A couple of days ago, I reread Ray Ozzie’s famous memo to top Microsoft’s top executives and engineers on “the internet services disruption,” as well as Bill Gates’s cover note. The sense of urgency in both men’s words remains striking. Gates spoke of the software-as-a-service model as being a “wave” that could swamp the traditional software business. Ozzie said that “the most important step is for each of us to internalize the transformative and disruptive potential of services. We must then focus on the need for agility in execution.”

It’s been a year, exactly, since those memos went out. A lot’s gone on in that time. It basically covers, for instance, YouTube’s entire lifespan, from early startup mode to explosive viral growth to being bought out for more than a billion and a half dollars by Microsoft’s nemesis in Internet services, Google. A lot of startups have jumped pell-mell into the so-called “Office 2.0” business, hoping to create online alternatives or complements to Microsoft Office. While their services, for the most part, remain rudimentary, they’ve progressed significantly over these last 12 months.

So where’s Microsoft? I think it’s fair to say that the company’s been distracted. It’s been struggling to get what seem likely to be the last major upgrades (in the traditional sense of upgrades) of its two major products, Windows and Office, out the door. It’s been working through organizational changes, not least Gates’s cutting back of his role in the company. It’s been continuing its seemingly permanent negotiations with European regulators. (“Another croissant, Mr. Ballmer?”) It’s been constructing big-ass utility data centers. And, needless to say, it’s been sucking in a ton of money. Oh, and there’s that Zune thing, too. Big companies tend to have a lot on their plates, and Microsoft’s is heaping full.

It’s not surprising, therefore, that the company hasn’t yet demonstrated the “agility in execution” that, as Ozzie argued, it needs if it’s going to make a successful transition to the services model. Yes, it’s been expanding the services, or “Live,” side of its business. But the steps have felt tentative, and the products, so far, have been underwhelming and ill-branded. (Like Google, Microsoft might really want to hire someone with a little talent in naming products.) The Live stuff hasn’t exactly been turning any heads.

Early today, Dan Farber reported on a conversation he had with Ozzie yesterday evening. He asked Microsoft’s new chief software architect about what he thought of the Office 2.0 crowd and the potential threat it posed. Ozzie’s response was as thoughtful as you’d expect, but it also was surprisingly tepid. It lacked the urgency you heard in his memo:

From Ozzie’s response, Microsoft is not in a hurry to deliver a pure Web Office, nor does it have its head in the sand. “People have been trying to create applications with Web technology since the Web began,” Ozzie said. “Just because you can do it, doesn’t mean you should. We are looking at Google Docs & Spreadsheets, and paying attention to Office 2.0 and Zoho. We are also putting those in front of customers and seeing what makes sense.[“] Ozzie said that Microsoft [is] taking a holistic view of how to proceed from a customer point of view, and modeling various user scenarios. ”

“Modeling various user scenarios” does not seem like a recipe for “agility in execution” in the new world of software – a world in which “user scenarios” are defined not in laboratory settings but in the rough-and-tumble of the web.

Farber continues:

I probed a bit more on the topic of whether a tipping point had been reached for browser-based suites. Ozzie said that no announcement is forthcoming. However, I would guess that Microsoft [is] busy coding browser-based Office components and could pull the trigger rapidly if it were deemed necessary to compete. Nonetheless, Microsoft could miss the window of opportunity, as it did in Web search, and have to play catch up in a category that is a major cash cow for the company. Developing the ultimate hybrid Office platform, beyond the forthcoming Office 2007, that accommodates all kinds [of] online and offline user scenarios could also take a long time versus the faster moving upstarts adding new features every few months and taking advantage of improvements in bandwidth and network reliability.

I’ve argued here in the past that Microsoft is in the catbird’s seat when it comes to leading the shift of personal productivity applications from the desktop to the web. We’re not at a “tipping point,” so far as the mainstream business market is concerned. We’re at the start of a transitional period in which the capabilities of desktop applications will be extended by, and slowly replaced by, the capabilities of services. As the dominant player – the only major player, for that matter – in desktop productivity apps, Microsoft has a strong natural advantage (some would call it an unnatural advantage) in coming up with the interim hybrid productivity apps that will be broadly adopted by businesses.

