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Before this week’s Lockheed Martin network breach story intervened, I wrote a column about the strategic dilemma faced by Microsoft from downward trends in both product pricing and new installations for its flagship Windows and Office products. That’s on top of an overall market transition to mobile where Microsoft does not seem to be playing a leading role. What’s Steve Ballmer to do? I think that to thrive Microsoft has to turn itself into a very different company. Fortunately there are archetypes — other companies that have faced similar pressures yet gone on to reach even great corporate success. I think the time is fast coming for Microsoft to emulate Warren Buffett’s Berkshire Hathaway.

When Buffett took command of Berkshire decades ago it was a profitable carpet company. But the writing was on the wall for U. S. carpet manufacturers: labor costs were rising while foreign product prices were declining. Berkshire could have protected its carpet business by accepting lower profit margins, but that would have just been delaying the inevitable. Buffett decided instead to turn Berkshire into a conglomerate with a difference, that difference being its decision to buy or buy into existing successful enterprises, keeping current management in place. Buffett was investing as much in the managers as in their companies.

Buffett used his cash flow to buy a share in the futures of many other companies. Like Peter, he became a fisher of men. Following such a strategy is a very real option for Microsoft.

There’s no lack of money for Redmond to diversify. For more than a decade the company has reliably thrown off at least $1 billion each month in cold cash that could be used for diversification without impacting in any way the day-to-day operations of Microsoft. But what I propose is something more than that — deliberately shaping Microsoft operations to maximize cash flow for external investments. If Microsoft eliminated its many products that don’t make money that would free at least another $1 billion per month and maybe a lot more.

I’m not saying to stop development or even to cut back on the necessities. The strategy I propose would be like that embraced by Hitler in 1943 when he canceled all military R&D that would not bring new weapons on-line within 18 months. While der Fuhrer made many tactical errors this decision was not explicitly among them.

Microsoft should look at its current businesses and commit increased funding to those where it is already first or second in market share and where the segment is showing (or likely to show) healthy growth over time. That means continued investment in a number of specialized server-based back-end products including Skype but reducing expenditures for many clients. This strategy that has served IBM well in recent years.

This means accepting a long decline for Windows and Office just as Berkshire did with carpets. It means abandoning phone handsets, for example, as Microsoft has already bailed on the Zune. xBox would continue, but with an intense concentration on integration with back end services.

Just as an aside here, I don’t expect Microsoft to jump immediately out of the mobile phone business. I didn’t anticipate Microsoft’s deal with Nokia (neither did Microsoft, I’m fairly certain) and that will get a chance to play out. If RIM drops much further I think Ballmer will try to buy the Canadian company and may well succeed. This does not mean, however, that Microsoft can buy its way to a successful mobile phone strategy. The train has already left that station. But Ballmer won’t be able to help himself and it might make the Microsoft phone business into something that could be sold or spun-off 2-3 years from now where today it literally has no value and would simply be abandoned.

What I am proposing is a dramatically smaller Microsoft, probably 25-30 percent of what it is today, though vastly more profitable. Converting corporate mass into energy there’s $70-100 billion to play with and probably another $50+ billion that has been stashed overseas, unable to be brought back to Redmond without a huge tax penalty.

Changing Microsoft into a Berkshire eliminates the downside of having all those profits stuck overseas since they can be used for international acquisitions at what’s effectively a 30 percent discount.

What could Microsoft buy with that $150 billion? A lot of the wrong stuff if the company relies on current management to find the deals. Ballmer is absolutely the wrong man for that job. Microsoft needs at the very least a Chief Investment Officer with a new vision and the clout to shout down Ballmer when it is needed… and it will be needed.

One implication of this strategy is in branding. The Berkshire strategy has emphasized buying established brands and allowing them to operate independently. For Microsoft to be successful with a similar strategy they’ll have to do the same. The Microsoft brand would become secondary over time.

Microsoft shares have been in the crapper for going on 15 years, so maybe finding different brands is a good idea. The company’s current course will not — cannot — change that. Bill Gates has played competition bridge for years as Warren Buffet’s partner. It’s time to expand that relationship. The easiest way to do that, in fact, would be for Microsoft to simply buy Berkshire.

Good idea.

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Update — Though I chose to keep secret the identity of the defense contractor to limit the damage it was subsequently revealed by Reuters to be Lockheed-Martin. There was one additional detail presented at the end of a story in Saturday’s New York Times.

Back in March I heard from an old friend whose job it is to protect his company’s network from attack. “Any word on just what was compromised at RSA?” he asked, referring to how the RSA Data Security division of EMC had been hacked. “I suspect it was no more than a serial number, a seed, and possibly the key generation time. The algorithm has been known for years but unless they can match a seed to an account it is like having a key without knowing what lock it fits. That might simplify a brute force attack but first the attacker would need something to brute force…”

Well it didn’t take long for whoever cracked RSA to find a lock to fit that key.

Last weekend was bad for a very large U. S. defense contractor that uses SecureID tokens from RSA to provide two-factor authentication for remote VPN access to their corporate networks. Late on Sunday all remote access to the internal corporate network was disabled. All workers were told was that it would be down for at least a week. Folks who regularly telecommute were asked to come into nearby offices to work. Then earlier today (Wednesday) came word that everybody with RSA SecureID tokens would be getting new tokens over the next several weeks. Also, everybody on the network (over 100,000 people) would be asked to reset their passwords, which means admin files have probably been compromised.

