how entertainment is transported from the producer to the consumer — will determine the survivors and victims of the early 21st-century digital storm.

If you want to see the future of distribution in the entertainment industry, glance up into the sky. Imagine a celestial space dotted with massively powerful computers directly storing and distributing personal data, movies, and music over an interconnected global network to consumers. This is the future and it’s called “cloud computing.”

Don’t be misled, however, by its ethereal sounding name. There’s nothing otherworldly about the cloud. Rather than a heavenly phenomenon, it is a very real technological revolution - pioneered by major online companies such as Google, Facebook, Salesforce, Microsoft, Twitter, Netflix, and Spotify — that is already radically disrupting the traditional distribution economics of all media companies, especially those in the entertainment industry.

The most radical idea behind the cloud revolution is the death of traditional notions of media ownership. As a very empowered looking businessman in a Microsoft advertisement for the company’s cloud services boasts: "I have the power to own nothing. And have everything I need. I have cloud power." The marketing folks at Microsoft are, in a sense, right. The cloud is, indeed, all about the power to own nothing. It shifts the location of our data, our music, our photographs, and our movies from our own personal computers, networked televisions, or mobile devices to the Internet. It is what author Nicholas Carr, in his excellent 2008 book about the cloud revolution, The Big Switch: Our New Digital Destiny, describes as the "thin client model" in which "having our files and software locked into our PCs will be an unnecessary nuisance."

Most of us, even if we don’t know it, already rely on cloud computing services from companies such as Amazon, Yahoo, Microsoft, Google, Salesforce, and Facebook. The death of ownership is, therefore, already becoming an unavoidable reality for anyone who regularly uses the Internet. For those of us with accounts at Yahoo Mail, Gmail, or Facebook’s new messaging service, for example, our correspondence is stored on servers owned by Yahoo, Google, and Facebook. And, in a similar fashion, YouTube and Vimeo store our homemade videos, while all our photographs reside on Flickr, Facebook, or Apple MobileMe servers. As one Silicon Valley-based cloud entrepreneur disdainfully said to me last month, "Ownership is so 20th century." In contrast, the 21st century thin-client model grants us access to rather than ownership of data. It’s the old "rent or buy" dilemma repackaged in digital form. Rather than downloading data onto our computers or smartphones, we rent access to data stored on massively powerful computers.

The digital cloud can be accessed by anyone, anywhere at anytime. In the future, to remix Gibson, everything will be distributed. The cloud is already radically changing the nature of computer hardware. “Yep, Apple killed the CD today!” screamed a headline in October on the popular website TechCrunch. This headline appeared in response to the release of the revamped and much acclaimed MacBook Air, a personal computer that lacks an optical drive, the transport that plays optical discs such as CDs and DVDs. "Yep," the headline could have added, "Apple also killed the DVD today.”

With the introduction of the CD in 1980, the optical disc quickly became the core for the distribution and sale of music and then, with the introduction of the DVD, movies too. This represented the classic ownership model of 20th-century media. For 20 years, the popularity of the optical disc drove the sales and profitability of the entertainment economy. But then the growth of the Web as a real-time and always-on medium, the global scourge of online piracy enabled by illegal peer-to-peer networks such as Napster and Kazaa, and the 2001 introduction of the iPod all combined to radically change consumer buying habits. CD sales have been decimated by the digital revolution - dropping, for example, 54 percent between 2000 and 2008. And DVD sales aren’t in much better shape. In 2009, for example, DVD sales were down 9 percent; Boston firm Strategy Analytics expects sales to be down about 12 percent more in 2010.

The optical disc will, of course, limp on for a few more years, squeezing out much needed revenue for the record labels and movie studios. But as hardware products such as the MacBook Air or Apple’s increasingly ubiquitous iPad emerge as the standard delivery devices for our mobile and connected age, so the writing is now on the wall for the dominant consumer distribution platforms of late 20th-century entertainment. Like Tower or Virgin Records, the CD and the DVD now appear increasingly archaic remnants of an analog retail economy that, over the past 15 years, has been engulfed by the destructively creative storm of the digital revolution.

As Disney CEO Bob Iger said in November 2010 in response to the disappointing DVD sales of the box-office hit Toy Story 3: "On secular versus cyclical and the overall question about DVD trends, I’ve been pretty vocal about that business, suggesting that while many believe that we are seeing cyclical trends that were due to the downturn, that we thought that they were secular trends that were also impacting the business due largely to just more competition for people’s time more than anything else.”

