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Dollar Shave Club and The Disruption of Everything

Probably the most important fact when it comes to analyzing Unilever’s purchase of Dollar Shave Club is the $1 billion price: in the world of consumer packaged goods (CPG) it is shockingly low. After all, only eleven years ago Procter & Gamble (P&G) bought Gillette, the market leader in shaving,1 for a staggering $57 billion.

To be sure Gillette is still dominant — the brand controls 70 percent of the global blades and razors market — but there is little question that Dollar Shave Club is a much better deal, in every sense of the word. Understanding why Dollar Shave Club was cheap means understanding why its blades are cheap, and understanding that means understanding just how precarious the position of P&G specifically and incumbents generally are in the emerging Internet economy.

The P&G Formula

No great company — and P&G is one of the greatest of all time — is built on only one competitive advantage. Rather, the seemingly unassailable profits and ceaseless growth enjoyed by P&G throughout its history — amazingly, the company basically doubled its revenue every decade from 1950 to 2010 — was driven through multiple interlocking advantages that created a whole even greater than the sum of its impressive parts.

  • Research and Development: P&G has long lived by the maxim articulated by former CEO Bob McDonald: “Promotions may win quarters, innovation wins decades.” To that end P&G has always outspent the competition when it comes to R&D: $2 billion in 2014, double Unilever, their next closest competitor, and the company employs over 1,000 Ph.D.’s and a host of ethnographic researchers. This has allowed P&G to consistently come up with new products and brand extensions and charge a premium for them.
  • Branding and Advertising: As inspiring as that McDonald quote may be, P&G also dominates advertising: in 2014 the company spent $10.1 billion in global advertising, 37% more than second-place Unilever. This is hardly a new trend: the company invented soap operas in 1933 to help hawk the cleaning products it was built on, and invented the idea of a brand manager who had a holistic view of products from research to creation to advertising to distribution.
  • Distribution and Retail: P&G’s huge collection of brands and products not only gave the company massive scale efficiencies in manufacturing, but more importantly led to a dominant position in retail. P&G built strong relationships with retailers that let them dominate finite shelf space, the scarcest resource for an industry producing relatively bulky inexpensive products.

P&G leveraged these resources in a simple formula that led to repeated success:

  • Spend significant resources on developing new products (more blades!) that can command a price premium
  • Spend even more resources on advertising the new product (mostly on TV) to create consumer awareness and demand
  • Spend yet more resources to ensure the new product is front-and-center in retail locations everywhere

In a world of scarcity this approach paid off time and again: P&G grew not only because its markets grew, but also because it continually justified price increases due to its innovations.

The Gillette Distillation

Small wonder the company was willing to pay a fortune for Gillette; “More blades for more money” was perhaps the purest distillation of P&G’s growth strategy, and Gillette opened the door to the men’s market that P&G had to that point largely ignored.

To be sure, that distillation was easy-to-mock; in 2004 The Onion famously wrote an article entitled Fuck Everything, We’re Doing Five Blades:

The market? Listen, we make the market. All we have to do is put her out there with a little jingle. It’s as easy as, “Hey, shaving with anything less than five blades is like scraping your beard off with a dull hatchet.” Or “You’ll be so smooth, I could snort lines off of your chin.” Try “Your neck is going to be so friggin’ soft, someone’s gonna walk up and tie a goddamn Cub Scout kerchief under it.”

I know what you’re thinking now: What’ll people say? Mew mew mew. Oh, no, what will people say?! Grow the fuck up. When you’re on top, people talk. That’s the price you pay for being on top. Which Gillette is, always has been, and forever shall be, Amen, five blades, sweet Jesus in heaven.

That’s exactly what had happened with the Mach 3, Gillette’s previous top-of-the-line model: Gillette increased blade and razor revenue by nearly 50% with basically no change in underlying demand, easily making back the $750 million it cost to research and develop the razor, simply through its ability to charge a premium for new technology, create awareness and demand through advertising, and capture consumers through retail shelf dominance.

Surprisingly, though, when the Onion’s satire became reality — Gillette launched the five blade Fusion with a 40% price premium in 2006, after being acquired — sales were slower than expected: many customers decided that three blades were good enough. Still, things weren’t that bad for Gillette and P&G: customers just kept buying the Mach 3. No business model worth $57 billion falls apart just because one component hits a soft spot!