It seems likely that whoever hacked the RSA network got the algorithm for the current tokens and then managed to get a key-logger installed on one or more computers used to access the intranet at this company. With those two pieces of information they were then able to get access to the internal network.

The contractor’s data security folks saw this coming, though not well enough to stop it. Shortly after the RSA breach they began requiring a second password for remote logins. But that wouldn’t help against a key-logger attack.

The good news here is that the contractor was able to detect an intrusion then did the right things to deal with it.  A breach like this is very subtle and not easy to spot.  There will be many aftershocks in the IT world from this incident.

But is this the only such instance of a major corporate network break-in? The very fact that we haven’t heard anything about this (I hadn’t, had you?) makes me think this probably ISN’T the first such network penetration from the recent RSA hack… or the last.

What if every RSA token has been compromised, everywhere?

“I have not seen anyone abandoning their investment yet,” said my friend back in March. “Most networks exchange token values over an encrypted channel anyway so the facade of security is still there. Until an attack succeeds (and how would you know?) the lemmings are complacent.”

Well an attack has succeeded, laying open who knows what national secrets?

The lemmings are now upset, or would be if they knew what you know now.

I guess now they do.

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The upcoming 64-bit version of Microsoft Windows, which Microsoftologists have taken to calling Windows 8 because Redmond has yet to announce an official name, has been appearing here and there and getting some press in the process. Microsoft has made a few statements, demonstrated early version of the OS, and some alpha code has even escaped into the wild. And the image that’s emerging is of Windows 8 as Microsoft’s take on the mobile transition, with the new OS running on everything from smart phones to server clusters. It also may represent Microsoft CEO Steve Ballmer’s last chance to preserve his company’s digital dominance.

Ballmer confirmed back in January that the next major version of Windows would have a version for power-sipping ARM processors, which are mainly installed in smart phones and tablet computers. He reinforced this idea more recently by explicitly saying Windows 8 would run on all the hardware platforms Microsoft currently supports right down to phones, calling the next version of Windows Microsoft’s “riskiest yet. ”

Ballmer is correct: Windows 8 is make-or-break for Microsoft.

PC sales in the developed world are declining while smart phone and tablet computer sales — particularly from Apple — have been exploding. Embracing mobile then is much more for Microsoft than a strategy for success: it is becoming a strategy for survival. The risk lies in Microsoft’s need to retain desktops while simultaneously leaping the mobile divide, which they have never before tried to do with a single product.

The alpha versions of Windows 8 that people are now trading over the Internet dates all the way back to last fall and may well be the version shown by Ballmer at CES in January. It was shipped to hardware manufacturers to test on their computers only to be leaked to the public. And what we see feels remarkably like, well, Apple’s OS X 10.6 Snow Leopard right down to the App Store.

Between features that are operational in the alpha version or are hinted at in the code comments and registry, users are now experimenting with a 64-bit operating system (32-bit for the ARM version) with lots of extensions for mobile use like syncing to the cloud, 3-second hibernation, push notifications (borrowed from Windows Phone 7), a built-in PDF reader, and an attractive new user interface with some elements of that borrowed from Windows Phone 7, too.

Also hinted at in the code are effortless network connections to servers, printers and other networked devices like televisions.

There could be lots of other features, too, though the user experience from Windows 7 was that Microsoft promised more than it ultimately delivered.

One feature that has been getting a lot of buzz from developers is Windows 8’s apparent ability to boot from a USB stick. The attraction of this is the idea, popularized in the Linux community, of carrying on your keychain your entire computing environment including individually tuned operating system and all needed applications and files. Put the USB stick in any borrowed PC and you are in business, right where you left off on another PC. But given that USB-boot has also been a popular way to circumvent PC security systems and it seems to go against Microsoft’s own Windows Live cloud strategy, this may be an alpha feature aimed solely at OEM hardware engineers and completely missing from the final product.

Most Microsoft product roadmaps show Windows 8 shipping to users in the fall of 2012 after entering a formal beta test at Microsoft’s Windows Developer Conference in September of this year.  Ballmer even said that last week in Japan, speaking to developers. But this week Redmond’s PR apparatus is saying Ballmer was wrong and the next version of Windows won’t ship to end-users until 2013.

Such a delay is not a good sign.

Though Microsoft is the dominant supplier of desktop software, what happens if a lot of those desktops go away or are not upgraded? That’s the fear that underlies Windows 8, making it so important. It is at platform transitions like DOS to Windows or standalone to networked where market leadership can change. Microsoft, as one of the smaller mobile players despite several tries over many years, is placing a huge bet that this time they’ll get it right. The company’s recent deal with Nokia, bringing the huge Finnish phone vendor into the Windows Phone fold, is an important part of this strategy.

But with desktops in decline overall, Microsoft losing desktop market share to Apple and being so far totally dominated in an exploding mobile market, the question to be answered is whether Windows 8 (or whatever it is finally called) will be good enough?

I doubt it.

If Windows 8 is a bust, then, what’s a Microsoft to do?  That’s my next column….

A third of the readers of this column are not in the USA and I can’t claim anymore that America is on the cutting-edge of all things Internet so I’ll just fall back on the argument that this is happening here and could just as easily be happening in your country, too. Which brings us to today’s story of Charlie Ergen’s plan to dominate the distribution of TV content to America in an all-IP, post-broadcast, post-satellite future. John Malone and Reed Hastings beware!