So, if the CD and the DVD are, effectively, dead in the long term as viable media formats for the distribution of music and movies, what replaces them? Does the demise of the optical disc herald the age of the downloaded song and movie — the victory of the iTunes model, which offers consumers the downloadable 99 cent song and the $4.99 movie?

No. Rather than the download, the future belongs in the cloud. And to understand why, let’s go back to the MacBook Air, which - like the iPad - has been heralded as the future of the mobile convergence of computing with entertainment. What is striking about the MacBook Air is the minuscule storage capacity of its hard drive. Like the iPad, this computer is not designed to store data; and, like the iPad, the MacBook Air is designed to play audio and watch movies that are all stored somewhere else. The good news, from the perspective of those of us who are in the business of protecting and selling our intellectual property on the Internet, is that owning nothing in today’s digital economy doesn’t necessarily equal free. The struggle to effectively monetize our content, which today sometimes appears Sisyphean, is actually winnable in the future. Although some advertising supported cloud services, such as Yahoo or AOL Mail, the Google Chrome Web browser or Facebook’s new messaging system, are free, there is a business beyond advertising supported content in many cloudbased services. That business is subscription. We are paying for content on the network that we don’t own but have a right to access.

From Spotify to Hulu to Netflix, this is becoming the dominant business model in our cloud economy. One place to get more than just a glimpse of the cloud’s economics, particularly its impact on the future of the recorded movie and music industries, is Sweden, the digitally progressive Scandinavian country where Europe’s Pirate Party was founded and whose young wired consumers have always been one step ahead of their American contemporaries. Our future really has arrived in Sweden, and it represents both a great opportunity and a potential threat to American entertainment companies still struggling to determine their distribution role in the early 21st-century digital economy.

In November, I was in Stockholm, speaking at SIME, Scandinavia’s leading conference about the Internet. On the evening before my speech, I met with Alexander Bard, the author of the international bestseller Netocracy, co-founder of Stockholm Records and a keen sociological observer of Sweden’s youthful online consumers. The digital future, Bard told me, lies in the difference between the media habits of Sweden’s 25 year olds and those of the country’s 15 year olds.

"Twenty five year olds are obsessed with possessing their media," Bard told me over dinner. "They spend several hours a week downloading movies, music and games legally and illegally which they then hardly find the time to consume. They are squirrels preparing for a winter that never comes." If Sweden’s 25 year olds are the squirrelly digital downloaders and the thieving pirates with whom we in America are unfortunately all too familiar, then the country’s teenagers offer the profile of a quite different digital consumer. "Fifteen year olds regard the squirrels as idiots," Bard explained. "Why possess anything when everything is and will always be instantaneously available?"

Today’s 15-year-old Swedish consumers, Bard said, demand automatic access to all media all the time. These are the pioneers of a new kind of media world, one in which the old scarcity of content is being replaced with a new model of abundance, in which everything will be always available, piped instantaneously over the network and accessible via the apps on our digital hardware - including personal computers, touch pads, smartphones, networked televisions, and gaming consoles.

"They are the real clouders," Bard told me. "They have no idea what a hard drive is. Dad pays for an all-you-can-eat streaming account for 10 bucks a month and in return they get free and infinite media consumption all the time everywhere." The encouraging thing, of course, is that in contrast with their elder siblings, Bard’s "real clouders" are like their parents’ generation - once again paying for their media rather than stealing it. Yet, these clouders haven't embraced the iTunes model, with its more conventional economic model of paying for movies or songs they will subsequently own. No, that kind of traditional economic exchange is simply foreign to today’s impatient generation of wired teenagers that demands their media to be immediate and ubiquitous. Sweden’s most significant contribution to the cloud economy is Spotify, launched by the young Stockholm-based entrepreneurs Daniel Ek and Martin Lorentzon in 2006. Spotify, which includes some of the major record labels as strategic backers, offers a legal streaming service to its users based upon a semi peer-to-peer architecture of about 10 million music tracks. Spotify’s business model is based on "freemium" - giving away a basic service for free and then charging monthly subscription rates of about 10 euros for additional services. Spotify, then, represents a fundamental challenge not only to BitTorrent and other P2P pirate technologies, but also to the legal, yet increasingly archaic-looking iTunes model of selling discrete songs or movies.

