Chris Dixon

When having the “open vs closed” debate regarding a technology platform, a number of distinctions need to be made. First, what exactly is meant by “open.” Here’s a great chart from a paper by Harvard professor Tom Eisenmann (et al).:

(Eisenmann acknlowledges the iPhone isn’t fully open to the end user – in the US you need to use AT&T, etc.  I would argue the iPhone is semi-open to the app developer and mobile app development was effectively closed prior to the iPhone. But the main point here is that platforms can be open & closed in many different ways, at different levels, etc.)

The next important distinction is whose interest you are considering when asking what and when to open or close things.  I think there are at least 3 interesting perspectives:

The company: Lots of people have written about this topic (Clay Christensen, Joel Spolsky, more Eisenmann here).   In a nutshell, there are times when a company, acting solely in its self-interest, should close things and other times they should open things.  As a rule of thumb, a company should close their core assets and open/commoditize complementary assets. Google’s search engine is their core asset and therefore Google should want to keep it closed, whereas the operating system is a complement that they should commoditize (my full analysis of what Google should want to own vs commoditize is here). Facebook’s social graph is their core asset so it’s optimal to close it and not interoperate with other graphs, whereas marking up web pages to be more social-network friendly (open graph protocol) is complementary hence optimal for FB to open.  (With respect to social graphs interoperating (e.g. Open Social), it’s generally in the interest of smaller graphs to interoperate and larger ones not to – the same is true of IM networks).  Note that I think there is absolutely nothing wrong with Google and Facebook or any other company keeping closed or trying to open things according to their own best interests.

The industry: When I say “what is good for the industry” I mean what ultimately creates the most aggregate industry-wide shareholder value.  I assume (hope?) this also yields the maximum innovation.  As an active tech entrepreneur and investor I think my personal interests and the tech industry’s interests are mostly aligned (hence you could argue I’m talking my book).  Unfortunately it’s much easier to study open vs. closed strategies at the level of the firm than at the level of an industry, because there are far more “split test” cases to study.  What would the world be like if email (SMTP) were controlled by a single company?  I would tend to think a far less innovative and wealthy one. There are a number of multibillion dollar industries built on email: email clients, webmail systems, email marketing, anti-spam, etc.  The downside of openness is that it’s very hard to upgrade SMTP since you need to get so many parties to agree and coordinate.  So, for example, it has taken forever to add basic anti-spam authentication features to SMTP.  Twitter on the other hand can unilaterally add useful new things like their recent annotations feature.

Here’s what Professor Eisenmann said when I asked him to summarize the state of economic thinking on the topic:

With respect to your question about the impact of open vs closed on the economy, the hard-core economists cited in my book chapter have a lot to say, but it all boils down to “it depends.” Closed platform provides more incentive for innovation because platform owner can collect and redistribute more rent and can ensure that there’s a manageable level of competition in any given application category. Open platform harnesses strong network effects, attracting more application developers, and  thus stimulates lots of competition. There’s some interesting recent work that suggests that markets may evolve in directions that favor the presence of one strong closed player plus one strong open player (consider: Windows + Linux; iPhone + Android). In this scenario, society/economy gets best of both approaches.

Society:  I tend to think what is good for the tech industry is generally good for society.  But others certainly have different views.  Advocates of openness are often accused of being socialist hippies.  Maybe some are.  I am not.  I care about the tech industry.  I think it’s reasonable to question whether moves by large industry players are good or bad for the industry.  Unfortunately most of the debate I’ve seen so far seems driven by ideology and name calling.

I can’t remember the last time the tech world was so interesting. First, innovation is at an all time high.  Apple, Google, Facebook, Twitter and even Microsoft (in the non-monopoly divisions) are making truly exciting products. Second, since the battles are between platforms, the strategic issues are complex, involving complementary network effects.

Twitter’s moves this week were particular interesting.  A lot of third-party developers were unhappy. I think this is mainly a result of Twitter having sent mixed signals over the past few years. Twitter’s move into complementary areas was entirely predictable – it happens with every platform provider. The real problem is that somehow Twitter had convinced the world they were going to “let a thousand flowers bloom” – as if they were a non-profit out to save the world, or that they would invent some fantastic new business model that didn’t encroach on third-party developers. This week Twitter finally started acting like what it is: a well-financed company run by smart capitalists.

This mixed signaling has been exacerbated by the fact that Twitter has yet to figure out a business model (they sold data to Microsoft & Google but this is likely just one-time R&D purchases). Maybe Twitter thinks they know what their business model is and maybe they’ll even announce it soon. But whatever they think or announce will only truly be their business model when and if it delivers on their multi-billion dollar aspirations. It will likely be at least a year or two before that happens.