But while there’s no particular reason for Microsoft to act rashly, there is a big danger in relying on “the holistic view.” The new world is not going to be created holistically. It’s going to be created piecemeal. Farber’s right that Microsoft could easily come to find itself playing catch up. That’s not the ideal position to be in when it comes to software services that can take over the market with YouTube-like speed. You have to be in the fray, if only to keep your competitors off balance.

I’ve been fiddling around with SlideShare recently. It’s a service that makes it simple to publish PowerPoint presentations on web sites and blogs. As Ross Mayfield has said, it applies the YouTube model to PowerPoint. It’s one of those products that you look at and say, “This is really useful. I need this.” There’s no doubt in my mind that there’s a big market for a service that makes it as easy to syndicate presentations as YouTube makes it to syndicate videos. There’s a problem, though. SlideShare, which is in beta, doesn’t work very well yet. It can’t handle a lot of the graphics and charts and other elements routinely found in PowerPoint presentations. Which means it’s still a long way from being “easy.”

And yet this is such an obvious extension of the usefulness of PowerPoint that you have to wonder why Microsoft isn’t out there with its own innovation. It can’t be a matter of resources and coding expertise. If a dinky firm like SlideShare can do it, Microsoft can certainly do it. And this service doesn’t threaten to cannibalize PowerPoint sales at all. In fact, it would make PowerPoint more valuable – and it would also open up to Microsoft an opportunity to gain additional revenues by hosting the syndicated presentations on its own servers. You give away a little storage space with every version of PowerPoint, and then you charge companies for additional space. It’s kind of a no-brainer, so far as I can see.

Why this kind of piecemeal service is dangerous to Microsoft is that it does have a YouTube-like quality. It solves a common problem. Once it gets good, it could take off rapidly. And if it’s somebody else’s service that takes off, it would put a dent in Microsoft’s control over the market. It would begin the process of erosion that’s the biggest threat Microsoft faces with Office.

Sure you should think holistically. But you shouldn’t let the whole blind you to the importance of the pieces.

As open-source software programs mature and become commercial products, the work of developing them naturally shifts, to one degree or another, from the original community of unpaid volunteers to professional programmers who are employed and paid by companies, in particular the companies that profit from selling services related to the installation and upkeep of the software. What Yochai Benkler calls “social production,” the system of creating goods through freely donated labor rather than through labor that’s purchased and controlled by corporations, begins, inevitably, to break down. You get, instead, a system in which paid workers and volunteers labor together, though not necessarily toward the same goal, in an uneasy alliance. Some may call this a hybrid system. Others may call it a corrupted one.

It’s always been clear that the system, however you view it, imposes an economic vulnerability on the profit-making companies that engage in it. Those companies have to pay labor costs for developing a free good, a public good that that they have no proprietary control over. Their rivals can reap the fruits of that labor without having to pay for it. That creates, in theory, a dangerous asymmetry in competition. But what hasn’t been clear is whether that vulnerability actually matters, whether the danger that exists in theory also exists in reality. Are there economic or other barriers that prevent competitors from capitalizing on the investments of the open-source companies?

We’re about to get a lot closer to an answer to that question, thanks to that great clarifying force in the technology business, Larry Ellison. Yesterday, Ellison announced that his company, Oracle, fully intends to eat the fruits of the labor of Red Hat, the leading for-profit supplier of the open-source Linux operating system. Oracle is taking the version of Linux developed by Red Hat and distributing it under its own brand, as “Unbreakable Linux.” And, in a stab at Red Hat’s very heart, Ellison claims that Oracle will substantially undercut the open-source firm’s prices for supporting the software. It seems like a claim that shouldn’t be hard to fulfill. After all, Oracle doesn’t have to pay those labor costs.

Once open source became a business, rather than a movement, the rules changed. Larry Ellison, whos’s nothing if not a non-sentimentalist, understands that, and he doesn’t particularly care what “the community” thinks. His attack on Red Hat would never be called neighborly, but it is, as Business Week’s Steve Hamm puts it, “a ruthless and brilliant act of capitalism.”

It’s also something more. It illuminates a much broader and deeper tension in the digital world, a fault line that runs not only through the software industry but through every industry whose products or services exist, or can exist, as software. The tension is between social production and the profit motive. Volunteer labor means something very different in the context of a community than it does in the context of a business. In the context of a community, it’s an expression of fellowship, of the communal value of sharing. But in the context of a business, as Ellison’s move illustrates, it’s nothing more than a cheap input. Many of the most eloquent advocates of social production would prefer it if this tension didn’t exist. But it does, and it’s important.

