Entrepreneurs tend to focus on opportunity rather than risk, and rightly so. As Steve Blank has written, at its core, a startup is an organization formed to search for a repeatable and scalable business model. In the lexicon of the lean startup movement, once “product-market fit” has been achieved, the focus shifts to scale and execution as the startup matures into a growth company.
In a sense, risk and opportunity are two sides of the same coin to early stage startups. The huge risk that eclipses all others is that the product or service being offered simply won’t succeed — there is no product-market fit, at least at numbers that would make for a financially viable business — in which case (assuming competent execution) the perceived opportunity, viewed broadly, wasn’t really there to begin with.Perhaps it shouldn’t be surprising that risk items on which legal and financial experts focus seem like afterthoughts to many startups. After all, if value isn’t created in the first place, isn’t it premature to worry about its impairment? Even at large corporations, legal departments are jokingly dubbed the “Department of Sales Prevention” because of their tendency to insist on the elimination of all risk from deals.
Relatively speaking, many claims such as consumer class action litigation or patent troll suits fall into the “good problem to have” category: If a company has grown large enough that it’s perceived as having “deep pockets,” or others feel threatened and are willing to invest resources in fighting some of these battles, that makes it successful by definition. Yet there are also existential legal risks that make some business models unworkable from inception, as entrepreneurs have found out the hard way.
A word about the title of this post: I’m not using “wrong” in any moral sense, but rather to refer to running afoul of the law in a way that makes for bad business. The very notion of intellectual property is a construct of legislation and court decisions made by fallible humans, riddled with exceptions, inconsistencies and ambiguities. We do the best we can under the circumstances, but in the age of social media, taking an expansive view, virtually every person who has touched a computer has infringed copyright at some point, probably hundreds or thousands of times. The law simply hasn’t kept pace with the largest upheaval in the distribution and consumption of content in human history, which has taken place in less than two decades since the consumer Internet was born in 1994. To a large extent, members of the general public have little idea what copyright is, how it works, or how it applies online, if at all. By contrast, how many items of merchandise have you shoplifted or cars have you stolen unintentionally? To equate infringement with theft, as industry propagandists do, is to insult our collective intelligence. But I digress.
In recent years, many of the most creative and disruptive startup businesses have involved the use of intellectual property in innovative, non-traditional ways that defy easy categorization and stretch the boundaries of concepts such as the fair use doctrine in copyright. When presented with a product or service in development, we often have to admit that there is no clear precedent and look for the best analogous situation to assess legal risk. Is Instapaper like collecting press clippings? (If so, do you have to buy a copy of each paper first?) Is pinning a photo or article on Pinterest more akin to showing someone an article in a magazine you’ve bought or actually making and handing them a copy? Does using a friend’s photo in a Facebook ad more closely resemble a personal recommendation by that friend to buy the product or plastering the friend’s photo on the product packaging in stores?
At the height of the “cyberspace exceptionalism” era in the mid-1990s, the giants of the Internet industry were so worried about these risks that they invested heavily in lobbying Congress and helped shape the legal landscape of the social Internet. Unlike startups, companies like AOL, AT&T, etc. had the clout to take on the content industry and strike a balance in copyright law that ensured their survival. As I’ve written before here at Gust, the social media explosion of the 2000s owes its very existence to their efforts. Nevertheless, the DMCA is showing its age with the advent of new communication tools (Twitter), content rendering platforms (Flipboard), curation formats (Pinterest) and even media consumption devices (iPad). What strikes the engineer or entrepreneur as brilliant and disruptive may come across to threatened incumbents as dangerous and illegal.
One poster child for this type of innovation is the original MP3.com’s introduction of a service called “My.MP3.com” way back in 2000. Its “Beam-It” tool enabled users to take music CDs they had already bought and upload them to an online “storage locker” of sorts (what we would now call “cloud storage“) from which they could then access the music anywhere on any compatible device. To implement the service, MP3.com bought a huge number of CDs — virtually every music CD available at the time — and made digital copies on its servers. A user could authenticate his or her physical CD and get access to the same tracks on the system without having to upload the actual song files. The benefits of this kind of system are clear: In the pre-iPod era, making one’s entire CD collection available anytime, anywhere was a vast improvement over carrying CD caddies around with scores of discs. (Remember them?) In the digital domain, the system also eliminated the tremendous redundancy involved if hundreds of thousands of music fans were to independently upload identical digital copies of the same tracks from the same albums to their personal “digital lockers,” with corresponding savings in bandwidth, storage, and time (“data deduplication”).
My.MP3.com was a bold, innovative cloud music service a decade before cloud storage became commonplace. As they say, no good deed goes unpunished, so it was essentially sued out of existence by the recording industry. Without getting bogged down in details, a service catering to consumers who owned legally purchased CDs furnished by a company that had also bought legal copies of the same CDs, making users’ music consumption more convenient and enjoyable while minimizing the burden placed on the related digital infrastructure, was crushed under the weight of century-old copyright law in the form of a $53 million settlement with one record label alone, plus many others.
If this product sounds vaguely familiar, it’s because Apple introduced virtually the same music service, branded iTunes Match, in November 2011 (count ‘em, eleven years later) as part of its iCloud suite of cloud storage and computing services. Presumably it helps to be one of the world’s most valuable companies controlling the most valuable music distribution platform on the planet when negotiating deals with labels and publishers. In any event, the lesson for new startups is to look both ways before crossing the busy IP highway. Next week I’ll get into a more contemporary copyright controversy involving one of the most popular social media sites, Pinterest, and lessons learned for new startups and their investors.