Echostar owns Dish Network, America’s second-largest satellite TV provider. Charlie Ergen is Echostar’s iconoclastic founder, CEO, and largest shareholder. Just as John Malone does with DirecTV, Charlie runs Dish any old way he wants to, which is why his grand plan has taken awhile to come together in my mind.

Charlie — like Steve Jobs — doesn’t do very much explaining.

Echostar has been putting together a digital strategy for the all-IP future where competitors like Netflix and Hulu may replace DirecTV and Comcast. This strategy can’t bet the bank because Charlie knows he can’t predict everything with total assurance (neither can I). But it is possible at this point for him to acquire or deploy enough assets at a low enough price to guarantee Echostar a solid place in that IP future almost any way the future plays out.

I believe Echostar has all but one component in place for this flexible strategy and no significant barriers to acquiring the last part (if it is even needed at all — more on this below). If there’s a question of critical mass it has already been answered. Charlie just has to pull the trigger. When he’ll do that is anybody’s guess.

Here are the tools at Charlie’s disposal — the Dish Network and its subscribers, Sling Media and its customers, Blockbuster Video and its customers, services and locations, Move Networks content distribution network (bought earlier this year by EchoStar), Echostar’s IP cross-licensing agreement with TiVO, and finally what’s behind Door Number Five.

The Dish Network has access to hundreds of video channels and the ability to place that content in tens of millions of homes in real time. Many of those satellite receivers have Digital Video Recorder capability with all of the DVR models having Ethernet ports and running the Linux operating system.

Sling Media developed the first mass market device specifically for streaming your own video content over the Internet. With a Slingbox you can watch your home video library, your nannycam, or even broadcast, cable, or satellite TV halfway around the world if you have a good Internet connection. I am unimpressed generally with Sling video quality but I don’t think that has to matter for this strategy to succeed. Just as there are millions of Dish DVRs installed, there are also more than a million Slingboxes, all of which also run Linux.

Under Echostar, Sling also markets a video streaming service offering movies and TV shows.

Blockbuster has a streaming video service, too, along with extensive license deals with the major film and TV studios — artifacts from when Blockbuster was the Big Kahuna of video rental and Netflix was a lot smaller than it is today. Blockbuster also has 4000+ rental locations, half of which the company is closing, but half are staying open, too.

Echostar’s TiVO license — the expensive outcome of a long legal battle — is something of a mystery here but I count it as an asset not just because it removed TiVO as an obstruction but also because it grants to Echostar a blanket license to TiVO IP, which no doubt includes some tech we haven’t seen before or have forgotten about. Remember all those video patents held by Burst.com? Well TiVO owns them now.

Charlie’s goal is clear. He wants to be a major distributor of professional video content for the rest of this century. He’s that right now, primarily with the Dish Network, but he wants to be at least as successful when IP video comes to dominate over the next 5-10 years.

In order to achieve this success Charlie needs a cheap supply of content, the right to distribute it, and a cheap, reliable, and pervasive method of video distribution. We’re not talking about 100, 1000, or 10,000 channels here. We’re talking about 50,000 movies and 150,000 TV shows — up to 200,000 channels in all and tens of millions of simultaneous connections.

I think Charlie is already there.

He has tens of millions of captive Dish, Sling, and Blockbuster customers, so Charlie’s marketing barrier is lower than it might be if he had to start from scratch. Netflix is in a similar position, which is why I feel this is a market segment where incumbents have a significant advantage over startups.

With only a licensing change Dish Network can be used to inject video content as-needed into millions of points on what will eventually become the Echostar (or Dish or Blockbuster) Virtual Video Network (VVN) — the successor to today’s satellite and cable systems. Every DVR becomes a repository or video cache on that network. All Charlie has to grab is a couple gigs per DVR to hold all the professional video ever watched.

The same will be true for Sling boxes, which can serve this distribution function whether or not there is a co-located satellite receiver.

And same for those 2000 Blockbuster locations that are not slated to close. That’s 2000 neighborhoods in up to 2000 cities that could each hold a copy of all 200,000 shows and films. That’s only 200 terabytes per library, by the way. I’m not sure why this is actually needed, but there has to be some reason for keeping open those Blockbuster locations.

Echostar and Sling already have streaming deals with the studios but my guess is that Blockbuster’s legacy deal is better. That’s the initial key to content, at least for awhile. And if you’ll look in your terms of service for Dish, Sling, or Blockbuster you’ll see nothing that keeps Charlie from leveraging behind your back that device you think you own.

The part behind Door Number Five, if I were Charlie, would be a peer-to-peer streaming client like Veetle. That’s a client for real-time streaming, not downloading — a client that caches only small bits of code on the network making it much more studio-friendly. More important, Veetle or a Veetle clone makes vastly more efficient use of network bandwidth to deliver an HD signal at little or no cost — a distinct advantage over Netflix, YouTube, etc.

A system like Veetle can aggregate smaller data streams from many sources into a full HD signal, making it immaterial that one-to-one Sling video isn’t really that great. Get enough peers together and many-to-one can run at any bandwidth your Internet connection can support while still costing Charlie nothing.

