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Accounting for Vendor Lock-in

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The Trojan Nuclear Plant on the Banks of the Columbia River Portland General Electric, the Builder of the Plant, Has Encountered Great Opposition From Environmentalists 05/1973

I am not an accountant.   However, as a Graham and Dodd value investor over the years, I’ve picked up some of the fundamental principles.   A key one is the Matching Principle, that revenues and expenses should be booked in a way that clarifies the underlying business performance, rather than based purely on the timing of cash transactions.  In some cases this requires the use of special accounts, for things like depreciation, where the lifetime of a fixed asset (say factory machinery) extends beyond a single revenue cycle.

A similar technique is used when dealing with deferred expenses. For example take the case of a nuclear power plant.  A plant has a useful lifetime, but when that end date arrives there is a clean up cost.   The property is not immediately usable for other purposes, but must undergo an expensive remediation.  From an accounting perspective there is an asset retirement obligation, a form of deferred expense.  This deferred expense is recognized on the books as a liability based on the present value of the expected clean up cost, which is then depreciated.

I think of vendor lock-in in a similar way, but one where the clean up costs are commonly not recognized, either formally or even informally, as a deferred expense.  Instead, the costs are attributed 100% to any alternative vendor.  This leads to absurdities like the claim that moving to OpenOffice from Microsoft Office would be a huge expense.  That is like saying that an old, non-functioning power plant cannot be used for any other purpose because the cleanup costs are too high.    The costs could be real, but we only obscure the economic reality when we recognize vendor lock-in only at exit.  It should have been considered at the entrance, and as a liability against picking a closed solution.

Something to consider.  When you pick:

  • A closed solution
  • A non-open standard

In those cases you are risking vendor lock-in.  And by doing so you are committing  your company to either a perpetuity of lock-in, or to a future expensive remediation to restore  your options to the point where you can make alternative choices.  The smart way of doing this is to consider, in terms of analysis to aid decision making,  the cost of lock-in up-front, as a deferred expense, a liability.  When this is done you can more accurately make comparisons among available solutions, closed and open, knowing that you are fairly accounting for the true economic costs of each choice.

The BSA’s New Candlemakers

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The Business Software Alliance  (BSA) is at it again.   They are claiming that new UK Cabinet Office policy in favor of open standards — the kind of standards that the web is built on and which has created billions in new economy jobs —  is actually a bad thing, since it would (according to the BSA), “reduce choice, hinder innovation and increase the costs of e-government”.

Really?  Are they serious?

Those with a penchant for the history of economic thought may recall the 19th century French liberal economist Claude Frédéric Bastiat and his satirical economic parables, which attacked prevalent economic errors of his time.  We have need of Bastiat at this hour, especially his skewering of an entrenched industry’s rent-seeking push for government protection from lower cost competitors.  His attack on protectionism was called “The Candlemaker’s Petition“, and a portion of it reads like this:

We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival, which is none other than the sun, is waging war on us so mercilessly we suspect he is being stirred up against us by perfidious Albion (excellent diplomacy nowadays!), particularly because he has for that haughty island a respect that he does not show for us.

We ask you to be so good as to pass a law requiring the closing of all windows, dormers, skylights, inside and outside shutters, curtains, casements, bull’s-eyes, deadlights, and blinds — in short, all openings, holes, chinks, and fissures through which the light of the sun is wont to enter houses, to the detriment of the fair industries with which, we are proud to say, we have endowed the country, a country that cannot, without betraying ingratitude, abandon us today to so unequal a combat.

Bastiat then goes on to enumerate the benefits that would ensue, if only the government would shut out the sun:

First, if you shut off as much as possible all access to natural light, and thereby create a need for artificial light, what industry in France will not ultimately be encouraged?

If France consumes more tallow, there will have to be more cattle and sheep, and, consequently, we shall see an increase in cleared fields, meat, wool, leather, and especially manure, the basis of all agricultural wealth.

If France consumes more oil, we shall see an expansion in the cultivation of the poppy, the olive, and rapeseed. These rich yet soil-exhausting plants will come at just the right time to enable us to put to profitable use the increased fertility that the breeding of cattle will impart to the land.