The Spotify model is being embraced by Bard’s clouder generation across Europe. As Spotify admirer Sean Parker, the founder of Napster and the first president of Facebook (played rather loosely by Justin Timberlake in David Fincher’s much acclaimed 2010 movie The Social Network), said, once people have committed to the service and uploaded their playlists onto it, Spotify has them "by the balls." And that is one reason why, in the words of the website Business Insider, Spotify is "actually crushing it." Available now in seven European countries, Spotify — which includes Hong Kong telecom billionaire Li Ka-shing as one of its investors - has more than 10 million users and 750,000 paid customers.

In 2009, the company experienced a sevenfold increase in its user base and drove 60 percent of its £11.32 U.K. revenue (U.S. $17.91 million) from its paid customers. Om Malik, the authoritative editor at the website GigaOM, estimates that Spotify will be profitable in 2010, bringing in a total revenue of about $134 million in U.S. dollars. No wonder, then, that the company has been the subject of persistent acquisition rumors, including supposed interest from Apple and Facebook and, according to TechCrunch editor-in-chief Michael Arrington, a failed billion-dollar bid in 2009 from Google. For a thicket of legal reasons, Spotify still isn’t available in the United States. But the future has arrived here in the unlikely guise of Netflix. Begun in 1997 by CEO Reed Hastings as a flat-rate mail DVD rental company, Silicon Valley-based Netflix has evolved into an on-demand video streaming company that is pioneering the cloud economic model in the United States. Like Spotify, Netflix - today a public company with a market cap of about $10 billion and 16 million paying customers - really is "crushing it."

But, like Spotify, the Netflix cloud model represents a fundamental challenge to many of the other players in the entertainment economy - not only to the iTunes download model, but also to the cable and satellite networks that are hemorrhaging subscribers at the very same time that Netflix is emerging as the dominant player in the burgeoning cloud economy. Having started the DVD rental business, the new Netflix model is selling access over the Internet utilizing the real-time apps of today’s online economy. It’s a classic cloud strategy, and reflects the growth of broadband access in the U.S. as well as consumers’ voracious appetite for streaming content to multiple hardware devices such as their Blu-Ray players, PlayStation3, Wii and Xbox 360 gaming consoles, and their iPhones and iPads.

Netflix gives its paid subscribers the power to own nothing. Over the past 18 months, Netflix has signed deals with some of the largest Hollywood studios - a near billion dollar licensing deal signed last year with Paramount, MGM, and Lionsgate - giving the company legal right to stream content over the Internet. For a monthly all-you-can-eat charge of $7.99, Netflix subscribers now can legally stream thousands of high quality movies and television shows over the Internet. If anything, this Netflix cloud model might actually be too successful. A Fall 2010 study by the network management company Sandvine shows a dramatic shift in Internet use in 2009.

What’s important to note, at least from the perspective of those who legally produce professional content, is that peer-to-peer traffic on mostly illegal networks such as BitTorrent has declined by 25 percent in 2009. That doesn’t, of course, mean that the global plague of piracy has suddenly gone away or that we should stop worrying about the destructive impact of the free culture movement on American creative industries. Nor does it mean that the increasingly sophisticated criminal groups on the Internet can’t hack cloud services and platforms. In fact, there is a growing number of illegal cyberlocker subscription "services" that offer unlimited streaming of movies, TV programs, and music for a monthly fee.

This underscores what we have unfortunately come to know all too well - criminals in the "business" of stealing other people’s online content are skilled at staying ahead of the technological curve and adapting their illegal models to the Internet’s latest innovations.

Yet this also suggests that the online technologies of tomorrow might enable us to confront the problem of mainstream consumer piracy and that, if we are diligent in our fight today, it may, in the long run, become a more manageable criminal problem, like retail shoplifting or domestic burglary.

As John Maynard Keynes once famously said, in the long run we are all dead. But even in the shorter term, the rise of the cloud economy raises new problems for the content industry. The problem with Netflix is that it’s too popular. The bad news, however, is that the service is increasingly becoming an Internet hog, sucking up massive amounts of bandwidth and potentially slowing down the network for everyone else traveling over it.

