Peer to Peer goes nuclear. Now using UDP instead of TCP to handle transfers. The supporters of Net Neutrality continue to ignore the lesson of the tragedy of commons.

Excellent essay by the master contrarian.

On the real issue: "Communications service providers do have a problem. But it is not that of a flood of video. Instead, it is … the erosion of their main revenue and profit source … voice."

"AT&T says consumer broadband traffic on its network has doubled in the last two years alone. Broadband customers are using 40% more bandwidth each year. Time Warner estimates that 5% of its users account for 50% of the bandwidth usage"

• Web 2.0 as an investment theme peaks. We were right on Akamai but wrong on Google. Cisco jumped on the Web 2.0 bandwagon in 2007, with John Chambers freely using the phrase. We feel this is a contrarian indicator. As 2008 unfolds we’ll see if 2007 was the peak.
• Google makes a really big move into hardware. Android, Google’s effort to develop a mobile OS, is this effort. Google chose to partner with many hardware folks – HTC being a notable one we should have seen.
• Sales of gaming platforms explode. The Wii was a hit and the PS3 started selling with the proper price cuts. While explode wasn’t the right word there is plenty of momentum to complete the trend in 2008 of the gaming machine emerging as one variation of the Third PC.
• AMD successfully integrates ATI. Whoops. AMD has done nothing to capitalize on this horizontal integration. ATI has been decimated in it’s technical competition with NVidia.
• High Def explodes. It is hard to find a non-HDTV in stores anymore. Comcast, Verizon and the satellite providers are all trying to one-up each other with more HD content. The high-def DVD wars wage on though the cost of players dropped more than 50% in 2007, and for $200 each consumers are starting to take sides. 
• Muni-Fi loses it’s luster. Nailed this one. Earthlink, poster child of Muni-FI, exited the business. Favorite quote from Anthony Townsend: “Muni-Fi is the Monorail for the decade“.
• Cisco attracts negative publicity. Not there yet, though one has to wonder with all of the sound and light emerging from the Cisco Marketing Investor Relations machine why the stock ended the year flat. 
• The luster comes off US Cable and Telecom stocks. Home run here on the Cable sector- they entered 2007 as the favorite sons and exited at 5-year lows. The only exceptions were AT&T and Verizon, which found strength from the only consumer Telco business that matters anymore – Wireless. Embarq and Qwest both suffered.
• Net Neutrality debates move to the wireless domain. Didn’t really happen, may not happen now that carriers see the additional revenue from data growth. The iPhone is having a profound impact on consumer perceptions of unlocked phones.
• Tivo becomes increasingly irrelevant. Easy one, but still right.
• China becomes the next investment meme. Jackpot. If the wheels come off, it won’t be ’till after the Olympics.
• Medical Tech and Silicon Valley increasingly team up. This is happening with medical startups proliferating in the Valley, particularly around Genomes. Check out 23andMe. This trend builds in 2008.
• Lots of M&A in the Networking Component and Equipment business. Hard to measure ‘Lots’ but it didn’t feel like there was ‘Lots’ – particularly after the big events of 2006; Alcatel/Lucent, Nokia/Siemens, Ericsson/Redback/Marconi. Meaningful M&A in the Component sector was absent. This prediction appears again for 2008, albeit revised.

It was terrible year for the small/mid-cap Networking sector, one in which the best decisions we made were the disasters averted for clients – MRV, Opnext, Level3, Mindspeed, Conexant – the list goes on.

Short positions in the Cable group worked and a massive short position in Nu Horizons worked. Our long position in Abovenet worked well in a market where it’s peers (LVLT, XOHO) were decimated. We successfully traded and timed Vitesse Semiconductor.

Outside of this, positions in just about any company in the sector were decimated. Close to home were Finisar (down 55%) and Adtran (even for year, but down 30% from 2007 peak) and Adva (down 60%).

One market prediction we got right was more volatility. It should be noted that as rough as the year seemed, volatility was in line with historical averages. (see here).

More on what is coming in 2008 over the next few days.

Everyone talks about the explosion in Video traffic. Everyone talks about the explosion in the bandwidth required to carry it. No one talks about who is going to pay for it. There is one likely source: transit bandwidth inflation.

Robert X. Cringely is hit or miss as far as I’m concerned. He’s on a rant lately about how Google (GOOG) is secretly planning to control the universe by purchasing dark fiber. I don’t buy it. However, the benefit of his frequent delusions are the interesting sources he uses to make his arguments. His most recent post cites a paper that investigates the costs of video distribution on the Internet.