The Dollar Shave Club Disruption

There was another product launch in 2006 that I’m sure no one at P&G even noticed: Amazon Web Services. Even if they did notice, I doubt the executives focused on the Fusion launch appreciated that P&G’s seemingly unassailable advantages were on the verge of declining precipitously.

AWS made it easy and cheap to start an online company; YouTube, launched a year earlier, made it cheap and easy to share video; Facebook, launched in 2004, made it possible to spread said video to millions of people. All three came together with the 2011 founding of Dollar Shave Club and its 2012 launch with one of the best introductory videos of all time:

Do watch if you haven’t — it’s really that good — but also look carefully at exactly what founder Michael Dubin is saying:

I’m Mike, founder of DollarShaveClub.com. What is DollarShaveClub.com? Well, for a dollar a month we send high quality razors right to your door. Yeah! A dollar! Are the blades any good? No, our blades are fucking great.

Gillette’s model and P&G’s formula generally cost a lot of money: R&D cost money, TV advertising cost money, and wholesalers and retailers had to earn a margin as well, and that’s before P&G realized the return on their investment. The result was that cartridges that cost less than a quarter to manufacture and package were sold for $4 or more. That worked as long as P&G’s other advantages in technical superiority, advertising, and distribution held, but were they ever to falter, it was eminently viable to sell cartridges for less and still make a healthy margin.

Each razor has stainless steel blades and [an] aloe vera lubricating strip and a pivot head so gentle a toddler could use it. And do you like spending $20/month on brand name razors? $19 go to Roger Federer! I’m good at tennis. And do you think your razor needs a vibrating handle, a flashlight, a back-scratcher, and ten blades? Your handsome-ass grandfather had one blade AND polio. Looking good Pop-pop!

This is a direct attack on Gillette having over-served the shaving market: P&G’s first advantage, their willingness to spend money on research and development, was neutralized because razors were already good enough.

Stop paying for shave tech you don’t need. And stop forgetting to buy your blades every month. Alejandra and I are going to ship them right to you…

AWS and Amazon itself, having both normalized e-commerce amongst consumers and incentivized the creation of fulfillment networks, made the creation of standalone e-commerce companies more viable than ever before. This meant that Dollar Shave Club, hosted on AWS servers, could neutralize P&G’s distribution advantage: on the Internet, shelf space is unlimited. More than that, an e-commerce model meant that Dollar Shave Club could not only be cheaper but also better: having your blades shipped to you automatically was a big advantage over going to the store.

That left advertising, and this is why this video is so seminal: for basically no money Dollar Shave Club reached 20 million people. Some number of those people became customers, and through responsive customer service and an ongoing focus on social media marketing, Dollar Shave Club created an army of brand ambassadors who did for free what P&G had to pay billions for on TV: tell people that their razors were worth buying for a whole lot less money than Gillette was charging.

The net result is that thanks to the Internet every P&G advantage, save inertia, was neutralized, leading to Dollar Shave Club capturing 15% of U.S. cartridge share last year.

Value Destruction

Note that metric: cartridge share. According to the traditional way of measuring marketshare Dollar Shave Club only has 5% of the U.S.; the discrepancy is due to the massive price difference between Dollar Shave Club and Gillette. And yet, the price difference is the entire point: in a world with good enough products (Dollar Shave Club imports their blades from Korean manufacture Dorco) that can be bought on zero marginal cost websites and shipped to your home directly there is no reason to charge more.

The implications of this go far beyond P&G: fewer Gillette razors also mean less TV advertising and no margin to be made for retailers, who themselves are big advertisers; this is why I argued last month that the entire TV edifice is not only threatened by services like Netflix, but also the disruption of its advertisers, of which P&G is chief.

More broadly, while razors with their huge gross margins and high replacement rate were a particularly good match for the Dollar Shave Club subscription model,2 I suspect this sort of disruption will not be a one-off: the Internet (and e-commerce) has so profoundly changed the economics of business that it is only a matter of time before other product categories are impacted, with all the second order effects that entails.

Perhaps the biggest of these second order effects is on value, and that’s where I come back to this purchase price: the tech community is celebrating the massive return for Dollar Shave Club’s investors, but $1 billion for a 16% unit share of a market dominated by a brand that cost $57 billion is startlingly small. Indeed, that’s why buying Dollar Shave Club was never an option for P&G: even if their model is superior P&G’s shareholders would never permit the abandonment of what made the company so successful for so long; a company so intently focused on growing revenue is incapable of slicing one of their most profitable lines by half or more.