When it comes to tangible stuff at least, abundance can turn to scarcity pretty quickly. For the past year or so, I’ve been hearing that the huge post-bubble glut in hosting space is history – that the supply of quality data-center space is tightening, and prices are rising. An article in today’s New York Times, by Kristina Shevory, provides some further evidence. After years of losses, the hosting industry is becoming profitable. Indeed Digital Realty Trust, an aggressive investor in hosting space, with 54 centers in its portfolio, “was the best-performing real estate investment trust in the country [last year], giving shareholders a 78 percent return … Now, the company is looking for one- and two-story office buildings that can be turned into Internet hubs or server farms.”

The big roadblock to expanding the supply? Electricity. Blade-stuffed centers suck up so much juice that some utilities just can’t handle the demand. “Power demands, which are now often the largest or second-largest expense for a data center, have helped lead to ballooning construction budgets,” writes Shevory. “It costs Equinix about $600 to $800 a square foot to build a data center, compared with $450 to $500 five years ago.”

It’s funny to think that real estate and electric power are what’s scarce in computing today. For the would-be utility computing giants, like Google and Microsoft, they’re particularly huge budget items. Call it the revenge of the old economy.

So there’s this new company named crayon (not Crayon, mind you, but crayon), and its claim to fame is that its offices are located on Crayonville Island in the imaginary world of Second Life. Ok, fine. You’ve got to have a shtick, and you can’t get much more shticky than that. But I’m asking myself: What does a company called crayon with an imaginary headquarters actually do? What business would such an enterprise be engaged in? Fortunately, one of the company’s founding employees has taken the time to describe “what crayon actually is” in a post on his blog. Here’s what he says:

We’re not an agency nor a consulting practice as is traditionally defined. What we are is whatever you want or need us to be.

I like to think of us as a true mash-up that combines the best in traditional and new thinking about marketing, advertising and PR.

We’re a solution provider. We’re an extension of your team. Consider us a new breed of partner – one that keeps everyone honest and on the right path. Our client is not the consumer: our client is the truth.

Now, come on. What we are is whatever you want or need us to be? Our client is the truth? This is a joke, right? I mean, it has to be a joke. If it’s not a joke, then we’ve definitely gone through the looking glass and are headed down the rabbit hole.

Our client is the truth? Hell, that doesn’t even pass the Turing Test.

In an important essay at First Monday, Paul Duguid takes a hard and rigorous look at whether, and to what extent, web-based peer production can produce quality work.

“Two ideas are often invoked,” he writes, “to defend the quality of peer production.” The first of these “laws of quality,” borrowed from open-source software development, is Linus’s Law: “Given enough eyeballs, all bugs are shallow.” Duguid points out, as others have before him, that applying this law outside the sphere of software production is problematic. The “stern gatekeeper” of software quality – the program has to run – is absent in the production of most cultural works. The second law of quality is what Duguid dubs “Graham’s Law,” after Paul Graham, who “claims that ‘The method of ensuring quality’ in peer production is ‘Darwinian … People just produce whatever they want; the good stuff spreads, and the bad gets ignored.'” This law, too, is problematic, argues Duguid. It reflects

an optimistic faith that the “truth will conquer.” While this optimism has roots in Milton’s Areopagitica, it is perhaps a particularly American, democratic belief, enshrined in the First Amendment. Such optimism no doubt makes good political principle, but it does not dictate political process. Freedom of speech is not the same as the freedom to replace other’s versions of the truth with your own. The authors of the U.S. Constitution and the Bill of Rights may have believed that open debate leads to political truth, [but] they did not believe that the Constitution would improve were it changed at the whim of each citizen’s changing view of truth. Consequently, the U.S. Constitution has significant built–in inertia … As this example may suggest, Graham’s implication that continuous tinkering only makes things better is highly suspect. It is hard to see why entropy would be indefinitely suspended by peer production. In areas of “cultural production,” in particular, progress is not necessarily linear, and neither the latest (nor the earliest) version of a work [is] always the best …

Rather than taking the laws on faith, we need to ask in which cases the laws work, in which they do not, and if they do not, why not. So we need to look at cases where the laws have failed to work and then to ask — in general, systemic rather than individual, particularistic terms — why.