Our moors will be covered with resinous trees. Numerous swarms of bees will gather from our mountains the perfumed treasures that today waste their fragrance, like the flowers from which they emanate. Thus, there is not one branch of agriculture that would not undergo a great expansion.

The same holds true of shipping. Thousands of vessels will engage in whaling, and in a short time we shall have a fleet capable of upholding the honour of France and of gratifying the patriotic aspirations of the undersigned petitioners, chandlers, etc.

But what shall we say of the specialities of Parisian manufacture? Henceforth you will behold gilding, bronze, and crystal in candlesticks, in lamps, in chandeliers, in candelabra sparkling in spacious emporia compared with which those of today are but stalls.

There is no needy resin-collector on the heights of his sand dunes, no poor miner in the depths of his black pit, who will not receive higher wages and enjoy increased prosperity.

It needs but a little reflection, gentlemen, to be convinced that there is perhaps not one Frenchman, from the wealthy stockholder of the Anzin Company to the humblest vendor of matches, whose condition would not be improved by the success of our petition.

“…and especially manure” .  Times have not changed much, have they?  I am so glad that IBM is no longer a BSA member.

The Joy of Mathematics

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The Wall Street Journal recently had an article on the best and worst jobs in the U.S., based on a mix of criteria including pay, stress level, work environment and employment outlook.

Any guesses for the best jobs?

The top 5 are:

  1. Mathematician
  2. Actuary
  3. Statistician
  4. Biologist
  5. Software Engineer

The top three places reminds me of a line in an old episode of The Simpson’s where a space shuttle crew is described as consisting of “a statistician, a mathematician, and another kind of statistician.”

Interestingly, “Philosopher” came in very high on the list. I would have expected it to have a low stress level, no demands from the boss, “I need some epistemology ASAP and a first draft of aesthetics on my desk by the end of the week, or else the Miller account will take their business to the non-Western philosophy firm!” But I didn’t know the pay was good.

The worst jobs, of the 200 surveyed? Lumberjack, followed by Dairy farmer and Taxi Driver. I don’t know any lumberjacks, but my uncle is a dairy farmer in Wisconsin, and he seems happy and peaceful in his work.

The Value of Choice

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Here in Westford, Massachusetts, some of our public schools have boilers that can be powered by natural gas or heating oil. This way the schools can have their choice of fuel, which they can alter year to year, or even month to month according to the comparative prices of these two commodities. Such a choice has a value, a very tangible value at any given point. For example, suppose that today the price of natural gas was $1.15/therm (100,000 BTU’s) and the price of heating oil was $1.72/therm. The value of choice is ($1.72-$1.15)*# of therms purchased. Those clever with finance could probably estimate the long-term value by pricing the analogous commodities futures.

Of course, choice here has a cost as well, namely the increased cost to purchase and maintain the more complex boiler that offers the choice of gas or oil. If the value of having the choice is worth more than the cost of maintaining a world that offers that choice, then you have a net gain by preserving the choice. Otherwise, you are losing by having choice. It is odd to hear that, isn’t it? You can lose by having choice, if the cost of maintaining that choice is greater than the benefit from having a choice.

For example, take shoe sizes. In the U.S. we buy shoes in 1/2 size increments. In theory a store could offer shoes in 1/10 size increments. This would give you, the consumer, an increase in choice, and this choice would have a distinct value to you. Whereas the previous shoe sizes would be an average of 1/4 of a size away from perfect fit, the new shoes would be on average only 1/20th of a size away. So a tangible benefit to you the consumer. But this comes at a cost, since the larger inventory and slower turnover for the retailer would increase their costs. Since we are unlikely to buy more shoes than we do today, this cost increase would be passed on to the consumer. So in this case, the benefit of better fitting shoes is not seen to be worth the increased costs to maintain those choices, so the industry remains with 1/2 size shoe increments.