Lazy Blog Reader Summary of Paper: P2P distribution of media is radically cheaper than distributing it yourself using your own datacenter or outsourcing it to a CDN like Akamai (AKAM). By a factor of 1000.

Not a huge surprise to folks who understand how the Internet works. Everyone from the datacenter that hosts this blog to Akamai to your ISP pay for the right to transmit and receive bits on the Internet. The big cost contributor to the non-P2P applications, and what makes them more expensive, is transit bandwidth - the cost of transporting bits from the NBC or CBS datacenter to the eyeballs in the household.

This blog sits on a shared server at Mediatemple. Mediatemple pays for connectivity to the Internet cloud that allows these bits to reach your screen, typically a fixed price per Mb/s. The rate companies like Mediatemple pay for transit is highly elastic- the more they buy the better rate they get.

Akamai’s business is technically complex, but fundamentally it is about buying transit bandwidth low and selling high. Big bandwidth users like Akamai pay the least for transit so there is an economy of scale in their business. They couple this with a distributed computing infrastructure that allows content owners to stay out of the datacenter business. But a big source of their advantage in the marketplace is the arbitrage gains of reselling transit bandwidth.

If this is a source of competitive advantage then this is the critical question - who has the lowest transit bandwidth costs?

It’s the Telcos and Cablecos themselves. If Verizon wants to distribute content to subscribers their transit costs are zero. They don’t need to peer with anyone, in fact the Akamai’s of the world pay to send data into Verizon’s network.

Theoretically, this means that the Telcos and Cablecos could all enter the CDN business with a structural cost advantage. I have little faith in the creative business strategy of these companies but I have full faith in their ability to extract a pound of flesh from others. And I think this day is coming.

Therefore it would seem that folks like Verizon (VZ), AT&T (T ), Comcast (CMCSA), Time Warner Cable (TWC), Cablevision (CVC), etc are in a very good position to charge higher transit costs into their network, as the majority of traffic growth (Video) is going into their network.

The amount of bandwidth going into Verizon’s network destined for FiOS customers watching YouTube may explode, but the costs of carrying it will explode too. Verizon has a monopoly on the connectivity to these eyeballs. Theoretically, they could charge whatever they want for transit into their network.

Akamai and others will grimace at this bill but can effectively pass this cost on to their customers. It’s the content providers that will ultimately absorb the increase.

As a result, Network neutrality will never need to happen. Carriers will simply charge more for everything. Cablecos and Telcos can simply keep their transit rates flat while the amount of bandwidth explodes. Since they own all the end customers, maybe they even jack up rates. And surprise surprise, the cost of transit bandwidth no longer is headed to the floor (note log y-axis).

Carrier transit bandwidth cost inflation will pay for the video bandwidth explosion. Prediction: Total fees paid for transit into Cableco and Telco networks are going way, way up. Couple this with the possibility of the Mb/s transit bandwidth rates increasing and you can see the carriers are sitting on a very attractive source of cash flow. This cash will finance whatever new infrastructure they care to purchase, and maybe a little (or a lot) left over to pay shareholders.

That is, of course, if they can keep legitimate content providers from using P2P to eliminate the need to pay transit altogether. That scenario completely destroys the above assumption. I’ve said before P2P isn’t a business, it’s a catalyst to force media companies to distribute digital content. It’s clear to me it’s also the only weapon they have to avoid transit bandwidth inflation.