Duguid goes on to examine the products of two well-established and seemingly fairly simple peer-production processes on the Internet: Gracenote (for compiling information about the contents of compact disks) and Project Gutenberg (for publishing online versions of out-of-copyright texts). While finding the products of both these projects “immensely useful,” he also documents, painstakingly, that they have deep and persistent flaws: “both suffer from problems of quality that are not addressed by what I have called the laws of quality – the general faith that popular sites that are open to improvement [will] iron out problems and continuously improve.”

He then examines Wikipedia, a more complex project in peer production. He documents the many flaws that bedevil the online encyclopedia, from plagiarism to the use of unreliable sources to sloppy writing, and shows how Wikipedia, “despite its creed of continuous improvement, can defy Graham’s Law” and evolve toward lower rather than higher quality as edits pile up. Duguid focuses his analysis on two entries, for the early English novelists Laurence Sterne and Daniel Defoe, and he admits that these entries “do appear to fall into a backwater of Wikipedia. Thus it may seem unfair to choose these as examples to illustrate aspects of the whole.” But he then makes a crucial point about assessing an encyclopedia’s quality:

I suggested earlier, however, that judging overall quality from the less– rather than the more–frequented parts, the weak rather than the strong links, is not a bad idea. After all, how is the ordinary user to know when he or she has landed in a backwater? With Linus’s Law in mind, we should acknowledge that the eyeballs that consult encyclopedia entries are, in the default case, quite unlike those beta testing or developing code and quite unsuited to recognizing or characterizing any but the most obvious errors. To use an Open Source program is in itself often an acknowledgment of a certain level of skill. To turn to the encyclopedia is, by contrast, more likely a confession of ignorance. If I want or need to find out about Defoe, then I’m not likely to be in a position to critique an entry on him.

“Editing,” Duguid writes, “is a hard task and needs to attract people prepared to think through the salient issues. Wikipedia is very sensitive to malice. It needs to be as sensitive to ineptitude.”

In the end, Duguid concludes that the two “laws of quality” underpinning today’s peer-production projects are insufficient. “If we are to rely on peer production in multiple different spheres of information production,” he says, “we need to look for other ways to assure quality.” But one comes away from this excellent paper wondering whether, once these “other ways” of quality assurance are imposed on a process, it would still qualify as “peer production.” As Duguid eloquently demonstrates, quality doesn’t just happen; it’s not an emergent phenomenon. It’s imposed on a work by people who know what they’re doing. Quality – true quality – may thus be incompatible with the democratic ideal that lies at the heart of what we call peer production.

Jaron Lanier recently called the Web 2.0 movement “digital maoism.” Now, as if on cue, the Cultural Revolution has begun.

Lawrence Lessig, in a post titled “The Ethics of Web 2.0,” suggests that some Web 2.0 companies are not fit to wear the Web 2.0 label. There are real Web 2.0 companies, and there are sham Web 2.0 companies. There are those that maintain their ethical purity, that obey the Code, and there are the transgressors, the ones that have fallen from the shining path. As in kindergarden, it all comes down to the way you share:

A “true sharing” site doesn’t try to exercise ultimate control over the content it serves. It permits, in other words, content to move as users choose. A “fake sharing” site, by contrast, gives you tools to make [it] seem as if there’s sharing, but in fact, all the tools drive traffic and control back to a single site.

YouTube is Lessig’s villain, the counterrevolutionary force that threatens the web’s emergent communalist state. “YouTube,” he writes, “gives users very cool code to either ’embed’ content on other sites, or to effectively send links of content to other sites. But never does the system give users an easy way to actually get the content someone else has uploaded … this functionality – critical to true sharing – is not built into the YouTube system.” It may hide its true nature behind a seductive mask of coolness, but make no mistake: YouTube is an imposter. It has failed “to respect the ethics of the web.”

“By contrast,” writes Lessig, “every other major Web 2.0 company does expressly enable true sharing.” The companies that Lessig uses to support this incredible statement are Flickr, blip.tv, EyeSpot, Revver, and “even Google.” Blip.tv? EyeSpot? Revver? These are “major Web 2.0 companies”? What about MySpace? What about Facebook? What about Digg? What about Craigslist? What about Google’s vast search business? Do any of these “expressly enable true sharing” of their core content? No, Lessig’s audacious attempt at revisionism just doesn’t fly.