As an aside, I’ll give you another example, as a brainteaser. You are walking down a street evenly lined with many stores, all of which sell some commodity, let’s say orange juice. The prices at the various stores are random. You want to buy orange juice at the best price, but you can only make one purchase, and you can only make one pass down the street. So you can look at many prices, but at some point you need to make a decision and purchase the orange juice, and you can’t turn back or make a second choice once you’ve made a purchase. The street is 1 kilometer long. Where do you buy your orange juice? Even with an abundance of choice, it isn’t always clear how you make an optimal decision. Note that many life decisions are like this, since time acts as a one-way street, where often we must make an important choice, based on the info we have so far, but with uncertain knowledge of the future, and often we can only choose once.

So what does this mean for document formats? It is popular these days to use the word “choice” as a “god term”, a phrase introduced by Richard Weaver in The Ethics of Rhetoric, referring to words like “progress”, “culture” and “for the Fatherland” that are used to appeal more by seduction than by rational argument. But we should avoid the seduction and ask ourselves what this choice really means. What is it really worth to you and your business? Sitting down today, writing a document, or creating a spreadsheet, what is the value to you, knowing that you could save a document to ODF, OOXML, UOF, SmartSuite, WordPerfect Suite format, etc.? And what is the tangible value of having that choice, that option?

What I want in a document format is:

  1. It is supported by my word processor.
  2. When I save the document and later retrieve it, the document looks and behaves the same.
  3. When I give it someone else, who may be using the same or a different word processor, on the same or a different operating system, it looks and behaves the same.
  4. It is easily processable by other software tools. I care about this directly because I am a programmer. But even if I were not, I would want this characteristic, since this is what ensures that an ecosystem of other tools will emerge to support the format, offering me more choice.
  5. I want the format to be open for the same reason, so it encourages the creation of other tools that I may later choose to use.
  6. I want the format to be controlled by a group of vendors and other interests, not dominated by a single player. Further, I’d want them to be to be working openly and transparently, so the public can all see what they are doing. We should all remember the line by Adam Smith, “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public.” The remedy is given by Justice Louis Louis Brandeis in his line, “Sunlight is the best disinfectant.”
  7. I want the format to be well-designed according to industry best practices, since I know that will make it easier to work with for tools vendors and will help ensure its longevity as a format.

Given a single format that can accomplish these goals, I see zero value in having a second standard. In fact, having multiple formats brings increased complexity and expense to the software vendor who maintains and supports all the translator code and this expense gets passed on to the consumer. And then there is the opportunity cost of the features that may have been coded if my vendor hadn’t been distracted by writing translator code. Also, there is the cost, in performance and fidelity loss when translating between formats, and the resulting business losses that may be caused by errors introduced in this processing. This is all very real. But where is the benefit?

To solve this puzzle, we need to look at it from Microsoft’s perspective. A standard in this space is a very scary proposition for them. A comparison can be made to the early years of the automobile industry:

Between 1904 and 1908, more than 240 companies entered the fledgling automotive business. In 1910 there was a mini-recession, and many of these entrants went out of business. Parts suppliers realized that it would be much less risky to produce parts that they could sell to more than one manufacturer. Simultaneously, the smaller automobile manufacturers realized that they could enjoy some of the cost savings from economies of scale and competition if they also used standardized parts that were provided by a number of suppliers.

Guess which two players were not interested in parts standardization? The two largest companies in the industry: Ford Motor Company and General Motors. Why? Because they were well able to achieve strong economies of scale in their own operations, and had no interest in “interconnecting” with anyone else: standardization would (partially) level the playing field regarding economies of scale at the component level. As usual, then and now, standardization benefits entrants, complementors, and consumers, but may hold little interest for dominant incumbents. — Carl Shapiro and Hal R. Varian, Intro for Managing in a Modular Age

We’re in a very similar situation now. Microsoft, the sole dominant player in this market, is perfectly happy with having total control over their proprietary formats. It has worked very well for them for many years. But just as Ford and GM eventually gave in to the obvious necessity of true interoperability, Microsoft will as well. The companies that win in this world are the ones that adapt, not the ones that sell adapters.