For their part, Unilever is fortunate they don’t have a shaving business to protect, because being an incumbent is going to increasingly be the worst place to be. Dollar Shave Club’s motto may be “Shave Money Shave Time,” but just how many shareholders and policy makers are prepared for the shaving of value that this acquisition suggests is coming sooner rather than later?

  1. Schick is the other major CPG brand; I won’t mention them again although they face the same issues as Gillette []
  2. I’ll write more about why Dollar Shaving Club wasn’t eaten by Amazon like so many other e-commerce companies in tomorrow’s Daily Update []

A Technical Glitch

One week ago, moments after her boyfriend Philando Castile was shot by a police officer during a routine traffic stop, Diamond Reynolds flipped on Facebook’s live streaming feature. The resultant video, with Reynolds documenting what had happened, as well as her interaction with the police officer, immediately started to spread like wildfire.

And then it was gone.

Approximately an hour later, the video was back, this time with a “Warning — Graphic Video” label attached:

Screen Shot 2016-07-13 at 4.17.47 AM

When asked why the video had temporarily disappeared, Facebook simply said “It was down to a technical glitch.” The company had no further comment on the matter.

Facebook Versus Journalism

One needn’t travel far on the Internet to find a think piece bemoaning how Facebook has destroyed journalism, with a whiff of nostalgia for a time when The New York Times decided what news was fit to print and Walter Cronkite declared nightly “That’s the way it is.” It’s a viewpoint that is problematic in two regards.

First, the destruction of journalism is about the destruction of journalism’s business model, which was predicated on scarcity. In the case of newspapers, printing presses, delivery trucks, and a healthy subscriber base made them the lowest common denominator when it came to advertising, right down to four line classified ads that represented some of the most expensive copy on a per-letter basis in the world.

TV news, meanwhile, in large part existed to fulfill broadcaster obligations under the Fairness Doctrine, which required licensors of publicly-owned radio frequencies to devote airtime to matters of public interest, and to air opposing views of those matters. The Fairness Doctrine was revoked in 1987, for reasons that were the canary in the coal mine for news’ business model. The New York Times reported at the time:

In explaining the conclusion that its fairness rules were “no longer necessary to achieve diversity of viewpoint,” Ms. Killory, the commission’s counsel, noted the major growth of broadcast outlets in recent years.

There are now more than 1,300 television stations and more than 10,000 radio stations in the United States — in contrast to 1,700 daily newspapers — and 95 percent of viewers receive five or more television signals. Radio listeners in the biggest 25 markets receive an average of 59 radio stations.

Two decades later the average American home received 189 TV channels, and thanks to the Internet, an effectively infinite number of news websites. Scarcity was gone, and the publishing bubble is popping as a result. That Facebook has been the most effective service in collecting and funneling attention to the abundance of news on the Internet is a separate story.

More importantly, the nostalgia for a world of journalistic gatekeepers is nostalgia for a world where the death of Philando Castile would be little more than a one paragraph snippet in the Minneapolis Star Tribune that would have sounded a lot like the initial police report that dryly noted “shots were fired”, and that would have been that.

Crucially, though, it’s not that, thanks to Facebook. On the conservative site Daily Caller Matt Lewis wrote:

In the era of Facebook Live and smart phones, it’s hard to come to any conclusion other than the fact that police brutality toward African-Americans is a pervasive problem that has been going on for generations. Seriously, absent video proof, how many innocent African-Americans have been beaten or killed over the last hundred years by the police—with little or no media coverage or scrutiny?

Those old business models were great for journalists; they weren’t so great for those not deemed worth covering. Those nostalgic for the “good old days” are likely wishing for far more problems than they realize.

Launching Facebook Live

On April 6, the day that Facebook Live launched for everyone, BuzzFeed ran a feature that included an interview with Facebook CEO Mark Zuckerberg:

“Because it’s live, there is no way it can be curated,” [Zuckerberg] said. “And because of that it frees people up to be themselves. It’s live; it can’t possibly be perfectly planned out ahead of time. Somewhat counterintuitively, it’s a great medium for sharing raw and visceral content.”