This distribution cost advantage is small but what’s important is it drops all the way to the bottom line, giving Charlie a decided profit advantage over the other guys, but it only works if you already have tens of millions of Linux machines connected to televisions all over America.

Only Charlie Ergen has that.



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The Intertubes are alight this week with old news — that Netflix is the largest user of U.S. Internet bandwidth. Most stories cite a Sandvine report I won’t link to because you’d have to subscribe and I like you too much for that. Better still, look at the very interesting graphic above, courtesy of Arbor Networks. This chart has been floating around the net for a couple of months and shows the result of an Arbor study of several U.S. ISPs illustrating how we Americans spend our Internet bandwidth. There are three lessons I think we can learn from this chart: 1) that BitTorrent is no longer (or perhaps never was) the threat were were told by ISPs; 2) that video is by far the Big Kahuna of bandwidth, and: 3) that Netflix may be approaching the point where it is too big to fail.

First a look at BitTorrent, which ISPs love to complain about. Torrents are down to only eight percent of Internet traffic, but much more important is the fact that torrents have always been more polite than video streams. Here are two more graphs courtesy of Arbor Networks. First take a look at how web traffic varies over a typical 24 hour period: Now look at p2p traffic over the same period:The two are reciprocals of each other. This is by design, not coincidence. The nature of BitTorrent is to grab bandwidth not utilized by other services. So when web surfing declines in the late night and early morning hours BitTorrent increases.

Using only eight percent of Internet bandwidth and substantially less than that during peak hours, I think BitTorrent’s day as the Internet bogeyman are past, though I doubt the MPAA will see it that way.

Even more interesting is the rise of Internet video. Back in 2005 when iTunes users were downloading seven million three-minute music videos, readers of this column were downloading 2.5 million hours of NerdTV. I remember those downloads cost me $0.25 per gigabyte — ouch! In 2010 Netflix spent about $0.015 per gigabyte with an average 1.8-gigabyte movie download costing 2.7 cents to stream. Compare this to the average $1.00 Netflix spends to ship and receive every DVD and you can see their current business transformation from DVDs to streaming will lead to dramatically lower costs, freeing-up capital to buy more content.  It’s a virtuous cycle that Netflix (and all it’s competitors to be sure) will attempt to leverage into its own form of too big to fail.

None of this is big news, I suppose, but think for a moment about the implications it has for both future services and for the commercial value of the Internet. Streaming costs are going down, not up, so what’s cheap today will be cheaper still tomorrow. These lower costs will allow higher quality (1080p video, for example) and they’ll shortly reach the point where stream costs will be lower than over-the-air broadcast costs on a per-viewer basis, which in the longer run is an inevitable prescription for the death of broadcast TV. It’s not a matter of if but when this will happen.

Even Luddites will be sucked into the Internet age if they want to communicate.

Despite having spent billions to help along the recent digital TV conversion, I’m sure the Federal Communications Commission will be happy to see broadcast TV disappear since it will do so with a flurry of spectrum auctions bringing-in many more billions to the Treasury. And that freed-up spectrum will go into more data services as we move toward the all-IP all the time future for carriers I have long predicted.

As for Netflix, it is hard to bet against the company. Hollywood studios glower and hint that Netflix will be deprived of content as current content deals — specifically Starz — expire, but that won’t happen. Dropping DVDs completely would transfer $2 billion straight to Netflix’s content acquisition budget through a combination of an increased subscriber base at lower prices and no more postal fees.

That $2 billion will buy a heck of a lot of crow in Hollywood, where cash is king.

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Search is a fundamental component of intelligence or even thought.  Maybe that’s why Google is now calling it knowledge. Our brains are already good at search. Look around a room and every object your eye passes is identified in your brain. Something out of place? It catches your eye.  That is where we are headed with Internet search, though not exactly the way one might expect.

This is where every new generation of computer scientists brings-up the idea of artificial intelligence. If only we made the network smart enough to know not only what we really mean but what we really need. Maybe someday, but for now don’t hold your breath waiting for that one.  Starting in the 1980s fortunes were spent and lost developing artificial intelligence that wasn’t, well, very intelligent. Absent some breakthrough that I have yet to see, this is not a good path to follow even today. Fortunately it isn’t really needed, at least not yet.

Google’s approach is leveraging its existing strength, which is hardware optimization. A couple years ago the company did research to figure out at what processor performance level — at what percentage of CPU capacity — data center power consumption was minimized. No other company but Google would consider a strategy of deliberately throttling-back its data centers.

Whether Google even realized it this approach to transport efficiency has been around for a long time… in aviation. What Google separately sought were two very special data center power levels known in aeronautical engineering as the Breguet Number and Carson’s Speed.

If you’ve never heard of a Breguet Number don’t feel bad.  It is the power level (typically represented by a cruising speed) at which a particular aircraft will have the longest range on its internal fuel. Fly faster or slower than the Breguet Number and you won’t go as far before running out of gas. Every airplane has a different Breguet Number, though the rule of thumb says that 32 percent power is pretty close. I don’t know what power level Google came up with from its data center research, but it is likely in that 32 percent range.

Google found that by operating its CPUs at very low power levels it could broadly optimize search in terms of total power consumption. Running at higher power levels (faster CPU clocks) could get you more search results but with a total power bill that was higher in simple terms of watts-per-search.

Operating data centers at their Breguet power level means building three times the facility that Google would need if they ran the place the old fashioned way — balls to the wall.