We need to start talking about what we can do to ensure that we have a single open document format that can be used by everyone. Making a second ISO standard for document formats is a bad idea. What we need to do is continue to evolve ODF, continue the work to harmonize UOF and ODF, and also take on the task of harmonizing OOXML and ODF. The value of having a single standard in this space is clear. We just need to remain vigilant in the face of those commercial interests that would stand to lose the most if customers had true document portability and could choose platforms and applications based on features and price and support, and not solely on fears, uncertainty and doubt about whether they could still access their legacy documents.

Broken Windows and the Ghost of Keynes

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Bad ideas never die.

The latest relapse is:

For every dollar of Microsoft revenue from Windows Vista in 2007 in the U.S., the ecosystem beyond Microsoft will reap $18 in revenues. In 2007 this ecosystem should sell about $70 billion in products and services revolving around Windows Vista.

The source for this rosy forecast is the recent IDC whitepaper, The Economic Impact of Microsoft Windows in the United States.

They summarize this boon as:

The IDC research shows that the launch of Windows Vista will precipitate cascading economic benefits, from increased employment in the region to a stronger economic base for those 200,000 or so local firms that will be selling and servicing products that run on Windows Vista. Nearly two million IT professionals and industry employees will be working with Windows Vista in 2007.

These direct benefits —157,000 new jobs and $70 billion in revenues to companies in the US IT Industry — will help local economies grow, improve the labor force, and support the formation of new companies. The indirect benefits of using newer software will help boost productivity, increase competitiveness, and support local innovation.

In the history of economic thought, this is Multiplier Effect, the belief that an increase in spending leads itself to more spending and even more spending, in a feedback loop that in the end amounts grows the entire economy. This bootstrap theory was popularized by John Maynard Keynes and became influential in some circles as a way to reduce underutilization in the economy. In other words, if unemployment is high and industrial capacity is underused, then it is worth while to have the government make work for people or spend money. Work, any work, will get the money flowing again. This lead to the various “alphabet agencies” of F.D.R.’s New Deal program.

Keynes, at his boldest, illustrated the magical properties of his multiplier effect like this:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course by tendering for leases of the note-bearing territory), there need be no more unemployment and with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

— from The General Theory of Employment, Interest and Money

The most cogent criticism of the Magic Multiplier goes back 50-years to Henry Hazlitt’s, Economics in One Easy Lesson, where he tells the tale of “The fallacy of the broken window”. It goes something like this:

Imagine the town baker’s shop window is broken by an errant baseball throw. A unfortunate expense to the baker, one might say. But that is a narrow parochial view. Look instead at the benefit to the whole community. The window will cost $300 to replace. That money will go to the glazier who will then use his profits to buy a new sofa from the furniture store, who will then use his profits to buy a new bicycle for his child from the toy store, and so on. The money will continue to circulate in over-widening circles, bringing joy to all. The original loss of $300 by the baker will more than be made up for by the aggregate increase in the amount of goods and services exchanged in the town. Instead of punishing the little boy who broke the window, he should be raised up and praised as a Universal Benefactor and Economic Sage of the First Order.

The problem with that argument is it fails to look at the poor baker and what he might have done with the $300 if his window had not broken. Maybe he would bought a new suit with that money. The tailor then might have bought a new sofa with his profits, and so on. The interconnectedness of the economy was not precipitated by the broken window. It was always there. The only thing that changed by the broken window is that the baker has no new suit, and the glazier has his money. Since you can never see the suit that was never made, it is easy to forget that the benefits to the glazier did not come from nothing.

So back to the IDC report, and this forecast of $70 billion dollars in Vista-related spending. The question to ask is, where is all this money coming from? And what might it have been used for if not spent on Vista-related purchases? Obviously this money was not created out of a vacuum. Is it coming from profits? From shareholders? From deferring other investments? Cutting back on training? Moving more jobs off-shore? Reducing quality? What companies and sectors of the economy are going to suffer for this shift in investment? What innovations will not occur because people are allocating resources to this upgrade?

In the end is $70 billion of new value really being produced? Or are we merely fixing broken Windows?