The Sandvine Global Internet Phenomena Report shows that 20 percent of Internet downstream traffic during peak hours is from Netflix subscribers (even though these subscribers made up only 2 percent of online users, dwarfing other legal cloudbased services such as Hulu and even the predominantly illegal traffic on BitTorrent with only 8 percent of traffic. And when, in September, Netflix introduced its streaming service in Canada, it immediately resulted in 10 percent of Canadian Internet users visiting Netflix with usage on the service doubling that of YouTube.

"The Internet core can’t actually handle the level of traffic that Netflix generates today," says Richard Bennett, the network engineer who invented the modern version of Ethernet. "You can’t undertake a radical paradigm shift to cloud computing without sending shockwaves across the entire network economy and opening up the question of who pays to increase network capacity by 10 to 100 times.”

As Farhad Manjoo wondered in November in the online magazine Slate: "Will there be enough available bandwidth for Netflix to keep growing?" The problem, for everyone but Netflix, is that the company’s cloud service still has massive growth potential, with the company not expecting its DVD rental business to decline until 2014. The fact that 20 percent of Internet downstream traffic in 2010 was realized by 2 percent of Internet users speaks to the enormous potential power of cloud-based video services like Netflix. So what happens in 2014, when 20 percent of Internet users are streaming Netflix content and, according to research published in November by In-Stat, on demand video revenues will have reached $10 billion? Will that mean that the entire downstream traffic on the Internet could be monopolized by a small coterie of companies or services?

What happens when, to misquote Gibson, the future is so well distributed that everyone streams his or her entertainment over the network? And what happens when everyone on the network is using cloudbased services, simultaneously streaming Netflix, Spotify, Hulu, and every other cloud computing service and product?

Might this result in the network mimicking Los Angeles traffic and the Internet coming to a perpetual stop?

“Theoretically,” Manjoo argued in Slate, “broadband capacity isn’t fixed,” and thus consumers will upgrade to faster broadband lines in order to access their services. Yes, that’s true, of course. But to get more broadband requires significant investment from Internet Service Providers (ISPs) and cable companies such as Verizon, Comcast, AT&T, and Time Warner Cable. And just like producers won’t make films if they can’t recoup their investment, neither will Internet Service Providers risk investing in billion-dollar broadband build outs if they are not confident about realizing a future return on their investment. Additionally to get that investment might require flexible laws allowing these ISPs to build what have become known as “managed services” and “paid peering,” meaning dedicated lanes on the network for high bandwidth cloudbased services. This is what makes the fight against digital theft so intertwined with the technological future of the Internet. The high-quality content created by the entertainment community drives consumer demand for broadband services; conversely, the demand for that content will only exist if these broadband services are reliable enough to guarantee a good online consumer experience.

Over the past decade, the entertainment industry has rightly become obsessed with the invidious and destructive specter of piracy. As I’ve noted, this threat remains very real and the creative industry should continue to diligently fight this, both politically in support of legislative initiatives such as the rogue website anti-piracy bill sponsored by Leahy-Hatch, and more broadly in terms of confronting the dangerous ideology of the free culture movement. That said, however, the success of cloud-based services such as Spotify in Europe and Netflix and Hulu in the United States and the consequent decline of pirate P2P networks such as BitTorrent may well reflect a slow but inevitable shift in both consumer behavior and in the balance of economic power on the Internet.

That shift may change the public debate and public priorities and attitudes toward their Internet viewing - and, of course, their willingness to pay for it. In the cloud economy, broadband is the new oil and network management the new great game. For entertainment companies, the battleground might now begin to shift from confronting piracy to the even thornier issue of network management, with providers of network services such as Verizon, AT&T, and even Google pitted against Spotify and Netflix, whose services are dependent on high-speed Internet access but will inevitably be resistant to being charged extra carriage by the network operators.

Late last year, we got a glimpse of this complex new Internet reality when Level 3 Communications, one of Netflix’s key infrastructure partners in enabling its streaming movie business, accused network operator Comcast of erecting a tollbooth on the Internet to charge Level 3 new fees for traveling over its network. Naturally, Level 3 couched this dispute in the context of the open network, claiming that Comcast was trying, in the words of the company’s chief legal officer, to create a “closed Internet.” Comcast, on the other hand, described this with its top lawyer accusing Level 3 of “trying to change the rules of the game.” And inevitably anti-corporate groups such as Free Press weighed in on Level 3’s side, calling on the FCC to keep Comcast in check with the group’s president warning that “this is just a preview of what a media monopoly will look like in the Internet age.”