Deliberately having three times the computing power available brought unintended consequences — the same consequences that any 17 year-old experiences when they replace the stock engine in their old clunker with a powerplant three times as big. Google acquired a lead foot. The first result of that lead foot was Instant Search — using extra CPU cycles to prefetch search results in real time. It’s not something Google set out to do but rather an unintended consequence of overbuilt data centers.

This brings us to Carson’s Speed. Bruguet was a French engineer best-known for his family’s fine watches, while Carson was a professor at the U. S. Naval Academy.

The problem with Breguet Numbers for pilots is that airplanes are intended to go fast and Breguet-friendly power levels are slow and boring. Going faster is a constant temptation with airplanes because they are of necessity built with a lot of excess power — power that is needed for climbing to altitude. An airplane built with an engine small enough to only reach Breguet Number speeds wouldn’t have enough power to even get off the ground. If you have excess power (and finite patience) what is the best speed to fly?

That would be Carson’s speed — the speed to get the most extra speed for the least extra cost. Or, as Carson put it, of finding “the least wasteful way of wasting.”  For aircraft the speed in question turned out to be 1.32 times the speed for most miles per gallon (the Bruguet Number). Carson’s Speed uses excess power most efficiently.

Other than three G-V’s and one Boeing 767 built for a harem, Google flies data centers, not airplanes. But Google’s situation going into its power experiment was actually very similar to aviation because it was an exercise in reducing power. Google data centers weren’t built to Bruguet specs, they were faster. Given this excess computing power that had already been paid for in capital terms, what was the most efficient way of using it? Carson’s Speed — about 43 percent power — leaving plenty of excess cycles for new services like Instant Search.

But once you enable Instant Search for everyone, the data center is again running consistently above its Carson’s Speed which means you need even more hardware to bring the building back to 43 percent. It’s an arms race that until this moment only Google may have known they were conducting.

Google competitors have been constantly building new data centers, too, but they never knew there was a specific target beyond just keeping up with Google.

Google sees the excess power above Carson’s Speed as a safety margin in case traffic spikes or a data center goes down, which makes sense. But is also a strategic advantage over Google competitors.

Having discovered its lead foot, Google will employ it more and more. We’ll see whole new types of brute force services aimed at using excess CPU cycles against expanded data sets to reduce the distance between searching and finding. If a question is answered as quickly as it is asked and all the answers are cached and analyzed the results may actually start to appear before they are needed.

That, my friends looks a lot like knowledge.

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Back in 2008 I declared that the information economy was giving way to what I called the search economy. The Internet was making it more important to know how to find information than to actually possess that information, because data — and therefore the fully-explored truth of any matter — might be constantly in flux. Even more to the point today, we need the same knowledge on many devices so it is usually better to find the link than to maintain multiple copies of aging data. This might explain in an ass-backwards way why Google just changed the name of its largest tech division from search to knowledge. A more accurate explanation for this name change is just that Microsoft’s Bing has better marketing than Google. But in the longer run the distinction between search and knowledge probably does mean everything.

Bing is a major influence on Google. Though Google is vastly more successful in terms of search volume, Bing has influenced Google’s look and feel, especially in the way that results are displayed. An even bigger success, though, has been Bing’s marketing campaign calling itself not a search engine but a Decision Engine — looking beyond the search to the answer.

Microsoft did more than just try to out-search Google. They gave some serious thought to how to make the quest for information on the Internet more productive and useful. Bing struck a chord with users and competitors alike and one result is that Google, too, is becoming more results-centric. That’s what is largely behind this perceptual shift from search to knowledge. It was behind Google’s Instant Search results, too — a technically non-trivial effort that lies at the heart of what this particular column is all about. For the moment, Google trading search for knowledge is just posturing, but in the longer run it has really significant meaning. It’s a game-changer.

“Not all smart people work at Sun (Microsystems),” Bill Joy used to say and not all smart people work at Google, either. You can put together the smartest team and still not produce the best product for any number of reasons, which Google is beginning to realize, especially as the company is having trouble retaining technical talent. It’s a small enough world where the current Google brain drain probably is worth the nine-figure bonuses the company has been handing-out here and there to keep important would-be defectors in the fold. But in the long run some of these big brains will leave anyway, so Google has to find a way to compete despite their loss. That way is through knowledge, the company has decided.

But actually moving from search to knowledge — from searching to finding — turns out to have a heavy systems component. As they show with Instant Search, Google’s sustainable advantage probably lies not in software but in hardware optimization. What they do may be a little better or a little worse, but if they can do it faster and (here’s the important bit) do more of it, Google will retain its lead and dominant market share.

This is a hardware war and Google so far is winning, primarily because most of their competitors don’t even realize that’s what is going-on.

Time for Cringely’s seventh law of information technology: all things evolve to abstraction over time, becoming uninteresting commodities. That’s what is happening right now in searching, which is why the major players are trying to jump to the next level, to finding. This is a case of evolve or die.

Microsoft and Google and their competitors, if any, may know a crapload of computer science, but for the most part that is becoming irrelevant. The fastest way to sort numbers was discovered years ago and mathematically proved. That’s not going to change. It is completely uninteresting trying to invent a faster method of sorting.

“What’s next after X?” on the Internet can usually be answered by turning the question into “what if X were utterly ubiquitous and free — what could we do then?”