But Lessig isn’t really interested in describing the world as it is. His eyes are on a further goal. He wants to redefine “Web 2.0” in order to promote a particular ideology, the ideology of digital communalism in which private property becomes common property and the individual interest is subsumed into the public interest – in which we become the web and the web becomes us.

The process of social enlightenment always begins with the reshaping of language. According to Lessig, Web 2.0 is not, as you might have assumed, a technological or a business term. It’s an ethical term, a moral term. Differences “in business models,” he writes, “should be a focus of those keen to push the values of Web 2.0.” In a gloss on Lessig’s post, Joi Ito writes that “we can’t really expect users to initially understand the distinction [between real sharing and fake sharing].” But “in the long run, users will understand that stand-alone or closed services do not allow them the freedoms that are becoming exceedingly more common in the Web 2.0 area.” It is hard not to hear the echo of Mao patiently explaining how the masses will make the transition from China 1.0 to China 2.0:

Because of their lack of political and social experience, quite a number of young people are unable to see the contrast between the old China and the new, and it is not easy for them thoroughly to comprehend … the long period of arduous work needed before a happy socialist society can be established. That is why we must constantly carry on lively and effective political education among the masses and should always tell them the truth about the difficulties that crop up and discuss with them how to surmount these difficulties.

But what’s the point, really? Does Lessig genuinely think that entrepreneurs and their backers are going to line up to take some True Sharer Pledge, to choose to pursue an abstract ideal of ethical purity rather than profit? To propose a moral test for membership in the Web 2.0 club seems, at this late date, like an exercise in reality avoidance. The wheels of commerce are turning, and they’re grinding all these grand intellectual distinctions into dust. Like Mao, Lessig and his comrades are not only on the wrong side of human nature and the wrong side of culture; they’re also on the wrong side of history. They fooled themselves into believing that Web 2.0 was introducing a new economic system – a system of “social production” – that would serve as the foundation of a democratic, utopian model of culture creation. They were wrong. Web 2.0’s economic system has turned out to be, in effect if not intent, a system of exploitation rather than a system of emancipation. By putting the means of production into the hands of the masses but withholding from those same masses any ownership over the product of their work, Web 2.0 provides an incredibly efficient mechanism to harvest the economic value of the free labor provided by the very, very many and concentrate it into the hands of the very, very few.

The Cultural Revolution is over. It ended before it even began, The victors are the counterrevolutionaries. And they have $1.65 billion to prove it.

John Hagel has written a thought-provoking post about the boundaries of offshoring. We now know that, thanks to the Internet, knowledge work is as susceptible to being moved overseas as factory work. But, it’s commonly assumed, there are some hard limits to the offshoring trend. Hagel quotes the economist Alan Blinder, who, earlier this year, wrote that we can at least take comfort that personal services will continue to be delivered locally: “Services that cannot be delivered electronically or that are notably inferior when so delivered, have one essential characteristic: personal, face-to-face contact is either imperative or highly desirable. Think of the waiter who serves you dinner, the doctor who gives you your annual physical, or the cop on the beat. Now think of any of those tasks being performed by robots controlled from India – not quite the same.”

This is the common wisdom, but, as Hagel points out, it has one big flaw: It assumes that the customer will stay put. In fact, globalization not only dramatically reduces the cost of transporting physical goods and electronic services to distant customers; it also reduces the cost of transporting customers to distant service providers. This fact is already beginning to disrupt the health care business. Many people in the United States are traveling to countries in eastern Europe and Asia to have major medical procedures performed. They not only save a lot of money but, in some cases, says Hagel, they actually receive better care. He points to “the emergence of highly specialized hospitals in offshore locations that offer state of the art equipment and highly trained physicians that can equal or better the quality record of US physicians. The surgeries being performed include very challenging cardiac, spinal and ophthalmologic procedures.” From what I hear, this phenomenon is even bigger in western Europe than in the United States. The proliferation of low-fare airlines throughout the continent has reduced travel costs to the point that it can make economic sense to travel hundreds or even thousands of miles for even fairly routine dental work.

Production, in other words, is not the only thing that can be offshored. Consumption can be offshored, too.

Hagel thinks that health care is only one of many personal services that may be vulnerable: “We need to broaden our horizons on offshoring. This is not just about service providers moving offshore. In a growing number of cases, it is also about service customers heading offshore in the quest for higher quality experiences at lower cost.” If the person can move, then the personal service can move as well.