Kindergartens and Walled Gardens – A Way to Grow Up

+ This article is a monthly column written for the Chinese business magazine Asian Business Leaders and TMT news service Interfax in December 2008 +

For various projects, we regularly organize user panels. We ask them what they do with their phone, what they use on the Internet and about their media consumption. We generally spend a couple of hours with them. We learn a lot.

From those panels, one element that might be surprising is how little “average” users know about the variety of services out there. Their usage is limited to a few major ones. On the mobile side, it looks like they never learn much new usages from mobile operators; they figure it out from their friends. It might sound like the perfect word-of-mouth mechanism but it’s not: it takes literally years for services to spread, and this is a major loss in potential revenues. I have been working with numerous telecom clients and frankly, if the engineering skills are generally great, user education is what they are the poorest at. Why is Internet usage evolving so much faster than mobile usage? I think I found an answer.

The problem with marketing

The issue spurs from a marketing problem: telecom operators are competing via mass media. Mass media is expensive and not suitable for conveying 10 messages simultaneously. In short, you can promote only one or two things at any given time, otherwise you end up confusing customers (“What is it exactly you’re selling?”). Your message must be a one-liner, a sharp arrow. While this is fine when selling kitchen knives, it is not when you sell what has become a “personal gateway” with so many functions and possibilities. You are going to leave most users on the sidewalk.

So which message would they select? Typically the most striking. However, this often happens to be neither the most useful nor the one with the best revenue potential. They promote videophone services and mobile TV, but not simple and useful things that the majority could use (what we call “dogs and demons“). Why? Because simple and useful things do not get talked about much as they are not remarkable. The consequence of this is that mobile operators sell great devices and people have no idea how to use them.

Walled gardens grow trees

There is strong controversy around so-called “walled gardens“, as opposed to the “open Internet”. But is the obsession with freedom and openness really the best path? Note that first, it is very difficult to stand against it: by the way this conversation is framed, to do so would make you mercantile, oppressive and closed.

The walled garden concept in telecom is in no way new. The French had the Minitel system back in 1982 offering pre-Internet services. It was used by close to half the population (25 million users) and still generated over $1.1 billion in revenue in 1998, over half of which were channeled to content providers. Closer to us, let’s think about kindergartens. These are surely walled gardens, confined spaces with limited exposure to the outside world. Their purpose is to protect and educate.

Now back to the telecom world, it is interesting to see that the most successful and talked about ecosystems are Apple’s iPhone and NTT DoCoMo’s iMode. Despite the “free and open” mantra, the general public in each market seems to celebrate them. They are both walled gardens.

Both of them control the hardware specifications, the content format, the business model, the payment system and guarantee the quality of services. The revenue model for content is similar: a cut on content fees (10 percent for NTT DoCoMo, 30 percent for Apple) and data revenues (100 percent for NTT DoCoMo, an undisclosed number for Apple – likely in the 10 percent to 30 percent range).

As written about a year ago by Thomas Hazlett in The Financial Times, walled gardens, surprisingly, promote innovation. I would add that they promote education. Why is that so?

There are a number of dynamics at work:

• Rules are clear so content providers know what to expect for some time – a striking contrast that with ever-changing regulations in China. In a way and to keep going with gardening images, it is a form of weather control.
• The user experience is consistent. Users know what to expect and the quality is guaranteed by the “gardener”.
• Each product competes to be the best.
• When other gardens appear, gardens also compete as a whole.
• The last and most important aspect is actually the following: Apple and NTT DoCoMo promote the ecosystem, but each application and service promotes itself. Instead of one marketing team trying to advertise, there are thousands of dedicated companies promoting themselves, making the combined marketing power incomparable.

More importantly, the walled garden is not the end. This might have been the mistake made by AOL in the United States, which tried to retain control at all costs. What happens when a kid grows older and is ready to move out of kindergarten? You take him out to the next school. When a tree is strong enough to be put in the forest, it is time to transplant. When iMode usage became large enough, some content providers started to experiment with new business models, outside the walled garden, relying at first on advertising, then on direct sales. In 2007, according to Japan’s Mobile Content Forum, the mobile content market in Japan was JPY 423.3 billion ($4.57 billion). The mobile commerce market was 723.1 billion JPY ($7.81 billion).

In its recently published annual report, Apple shows over 11 million iPhones sold and yearly revenue of $844 million from iTunes. According to an ad in the New York Times, over 300 million iPhone applications have been downloaded. This likely represents already around $150 million in sales. If iMode is any indicator, the potential is very large.

Walled gardens produce more fruits

Now that some social networking services are opening up their platforms to third-party developers (Facebook, MySpace, Xionei, 51.com, even Mixi joined the dance recently), will that provide them with enough innovative power to compete with closed systems? In the wake of the convergence of online games and social networking services towards social gaming, this might provide interesting challenges for dominant players such as Tencent and World of Warcraft (operated in China by The9). How about the telecom world? Unfortunately, it seems that in China, the policy of baby-feeding basic services in a closed system is going to continue, while content providers are treated as VC-backed free R & D. Sadly, in such a growing market, who would account for the lost growth opportunities?