That’s the question Google is now asking itself with prompting from Bing.

Next — the future of search…

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This is one of those columns that will piss-off some of my geekier readers. They’ll complain that I am covering this subject at all, they will declare me dead or at least too stupid to be worth reading, and they will claim to be departing Cringelyville never to return. Frankly, I don’t give a damn. And it is important that I not give a damn, because that’s what freedom of the press is all about. This column concerns a particularly damning story about Goldman Sachs, the big Wall Street bank, that is available online now from the Rolling Stone. But I’m not so interested here in Goldman, or even in our ongoing global financial nightmare: I am fascinated by the fact that the story is in Rolling Stone and not in the Wall Street Journal or the New York Times.

This is not liberal media bias or conservative media bias, it is simple dollars and cents — the inevitable economic pressures that are felt in any media organization that relies on advertising for revenue. If you went to the Wall Street Journal or the New York Times they’d tell you there is a wall between “church and state” as it is sometimes referred to in the newspaper business — a wall that keeps ad salesmen from calling reporters and ostensibly gives the news side carte blanche to follow stories wherever they go, no matter who they annoy.

Except that usually isn’t the way it works in real life.

Read the Rolling Stone piece. It is one of a series of long stories about the financial crisis in that magazine from writer Matt Taibbi — stories that paint a scathing and foul-mouthed picture of corporate greed, especially at Goldman Sachs. In this particular installment the writer makes a strong argument that Goldman executives should be in prison. And he’s probably correct.

Why isn’t this story in the Wall Street Journal, minus the cuss words? Why isn’t it in the New York Times? Will something like it ever be in either of those papers? Probably not. And I write this freely admitting that I like the New York Times and I think the Wall Street Journal often does a pretty good job with its technology coverage.

As Deep Throat said, “Follow the money.”

I first noticed this media syndrome as a child reading airplane magazines. I came from a flying family and airplanes have been part of my life all my life, so I grew up reading Flying, and AOPA Pilot, and Sport Aviation. And I noticed that when those magazines reviewed a new airplane they hardly ever said anything bad about it. Yet a few years later, when they covered the same airplane as something you might buy used, it was as though they were flying a completely different machine. The very same writers were suddenly pointing-out “chronic problems” in a plane that might be “something of a dog.”

Airplane manufacturers don’t run ads for their old models, just the new ones. And used aircraft are competition for new ones so it is in the manufacturer’s economic interest for journalists to like the new stuff but not like the older stuff. And that’s how it seemed to play.

So I became, at 12, a media cynic.

Jann Wenner owns Rolling Stone which he founded during the Summer of Love when I was 15. He can publish these stories that don’t appear — and will probably never appear — in the Wall Street Journal or New York Times mainly because his business is radically different from their businesses. Rolling Stone doesn’t look to Citibank or Morgan Stanley for advertising. And Jann Wenner has nobody to report to except himself. Like me, he doesn’t give a damn.  Those other papers have shareholders and boards of directors that inevitably create a cesspool of interests and intrigue no matter what the church-versus-state rules are supposed to be.

This is not to say that the Journal and the Times won’t jump on this story at some point, but that point will carefully be after it is already too late. If Goldman CEO Lloyd Blankfein goes to jail, those papers will cover it, not predict it, and they certainly won’t make it happen. At best they’ll carefully explain the story after the fact.

If this was an equivalent crisis in the music business, would Jann Wenner cover that as zealously and risk offending his own advertiser base? I hope so, but maybe not.

We’re in the middle of a global trend toward media consolidation so what I decry here is only going to get worse. Against it our best hope isn’t Wenner — though he is for the moment my hero — it is the blogosphere, the edge of which you are touching right now. Longtime readers will recall dozens of pretty darned big stories of technological bullying and badness that were covered right here and often nowhere else. When I was beating the crap out of Microsoft over Burst.com, for example, reporters from Big Media kept saying to me, “I wish we could write stories like that.”

What was stopping them?

As the blogosphere evolves, my worry is that whatever independent voice or impact we have will be lost. I fear that the Huffington Post, for example, will be less useful to society as part of AOL than it was before.

Consolidation breeds mediocrity. What we need, then, are better ways to disseminate both information and opinion. The search engines can’t do it, or won’t. Google News won’t index this rag, for example, so what good is it? Is Google for searching or finding? More on that tomorrow.

There is so much to write about but I’ll begin with Microsoft buying Skype for $8.5 billion. The pundits are debating whether this move by Microsoft CEO Steve Ballmer makes good business sense, but that’s the wrong way to look at it. The better approach is to wonder what would have happened had Microsoft not bought Skype? Based on the high price alone I’m fairly confident that Ballmer felt he had no choice but to buy. In fact I’m fairly certain he felt that not buying could have doomed Microsoft.

Remember eBay bought Skype a few years ago for $2.6 billion, failed to make a go of it, then took a big write-off and sold much of the rest of the company to private equity firms. Skype was changing hands at a discount to the old eBay price only a year ago, so what had changed so remarkably to make Skype suddenly worth more than three times as much? Nothing had changed operationally. In terms of pure financial performance Skype isn’t worth anything like $8.5 billion. But the corporate chess board has changed quite a bit in the last couple years so it is possible to see where this acquisition might make strategic sense to Microsoft.