Full Disclosure: Author is long AT&T and Verizon

• Web 2.0 as an investment theme peaks. Equities like Akamai (AKAM), Google (GOOG), suffer though their businesses continue to do well.
• Google (GOOG) makes a really big move into hardware. This is accomplished by close partnership with Samsung or Sony (SNE) who finally realizes it needs a software partner to sell hardware.
• The Third PC emerges, after the desktop and laptop in many homes, and its in the living room. This drives all sorts of new trends, from a focus on highly integrated chipsets to low power to new software companies.
• Sales of gaming platforms explode though most aren’t used for gaming as the general public recognizes that game machines serve additional purposes, particularly as a Third PC. They become the must-have high def accessory. The major players at the end of 2007 are Microsoft, Sony, Nintendo, and Apple (AAPL).
• AMD (AMD) successfully integrates ATI and positions itself as the leading provider of silicon for The Third PC, using the Nintendo Wii as the flag bearer. Markets agree.
• High Def explodes. A perfect storm of cheap DVD hardware, content, and carriers finally make it accessible to mainstream consumers.  Service providers Verizon (VZ), Comcast (CMCSA), Cablevision (CVC), etc. figure out that High Def subscribers are profit centers and catalyze adoption.
• Muni-Fi loses it’s luster. After a year of really good publicity and some isolated deployments the public forgets about Muni-Fi and it enters the “Trough of Disillusionment“. (Graphic Here)
• Cisco (CSCO) attracts negative publicity. People realize it’s lack of innovation and monopolistic behavior makes it the Microsoft of the communication hardware business. Market share peaks as customers purposely enable competition, and Chinese suppliers like Huawei and 3Com (COMS) benefit.
• The luster comes off US Cable and Telecom stocks as investors realize they have only begun to beat the living shit out of each other. Cable fares worse. Net Neutrality debates in the fall of 2006 turn into infrastructure subsidy debates by spring of 2008.
• Net Neutrality debates move to the wireless domain, which is where they should have started in the first place. Anti-trust rumblings are heard about Verizon and AT&T/Cingular (T ) locking hardware and complicating the use of unlocked phones. One of the Four cellcos offers an ‘almost unlimited’ data plan for $9.99.
• Tivo (TIVO) becomes increasingly irrelevant.
• China becomes the next investment meme as retail investors pour money into the country. Every company rushes to present their China strategy. Any investment with China attached to it get a premium. The 2008 Beijing Olympics become the must-have ticket for the glitterati.
• Medical Tech and Silicon Valley increasingly team up. Silicon medicine is the new buzzword.
• Lots of M&A in the Networking Component and Equipment business (Full disclosure: Key Nyquist investment theme)

And finally, the most useless prediction of all – the markets. I’m going to waffle here and say what they won’t do – The S&P500 and Nasdaq will close +/- 5% from where they are today. Key word- VOLATILITY.

If I missed a particular theme, let me know and I might take a shot at it.

The Wall St. Journal editorial yesterday captures the true issue at hand, and why the FCC is now deadlocked on approving the merger.

Meanwhile, Congressmen Ed Markey and John Dingell deserve their place in this story, having bared their teeth at Mr. McDowell in a threatening letter last week that questioned Mr. McDowell’s suitability to vet the merger. Their true interest was in strengthening the hand of Democratic Commissioners Copps and Adelstein, who seem bent on using this merger review to advance “Net neutrality” mandates that neither Congress nor the FCC have seen fit to impose through normal channels.

We’d like to see these two Congressmen demonstrate the same concern for public integrity by calling on the Commission to quickly approve a merger that everyone from shareholders to the relevant unions supports. But that probably makes us “uncurable optimists” too. The duo are eager to do favors for the campaign check-writers at Google and MoveOn.org, which want Net neutrality rules so AT&T and other telecom companies can’t charge market prices for use of their broadband pipes.

Check out the latest video from the “Save the Internet” coalition.

The only thing worse than having Washington involved in free markets is when they are trying to solve a problem that DOES NOT EXIST. My extended opinions can be found here.

Source: Cachelogic

Peer to Peer (P2P) traffic is the stowaway traffic of the net. It is latency and QoS insensitive and happy to fill broadband unused capacity. The big growth rate on the above chart gives P2P the illusion of being important- The reality is it is just being efficient.

P2P is using the existing resources of the net more efficiently and unless it can be monetized will never drive the deployment of more FTTH, more transport bandwidth, and more switching hardware.

I’m convinced that the inflection point for FTTH deployment will come when a killer application arrives that requires large upstream bandwidth. On the surface, P2P fits this bill, as it is the only widely deployed consumer application that stresses upstream bandwidth. The problem is P2P is a lunatic fringe application built on illegal activity. The nature of P2P’s popularity makes it impossible to monetize.

The frustrating reality for carriers is that as broadband connection speeds increase, the amount of peer to peer traffic grows disproportionately, an effect I wrote about while discussing network neutrality. (see Net Neutrality – Tragedy of the Commons).

In short, when someone gets a faster connection, they are more likely to either start using P2P, or use a lot more than they did before. Traffic increases geometrically with bandwidth, driving up the costs of backhaul connectivity and reducing carriers ability to do statistical multiplexing.

However, P2P is currently playing a vital role by forcing the media companies to evolve. They must adjust their business models to sell content electronically or die. Without Napster for music or BitTorrent for movies, there would not have been a catalyst for these companies to start selling media electronically.

Media distribution will evolve, and then P2P will fade into the background as an inexpensive best-effort way to deliver content, and a domain for those who still refuse to pay.

Conclusion: P2P isn’t a business. It’s a catalyst. Keep that in mind.

Footnote – Mary Meeker, ex-Queen of the Net, is back in the swing of things at Morgan Stanley. She recently gave a presentation on “The State of the ‘Net” that is filled with good data, including the above chart.

