• Deflation's Risks to the Broadband Video Ecosystem

    Yesterday was one of those days that made my head hurt. I suspect you've all had days like this as well, as the economic crisis unfolds. One moment there's news that temporarily makes you feel better, the next moment, news that makes you feel worse than ever.

    For example, yesterday morning I appeared on a panel with four market researchers at a conference focused on New England startups and technology. As I listened to the others talk glumly about the fundamentals of the sectors they cover, I was feeling a little more optimistic. As I explained when it was my turn to speak, "the fundamentals of the broadband video economy are relatively strong" (note: I always feel queasily like John McCain when I say that) and there's much reason to be optimistic going into '09.

    It's true. Broadband video usage is growing each month. There's a vibrant ecosystem of early stage technology companies that continue to attract new investments. Many of these companies are hiring. The overall user experience is getting stronger and stronger, making the broadband medium a more appealing environment for consumers, advertisers and content providers. And importantly, there are large pots of existing spending that broadband can share-shift.

    Add it all up and compare broadband to say auto manufacturing, retailing, financial services, home building and other industries that have been decimated by the economic slowdown and things look pretty decent.

    That feeling of tempered optimism dissipated last night though, not just because the market dropped 400+ points yesterday to a level not seen since 2003, but because of an article I read on NYTimes.com ("Stocks Are Hurt by Latest Fear: Declining Prices") about an insidious new consequence of the meltdown called "deflation," which has economists deeply worried about what still lies ahead for the global economy.

    Most of us have never experienced deflation, which is defined as a "general decline in prices." As one measure, the Consumer Price Index, which tracks how much we pay for groceries, entertainment, and other goods and services, dropped by 1% in October, the largest decline in the 61 years the index has been calculated.

    Deflation is so scary because it basically forces all businesses to cut costs to meet the realities of lower prices. The contraction process feeds on itself, causing a downward spiral of economic activity and paralysis. This is bad enough even in established sectors, where inelasticity helps to buffer deflation's effects. My concern is that in a nascent ecosystem like broadband video, deflation's impact could be far worse.

    Here's what I mean: say you're an early stage broadband technology provider selling to media companies. Your product meshes with the customer's own roadmap and has clear advantages. You've priced it in a way to be sensitive to market competitiveness and also internal profitability goals. You may have also developed business cases showing the customer benefits.

    But now the media company says that its ad spending has slowed (itself driven by reduced consumer spending), in turn cutting its willingness to pay (the forces of deflation at work). So if you want the deal, you have to accept it at a lower-than-expected price. If too many of those situations arise, your business model gets blown. When too many business models get blown early stage investors say "freeze" and decide to hold off investing until the climate warms up again. When that happens, the cycle of innovation locks up.

    Anyway, you get the picture of how the dominos can fall. Since the broadband ecosystem is still quite fragile, with value propositions often still works in progress, the specter of deflation is quite nerve-racking. Let's hope its full brunt isn't realized.

    What do you think? Post a comment now.