Ballmer and his company are at a tipping-point and he knows it. Microsoft is still big and powerful and rich, but no longer is it the biggest, most powerful, and richest. It is no coincidence that Department of Justice oversight of Microsoft’s anti-trust consent decree ended this week, because Redmond is nowhere near the threat to competitors that it used to be. The company can go from here either up or down and Ballmer’s fear is that the direction will be down, down, down. Microsoft will still make plenty of money but that might be from milking declining markets.

Ballmer needs a new market to milk.

Maybe that new market is telecom. Here is where I might write a paragraph about the Microsoft vision of unified communication where they’ll suck market share and market cap from the old telcos. That’s happening already and if someone is going to benefit, why not Microsoft? But I’m not writing that paragraph because I don’t think Ballmer or Microsoft are actually that smart. They have lost confidence. Microsoft no longer believes it controls or even can control the game. Worse still, they don’t have confidence that they even know the rules. So they’ve adopted a defensive posture and this Skype acquisition is more of a block than anything else.

Microsoft bought Skype to keep Google from buying Skype.

Notice I didn’t mention Apple. In terms of being the baddest MoFo in the market Apple has no peer, but Apple is following its own very different course. Apple isn’t the next Microsoft, you see. Apple is not the next anything because the role it aspires to transcends anything imaginable by Microsoft, ever. Google is the next Microsoft, so Google is seen by Ballmer as the immediate threat — the one he has a hope in hell of actually doing something about.

In the end Apple will probably beat both Google and Microsoft, but that’s not a story for today.

Were Google to buy Skype they’d convert those 663 million Skype subscriptions to Google Voice and Gmail and in a swoop make parts of Yahoo and MSN irrelevant. They’d build a brilliant Skype client right into the DNA of Android, draining telco revenue and maybe killing smaller players like Windows Phone. They’d cut deals with equipment makers like Cisco (Linksys) and NetGear and steal voice revenue from telcos and cable companies alike.  That’s all Redmondesque behavior and if anyone is going to be behaving that way, Ballmer feels, it had darned well better be Redmond.

If Microsoft is to continue to grow and have an existence post-PC it has to be first or second in the mobile market, Ballmer knows that. Buying Skype doesn’t guarantee Microsoft that success, but NOT buying Skype would have practically guaranteed Microsoft’s failure.

And the $8.5 billion price? That was effectively set by Google, not Microsoft. Ballmer would have paid anything for Skype. $8.5 billion is just the price at which Google feels it is better for them to build rather than buy.

So look for heavy activity in this space as Microsoft assimilates and Google constructs. More acquisitions will come for both companies along with any number of strategic realignments. But remember that neither is actually in control. The conclusion is not only far from certain, there’s still a chance that neither company will dominate.

This is not an end-game, not yet.

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Whether at the casino or the race track, the house always wins. That’s the way it has always been, too, with Internet advertising. Nearly all Internet ad dollars are spent in two ways: 1) buying ads from advertising networks whether that network is Google or Yahoo or even IDGTechNet, which sells space on this rag, or; 2) buying search terms — the right to have your ad shown every time someone searches on the word hermaphrodite, for example. Network profit in those transactions comes from arbitrage — buying low and selling high. But what if there was a more efficient way to buy and sell Internet ads? As of this morning it looks like there is a better way called Clickochet (for Click Richochet), the first ad trading network.

Clickochet is the baby of my old friend Paul Tyma and I have no financial or other interest in the product or the company. It’s just something cool to write about. I want you to know about it because it is different, probably a lot more efficient than competing solutions, and it might just change the world.

Paul is a great programmer who spent a number of years working as a senior developer at Google where his major achievement was a major rewrite of Gmail. He is also the author of Mailinator, one of the first and best anonymous e-mail services. But the idea for Clickochet sprang not from anything at Google, but from a Christmas gift Paul gave to his girlfriend Tanna, who runs a celebrity gossip blog called StarSnarks.com.

“She started it last fall and is pretty passionate about it,” Paul explained. “At some point she put up AdSense on the site and, no kidding, was making about five cents a day. She didn’t have a ton of traffic so it wasn’t terribly surprising. As a Christmas gift I bought her $100 worth of AdWords to help her get traffic. With no exaggeration this campaign lasted three days and yielded a total of 100 clicks. If you do the math, I successfully turned $100 into about 15 cents by converting to and from ad impressions.”

Ad networks work by selling ads, but if you close the loop between publishing and advertising there is an exchange rate between money and ad impressions. Existing ad networks create a market inefficiency in that exchange to make money. Using Tanna’s example, above, $100 bought $0.15 worth of ad impressions. That’s $99.85 in gross profit there, some of which goes to web sites participating in the program but most goes straight into the massive fuel tanks of Eric Schmidt’s G5 jet.

That is the way Google makes so much frigging money.

All web sites want traffic, yet I won’t buy ads for cringely.com. Why not? Because it is a non-economical transaction. The only revenue I get from this site is from ads, but as the example above shows it would be insane for me to buy ads to sell ads. That’s a perpetual motion machine and perpetual motion machines are always defeated by friction — in this case the friction of the ad network’s revenue cut. This is the market inefficiency that ad networks introduce. Ad networks provide value in other ways, but this closed-loop is not it.

It might make sense to buy ads for this site if I was offering more than just ideas. If I was selling diamonds or penis enlargement pills, okay, but buying ads just to sell ads is a fool’s game. As always, though, there are plenty of fools.