The big deal isn’t the iPhone itself, which is what the mainstream investment, gadget and tech media is focusing on. It’s the way that it will fundamentally challenge how carriers have coupled services with connectivity with a hardware distribution monopoly.

There never has been ‘net neutrality’ when it comes to mobile phone hardware. The Apple iPhone would be the first big test.

The new (rumored) iPhone will be sold (rumored) directly from Apple and (rumored) require the user to pull the GSM SIM card from their device (only T-Mobile or Cingular use GSM domestically) and insert it into the iPhone. No hardware manufacturer has ever tried this, instead they bend to the wishes and requests of the carriers in order to gain acceptance and distribution of their hardware by the carrier.

Apple’s decision comes as no surprise (see iPod Competition – a Fighting Retreat). Jobs himself was quoted in May of 2005 referring to the four largest wireless carriers as the ‘four orifices’, a graphic reference to how they control the distribution and use of mobile hardware on their networks. Walt Mossberg summarizes the effect well:

Cellphone carriers say one reason they keep tight control over what phones run on their networks is to protect the networks from harm and assure service quality for their subscribers.

But we’ve heard that before, and it wasn’t true then. Until the 1970s, when the government forced open the market, the old AT&T phone monopoly refused to let consumers buy phones and plug them into their home phone lines. You could only rent phones, and they had to be models made by an AT&T subsidiary. AT&T said the restriction protected the quality of the wired phone network. But, lo and behold, when the ban was lifted the phone network was just fine, even though consumers were plugging in millions of less expensive, more innovative phones.

Much effort has been expended by carriers to enter the content space by selling ringtones, games, music, useless wallpaper rubbish, etc. They control the user experience and subsequently control the revenue generating services.

If Apple does indeed attempt to distribute around the carriers, and is successful, they will usurp this capability and turn the wireless carriers into ‘dumb pipe providers’. This is the carriers worst nightmare, and I would expect them to push the limits of anti-competitive behavior to stop Apple.

It will be very interesting to see how the carriers respond.

For decades, the experts have been telling us that content is king. Whoever controls content, they say, will profit the most from network services. And video-on-demand will be the ultimate Internet moneymaker.

But history disagrees. Interactive communication has always made more money than content distribution. In the nineteenth century, before telephones and email, newspapers accounted for 95% of U.S. postal traffic by weight, while ordinary letters generated 85% of postal revenues. Alexander Graham Bell thought that people would use his telephones to listen to distant concerts. That didn’t happen. Napster, while a huge overnight success in terms of users, never made any money. Today, data consumes half or more of public network bandwidth, but ordinary telephone calls generate over 80% of total earnings (Figure 1). In fact, the telephone industry earns as much in two weeks as the movie industry makes in a year. And while informational Web sites like Britannica.com struggle to survive, email remains the Internet’s killer app, with instant messaging close behind.

One thing I disagree with, though I am not certain this was the authors intent, is that content OWNERSHIP is not king. Owners and efficient/effective generators of quality content have never in history had such wide and efficient distribution. The marginal cost of an additional media customer is approaching zero. Imagine how excited Shakespeare would have been to transition from a Globe Theatre audience of 3000 to a fully distributed IPTV broadcasting system reaching billions.

I think the point is content DISTRIBUTION is not king, and that history shows facilitating interactive communication generates the most value.

By this analogy, Akamai is just in the mail delivery business. Perhaps this time is different, and since the cost of communication now approaches zero this is no longer true. I don’t have an opinion yet since predicting the future on a large scale is a risky business.

Regardless, I thought the passage was worth sharing, particularly since the reference to how Internet Video will simultaneously save chip companies, equipment companies, and Telcos/Cablecos seems increasingly absurd to me.

I’m still wading through the implications of Session Border Controllers and trying to form an opinion on what role they play in the future. If SBC technology is inexpensive enough, does the QoS it brings to media sessions drive the concept of remote caching (typically in high cost urban datacenters) to extinction, at least for all but the most popular media content? Instead of caching 10000 songs, Apple can cache their top 250 songs with Akamai but rely on SIP and (Net Neutrality supporters can leave the room now) guaranteed transit services from carriers using SBC technology.

Which approach is cheaper? Today, clearly it’s the Akamai solution. If core bandwidth gets cheap and SBC’s get cheaper, that may not always be the case. It would be very interesting to hear Akamai’s position on this, as well as those of my readers.

Full Disclosure: I am long Acme Packet, and hold both long and short positions in Akamai.