A week later, during the opening keynote of Facebook’s F8 developer conference, Zuckerberg enthused:

Just the other week I saw a live video of a woman and her kids skiing down a hill. It was just mesmerizing! I watched it for a few minutes because I was like ‘I just want to make sure these kids get down this hill.’ There’s usually people who are playing music or dancing in there, but every once in a while there’s something that is really important and special happening. Like a couple of days ago a woman named Lena commented on one of my posts to tell me that when her mother was sick in the hospital she streamed her wedding on live so her mother and her friends across the country could not only see it but could be there with them. Now that’s pretty meaningful.

Raw, visceral, meaningful. That’s a pretty good way of describing Reynolds’ video. Newsworthy is another, and that’s where things get a whole lot more complicated for Facebook.

Facebook the Journalism Company

I noted above that Facebook is not necessarily to blame for the destruction of journalism’s business model, but with live video the social network has moved from feasting on what remains of publishing to becoming a journalistic company in their own right: Facebook’s 1.6 billion users have been deputized to not only chronicle their ski trips and weddings but also killings by police and, a day later, the killings of police.

In retrospect, given this reality, what is so striking about the aforementioned BuzzFeed feature and all of Facebook’s public comments about live video is how little thought seems to have been given to this use case. There is talk about recruiting engineers (150 in a week), all of the features that had to be built, the huge technical problems involved, and of course the potential payoff for Facebook:

Live solves a lot of problems for Facebook. It gives people an easy way to create video content that doesn’t require scripting or much production. Which in turn creates more content for Facebook. Live also helps the company tap into real-time events, an area where it’s struggled compared to Twitter…

One recent trend in social media has been a move away from highly produced content, particularly video…This is precisely what Snapchat is so good at, and why it has become such a threat to Facebook. And it’s clearly something that’s been on Zuckerberg’s mind as well.

“People look at live video and they think this is a lot of pressure because it’s live; it takes a lot of courage to go live and put yourself out there. But what we’re finding is the opposite,” Zuckerberg said in a phone interview the day before the Live relaunch. “A lot of the biggest innovations have been things that take some of the pressure out of posting a photo or video.”

I wrote after this year’s F8 about how Facebook from the very beginning had always been about projecting your best self online; given that, I wondered if the focus on Live Video might ultimately prove to be a distraction from what Facebook was good at (owning identity online). This last week is validating that concern in a far more profound way than I appreciated.

The risk is this: Facebook’s control over what the vast majority of people see online — news included — is overwhelming. Before the advent of Live Video, though, Facebook could more easily claim to be a neutral provider, simply serving up 3rd-party stories via an allegedly objective algorithm that was ultimately directed by the user itself, and using that user direction to build the best identity repository in the world to sell ads against. And while the reality of Facebook’s News Feed is in fact not objective at all — algorithms are designed by people — actually creating the news will, I suspect, change the conversation about Facebook’s journalistic role in a way that the company may not like.

Facebook and the Fairness Doctrine

Back in 1949, when the Fairness Doctrine was established, the FCC wrote in a report entitled In the Matter of Editorializing by Broadcast Licensees:

We do not believe, however, that the licensee’s obligations to serve the public interest can be met merely through the adoption of a general policy of not refusing to broadcast opposing views where a demand is made of the station for broadcast time. If, as we believe to be the case, the public interest is best served in a democracy through the ability of the people to hear expositions of the various positions taken by responsible groups and individuals on particular topics and to choose between them, it is evident that broadcast licensees have an affirmative duty generally to encourage and implement the broadcast of all sides of controversial public issues over their facilities, over and beyond their obligation to make available on demand opportunities for the expression of opposing views. It is clear that any approximation of fairness in the presentation of any controversy will be difficult if not impossible of achievement unless the licensee plays a conscious and positive role in bringing about balanced presentation of the opposing viewpoints.

Facebook is not a broadcaster: they don’t depend on a government-granted monopoly over radio frequencies that comes with strings attached. And frankly, even were I inclined to agree that the end of the Fairness Doctrine contributed in some way to the United States’ increased polarization, the clear free speech issues inherent in its application, combined with the explosion in media outlets, lead me to believe the FCC was right to revoke it.

That said, Facebook’s influence over what most people see quite clearly rivals that of television broadcasters circa 1949, and the vast majority of jurisdictions in which Facebook operates have much less absolute free speech laws than the United States. The more that Facebook is perceived as a media entity, not simply a neutral platform, the more likely it is that the company will face calls for regulation of the News Feed in particular, in language that will likely sound a lot like the Fairness Doctrine.