That’s when Paul came up with the idea of trading ad impressions. Tanna could show an ad for other small sites like hers and those other small sites could show her ad. It’s like a link exchange but way smarter because it isn’t just for Search Engine Optimization (SEO). It’s an ad trading network.

Clickochet is free, social, and tied to Facebook and Twitter. Clickochet is a social ad community for web site owners like me for whom buying ads doesn’t make economic sense.

“I realized right away that ad-for-ad didn’t exactly work,” Paul said. “First, when you show a normal text banner ad, you’re not just showing one ad — you are showing three. There are three text ads inside a 728×90 banner ad creative. I can pass that multiplier back to the Clickochet member. So to start, if Tanna shows 1000 banners in one day, I can show 3000 of her smaller ads across the network.”

Enter at this point the inevitable honking-big algorithm to make this all work, because there are many factors that come into play when doing transactions like this — factors like ad placement, ad quality, and even my reputation as a journalist — to determine the exchange rate for each ad. So instead of taking the traditional ad network route of converting clicks directly into dollars (CPM), Clickochet converts ad impressions into virtual currency.

Here’s where it gets very geeky and leaves traditional ad networks in the dust, because where a DoubleClick would take the money and run, Clickochet introduces a clever multiplicative effect.

On Tanna’s blog right now she’s showing a skyscraper containing five ad-equivalents. So showing one ad on Starsnarks could get up to five ads for her site showing on the network. She can get more out than she puts in.

There are 40 billion webpages in Google’s index, almost none of which make a profit by selling ads. Clickochet is, in some respects, an ad network for the long tail — the 39 billion web pages where participating in the present monetary ad system makes little sense. For those pages gaining traffic is important and forgoing nickel-a-day ad revenue is painless.

Clickochet removes the market inefficiency that ad networks create to make money. There are two facets to that inefficiency. One is money: the networks take their cut. But the other is time. If you took your AdSense money and paid into AdWords with it you’d be delayed 30 days because Google waits that long to pay and so do all the other networks. You finance Google. But Clickochet is an instant transaction. The moment you get an ad impression, you can configure the system to either bank the credits, or spend them immediately. Show an ad on your site, and 3 of your smaller ads show nearly instantly elsewhere on the network.

And unlike the $100 AdWords campaign Paul bought for Tanna, a Clickochet campaign runs indefinitely. You get out of the system only what you put in, but on a perpetual basis. If Tanna is only putting 1000 ad impressions a day into the system, she won’t get 1000 new users overnight, but will increase her traffic over time.

Because Clickochet converts ad impressions into virtual currency, you can save them instead of spending them right away. Say you are launching a new product or even a new company in six months. You can run ads on your knitting blog, bank the credits, then spend all your money in a big ad blast when the product or company is ready to go. Your friends and family investors can even pay you in ad impressions if they like.

Here’s another even more subtle effect. I have a link on this site for portraitquilts.com, which is run by my little sister. She wants the link mainly for Search Engine Optimization but doesn’t mind if you buy a quilt or a pillow with Grandma’s picture on it (or Elvis’s). I get a lot of traffic here, which is good for Sis to some extent, but my readership is also very stable. The same people keep coming back week after week after week. Eventually you’ll stop clicking on that quilt link and my good brother brownie points will cease to accumulate. The link will go stale as advertising, if it hasn’t already.

With Clickochet, however, I could distribute ads for my sister’s site elsewhere on the ad network — perhaps even on sites more relevant to photo quilts than this blog. I can directly convert my ad impressions into my sister’s. To be fair, Google would let me do this too — make money off cringely.com and buy ads for portraitquilts.com — but I’d never do that because it would be a losing proposition.

Clickochet is a great idea and since it is coming from a great developer I’m pretty sure it will work technically. But can Clickochet gain critical mass? That’s the problem faced by all new networks: they need lots of traffic to succeed but, absent some viral effect they don’t have any traffic to start. PayPal famously handled that simply by sending people money, but most networks can’t afford that gimmick so they die. What makes Clickochet any different?

The clever answer here is that Clickochet may well have all the mass it needs to start, courtesy of Paul’s other site — Mailinator.com.

“I’m doing a virtual economic stimulus,” Paul explained “I’m injecting Mailinator’s several hundred thousand ad impressions into the system every day, without taking any out. Active users could get a lot of free ad impressions.”

Mailinator’s ad inventory allows Clickochet on its first day (today) to start where it might otherwise be a week or a month into viral growth. Paul hopes that’s past the most likely failure point.

Yeah, but how does Clickochet expect to make money?

Initially it will be as a cheaper competitor to AdWords. Many sites will find this to be a new (and cheap) venue for advertising. They will simply buy ads on the network just as they would through Google. But where the term “mesothelioma” costs about $50 on AdWords, it could be much cheaper on Clickochet.

“We’ll level the cost of ads, ” says Paul. “This won’t help with cheap search terms but creates a new outlet for currently expensive ones. With the right ad sales team in place what percent of that market could we capture?”

We should all want Clickochet to succeed just the same way we want Southwest Airlines to start serving our local airport — because it will drive down the profit margins for all ad networks, increasing transparency and efficiency and saving money for us all.

The house will still win, but their profits won’t be so obscene at our expense.