Normally, when third parties try to predict whether their products will be subsumed by a platform, the question boils down to whether their products will be strategic to the platform. When the platform has an established business model, this analysis is fairly straightforward (for example, here is my strategic analysis of Google’s platform).  If you make games for the iPhone, you are pretty certain Apple will take their 30% cut and leave you alone. Similarly, if you are a content website relying on SEO and Google Adsense you can be pretty confident Google will leave you alone. Until Twitter has a successful business model, they can’t have a consistent strategy and third parties should expect erratic behavior and even complete and sudden shifts in strategy.

So what might Twitter’s business model eventually be?  I expect that Twitter search will monetize poorly because most searches on Twitter don’t have purchasing intent.  Twitter’s move into mobile clients and hints about a more engaging website suggest they may be trying to mimic Facebook’s display ad model. (Facebook’s ad growth is being driven largely by companies like Zynga who are in turn monetizing users with social games and virtual goods.  Hence it’s no surprise that a Twitter investor is suggesting that developers create social games instead of “filling holes” with URL shorteners etc.) Facebook’s model depends on owning “eyeballs,” which is entirely contradictory to the pure API model Twitter has promoted thus far.  So if Twitter continues in this direction expect a lot of angst among third-party developers.

Hopefully Twitter “fills holes” through acquisitions instead of internal development. Twitter was a hugely clever invention and has grown its user base at a staggering rate, but on the product development front has been underwhelming.  Buying Tweetie seemed to be a tacit acknowledgement of this weakness and an attempt to rectify it. Acquisitions also have the benefit of sending a positive signal to developers since least some of them are embraced and not just replaced.

What’s Facebook doing during all of this?  Last year, Facebook seemed to be frantically copying Twitter – defaulting a lot of information to public, creating a canonical namespace, etc. Now that Twitter seems to be mimicing Facebook, Facebook’s best move is probably just to sit back and watch the Twitter ecosystem fight amongst itself.  As Facebooker Ivan Kirigin tweeted yesterday: “I suppose when your competition is making huge mistakes, you should just stfu.”

Disclosure: As with everything I write, I have a ton of conflicts of interest, some of which are listed here.

I recently tweeted:

New early-stage start up trend: get big quietly, so you don’t tip off potential competitors.

Chris Sacca agreed:

@cdixon Agreed. As of this morning, I have four companies who don’t want investors mentioning that they’ve been funded.

Business Insider took these tweets to mean “Stealth mode is back.”  But that’s actually not what I meant.  The companies I’m referring to (and I think Chris is referring to) are publicly launched, acquiring users and generating revenue. They are modeling themselves after Groupon, where the first time the VC community / tech press gets excited about them, they are already so successful that it’s hard for competitors to jump in.

This trend strikes me as a response to the fact that 1) raising money from certain investors can be such a strong signal that it triggers massive investor/tech press excitement, 2) things are “frothy” now – meaning lots of smart people are starting companies and easily raising lots of money, 3) word seems to travel faster than ever about interesting startups, and 4) there are big companies like Facebook and Google who are good at fast following.

I don’t know what to call this but it’s not stealth mode.  Maybe “underhype” mode?

Anyone who has pitched VCs knows they are obsessed with market size.  If you can’t make the case that you’re addressing a possible billion dollar market, you’ll have difficulty getting VCs to invest. (Smaller, venture-style investors like angels and seed funds also prioritize market size but are usually more flexible – they’ll often invest when the market is “only” ~$100M).  This is perfectly rational since VC returns tend to be driven by a few big hits in big markets.

For early-stage companies, you should never rely on quantitative analysis to estimate market size. Venture-style startups are bets on broad, secular trends. Good VCs understand this. Bad VCs don’t, and waste time on things like interviewing potential customers and building spreadsheets that estimate market size from the bottom-up.

The only way to understand and predict large new markets is through narratives. Some popular current narratives include: people are spending more and more time online and somehow brand advertisers will find a way to effectively influence them; social link sharing is becoming an increasingly significant source of website traffic and somehow will be monetized; mobile devices are becoming powerful enough to replace laptops for most tasks and will unleash a flood of new applications and business models.

As an entrepreneur, you shouldn’t raise VC unless you truly believe a narrative where your company is a billion dollar business. But deploying narratives is also an important tactic. VCs are financiers — quantitative analysis is their home turf. If you are arguing market size with a VC using a spreadsheet, you’ve already lost the debate.