Innovation and hacking regulation

Network effects

The scrappy technology startup faced an existential threat. The company was down to its final arguments in the United States Supreme Court, where the ruling would determine its fate and if millions of invested dollars would be lost. The fact that Aereo existed at all was a byproduct of arcane telecommunications regulations, which had evolved over the decades along with the medium of broadcast television, which it intended to disrupt.

The American government mandated that over-the-air channels using the public airwaves be distributed for free.1 Their shows could be viewed by anyone with a basic antenna.2 This could be a clunky means of accessing television, as broadcasting is subject to the vagaries of weather and topography that interfere with the signal.

Cable and satellite providers stepped into the gap, becoming the preferred entertainment sources for many households. In addition to numerous specialty channels they always included the primary broadcast networks viewers demanded. The wrinkle in this arrangement arose from the fact that television providers had to pay over-the-air networks for the rights to carry their programming, even though a home viewer could presumably access the same content for free.

For Aereo, paying these fees would have dealt a fatal blow to their business model of inexpensive monthly subscriptions. Management believed it had found a viable workaround. Courts had long recognized that recording broadcasts for personal use was permissible, as was storing them digitally for later watching. Aereo decided to commercialize the provision of this specific service. However, it couldn’t just capture signals from the airwaves and then sell access to this content library, which would be unambiguous copyright infringement of the sort that makes legal departments nervous.

The company hit on a novel solution to this problem, designing and setting up a dense grid of tiny, individually assigned antennas. These were placed within range of broadcasting towers in targeted metropolitan markets. Subscribers could then access or record any programs they wished from their personal receiver, just as if they had fixed an antenna to their own roof. The hope was that by charging subscribers for this service while not paying for the actual content Aereo would have a significant advantage over alternatives.

Broadcast networks were understandably incensed by the practice of their shows being sold with no compensation in return. Content providers like sports leagues were similarly aggrieved by the prospect of a service that gave cord-cutters yet another reason to drop pricy monthly subscriptions, which indirectly paid their giant rights fees.3 They came together to sue Aereo into oblivion, and eventually the litigation made its way to the highest court in the country. The U.S. Supreme Court had ruled favorably on consumer technology before, including a pivotal ruling that allowed for the commercialization of the home video cassette recorder.4

It was obvious with Aereo that nothing of groundbreaking technological or social value was being created. The main innovation was principally a regulatory workaround—creating thousands of tiny coin-sized antennas in a carefully situated array was obviously less efficient than having a single large antenna, or just hooking into the source feed directly. Creating individual file storage and duplicating the same programs thousands of times was likewise inferior to storing and serving up a single copy of a desired program to everyone.

Above the law

In the highest sense, value comes from creating something new, finding efficiencies, combining offerings in a novel way—ultimately meeting consumer needs in ways that previous solutions could not. Modern capitalism is often characterized by a different form of corporate value creation. This kind operates by maneuvering within areas of poor or outdated regulation, places where the law has yet to catch up, or where insider information is privileged at the expense of society overall. If governments don’t act in timely or effective ways, the lure of potential profits can build to the point that entrepreneurs finally force their hand.

In recent history, Uber is probably the uber-example of such regulatory hackery. Its use of the smartphone to link passengers and riders was groundbreaking, but equally crucial to its success was how it bypassed sclerotic taxi licensing schemes to provide a valued service without the cost and unpleasantness of traditional cabs. Pricing was very appealing as well, partly due to a classification scheme that avoids many of the expenses associated with full-time employees. In cities like New York the values of medallions required for operating a taxi have plummeted, while the number of circulating vehicles for hire has boomed.

Such behavior marks companies across all kinds of industries.

Tax software providers, despite their marketing image of making tax filing simpler, have every incentive to keep the overall system as inscrutable and frustrating as possible, which makes their role even more necessary. Get customers to subscribe to your online service, or your gym, or monthly delivery service, and then bury the cancellation process in a few layers of hassle and hope that your customers didn’t pay too close attention to the fine print.

If you’re a pharmaceutical manufacturer whose research pipeline is failing to yield promising new molecules to replace the ones about to lose patent protection, you can instead tweak an existing product, ram it through the patent system, and milk a few billion more in profits from a clinically indistinguishable rebranded drug, unfortunately at the expense of a healthcare system already creaking under financial strain.

If the policy environment leads to high drug prices in America, politicians call for reimportation from lower-cost countries like Canada, eliding the fact that neither the companies that own the patents nor the factories producing the medications are located in these places—price differences are due to regulation. Instead of adding yet another unnecessary touchpoint to a roundabout supply chain, the real unmet need was to fix the structural causes leading to the issue.5

As for Aereo, the Supreme Court viewed their technological hacks as a transparent attempt to avoid required license fees. By a vote of 6 to 3 their business was deemed illegal, a ruling which instantly sunk the company. Aereo disappeared quickly and its assets were sold off for a pittance. The billionaire media investor who was the primary investor in its longshot business model understood when he was beaten and quickly moved on.

If something is truly broken or inefficient, fix it as close to the source as possible. Much energy is expended in finding loopholes and wedging an organization into them, when it could be put to greater societal benefit by attacking the structural issue. Plenty of activities makes no sense on the merits but are still profitable or viable. The easier path is to exploit the weakness. The better way is to try to fix the underlying problem.

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References

The U.S. Supreme Court’s ruling in the Aereo case is available on its website, for anyone who wants to delve into the legal arcana of the decision.

Vox has a detailed narrative of Aereo’s rise and fall.