Over the next year, expect also to see an explosion of well-financed start-ups such as the new on-demand gaming platform OnLive, and a frenzy of acquisitions in the cloud entertainment space. Google’s pickup last month of Widevine, a Seattle-based vendor of digital rights management software for streaming video, is an augury of the growing maturity of this sector. Indeed, it’s probably only a matter of time before the Mountain View, Calif., advertising leviathan that, of course, acquired YouTube in 2006, begins to see Netflix as both a major threat and competitor.

It’s not only Google that is greedily eyeing this fast evolving space. All the major digital media companies - including Microsoft, Amazon, and Facebook - will obviously want to build their own ecosystems in the cloud entertainment economy. It will be particularly intriguing to see how the current mania with social media business models become integrated into the cloud economy. Amazon’s recent $175 million investment in the social e-coupon service LivingSocial, for example, could eventually result in a streaming video service for Amazon customers priced according to the number of consumers who sign up for it.

So where do the interests of the movie industry lie? With the Netflix/Level 3 camp or with network operators? The network neutrality debate has been successfully framed by anti-corporate and free content netroots lobbyists like the Electronic Frontier Foundation (EFF), Public Knowledge and Free Press as a struggle between a good open Internet and an evil closed one. In truth, however, the picture is far more complex then that, and the irony is that many of the companies that these cyber anarchists have championed over the last few years may well become the very monopolistic or oligarchic “nightmare” that they’ve warned against.

For Hollywood, which is likely to regard Comcast, Netflix, and Google/YouTube with equal wariness, things are much less black and white. Indeed, the media monopoly that Free Press and others warn of is as likely to come from Netflix or Google/YouTube as from Comcast, thereby adding even more uncertainty to the complex future of the cloud economy. I think that the movie business should ignore all the ideological dogma about openness and be focused on ensuring that the Internet’s new cloud economy protects the content they create and in doing so is able to provide paying consumers with a reliable and high-quality video experience on the network. If this requires “managed services” and “paid peering” to guarantee an Internet that doesn’t grind to a halt, then Hollywood should support public policy that focuses on network innovation and investment rather than the netizen fetish with openness. For better and worse, the cloud transforms the network into the key reality of the digital entertainment economy.

Empowering consumers to own nothing is a seductive marketing ploy, but the reality of the cloud economy might be of media ownership being located in fewer and fewer hands. The future, to reverse Gibson, is likely to become even more unevenly distributed as the cloud revolutionizes the way that entertainment is distributed and sold in the 21st century. Tim Wu, a Columbia University law school professor and author of the 2010 pro-network neutrality manifesto The Master Switch: The Rise and Fall of Information Empires, told The New York Times in November that Netflix has used what he calls "the open-source network, the Internet, to transform the business" of media. But the problem with any open-source network, like a country without an army, lies in its vulnerability to invasion by a foreign power. And just as the Web 2.0 Internet was successfully colonized by Google, so the cloud economy - for better or worse - is likely to be dominated by a new oligarchy of streaming superpowers such as Netflix and Spotify.

Yet, in spite of all this dramatic technological and economic change, some things never change. Let’s not forget that the cloud has no value without the high-quality content of the professional creative industries. What the success of Spotify and Netflix shows is that the unproductive Web 2.0 period - with its celebration of bad quality, user-generated content - is now over. Even YouTube recognizes that the future of the entertainment economy lies with films such as The Social Network rather than the homemade videos distributed over social networks. That, in conclusion, is the really good news for creators and movie producers whose professional livelihoods are dedicated to the creation of valuable creative work.

There will be no 21st-century cloud without a 21st-century Hollywood, no cloud without the high-quality content for which it seems more and more consumers will, thankfully, be willing to pay to access on the Internet. The future might not quite have arrived, but at least we now know what to expect. To get to this promised land requires particular vigilance today in protecting our intellectual property. A 21st-century Hollywood will only be guaranteed if we continue to focus on today’s unfortunate reality of rampant online piracy. Yes, we might all be dead in the long term, but that’s still a much better fate than being dead in the short term.

Internet Theft
As part of the Guild’s effort to keep members informed about the complex issues of Internet theft, the Quarterly has run an ongoing series of stories on the subject.
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