Facebook and Transparency

Two weeks ago Facebook took an important step in dealing with the increased scrutiny it will inevitably face, posting a document detailing “News Feed Values”. For the first time Facebook offered a hint of transparency about how its algorithm works, making clear that “friends and family come first”, but also that “your feed should inform” and “your feed should entertain.”

To be sure the document does nothing to address the question of providing both sides of an issue; quite the opposite, in fact. The document states:

We are not in the business of picking which issues the world should read about. We are in the business of connecting people and ideas — and matching people with the stories they find most meaningful. Our integrity depends on being inclusive of all perspectives and view points, and using ranking to connect people with the stories and sources they find the most meaningful and engaging.

We don’t favor specific kinds of sources — or ideas. Our aim is to deliver the types of stories we’ve gotten feedback that an individual person most wants to see. We do this not only because we believe it’s the right thing but also because it’s good for our business. When people see content they are interested in, they are more likely to spend time on News Feed and enjoy their experience.

You may think this is problematic for society (as I do), but at least Facebook is being honest about it; transparency is the company’s best tool to remain free of regulation.

It’s also why the “technical glitch” was so disappointing. The reasons why Reynolds’ video was taken down are probably innocuous — I suspect the video was flagged for graphic content by a Facebook user and removed by a contracted content reviewer (like these in the Philippines), and then restored by someone at Facebook headquarters — and the company is probably both embarrassed that it happened and shy about revealing the degree to which it farms out content review. The most powerful journalistic entity in the world, though, doesn’t get the luxury of sweeping such significant editorial decisions under the rug: that rug will be pulled back at some point, and it would be far better for society and for Facebook were they to do so themselves.

One thing is for sure: this won’t be the last time something truly raw, visceral, and meaningful happens on Facebook Live. Zuckerberg has gotten his wish, even if the implications will ultimately be more than he bargained for: all of the eyes on those live videos will only increase the number of eyes on Facebook itself. It’s a classic case of unintended consequences: Facebook’s attempt to capture Snapchat’s private gestalt has only solidified its position as a public platform with the added component of a newsmaker in its own right, and while that carries clear benefits for society, society will expect more transparency from Facebook, willingly delivered or not.

The Brexit Possibility

The TV upfronts that I wrote about last week may seem like an odd entry point to discuss Brexit and its relationship to technology, but the core insight in that piece is critical. From my follow-up in The Daily Update:

While it is fine and useful to look at industries like TV or transportation or consumer packaged goods or retail in isolation, if you step back far enough all of these industries are interconnected and symbiotic. TV and our modern transportation system and big consumer packaged goods conglomerates and brick-and-mortar retail all came of age in the post World War II era, and all were built with the same assumptions like the importance of scale, controlling distribution, and crucially, that each other existed. There were positive feedback loops driving the growth of all of them together (and many other industries as well).

The implication of this symbiosis is that just as these different industries rose together, they will assuredly fall together as well, and indeed that is slowly but surely happening for all the reasons I detailed last week. For now, though, leave these particulars to the side; I’ll return to them later.

The key takeaway, and my starting point, is the realization that no single issue or company or industry or country stands alone: everything operates in systems, and both influences and is influenced by the system within which it operates. By extension, any change to one part of the system must impact and change other parts of the system: the greater the change, the greater the upheaval until the system can return to equilibrium. Sometimes, though, the change destroys the system completely.

The Old System

During the 20th century, particularly the post World War II era, the United States led the formation of a multinational system that balanced the government, large corporations, and labor.

stratechery Year One - 283

The U.S. focused its foreign policy on the interrelated goals of containing communism, preventing inter-European wars, and creating markets for the massive industries that had sprung up during World War II and now needed to accommodate millions of returning soldiers. In Europe the headlining effort was the Marshall Plan that combined aid used primarily to buy American-produced goods with an insistence on reducing trade barriers; the General Agreement on Tariffs and Trade came a year later. The Marshall Plan was administered by the Organisation for European Economic Co-operation, one of the first pan-European bodies that started the continent on the long road to the European Union (a road that was paved with U.S. government money1). This dual mission of peace through bureaucracy paid for with trade has endured.

For their part, increasingly massive corporations built out the U.S.’s military power, manufactured most of the industrial and agricultural equipment on which Marshall Plan money was spent, and produced all of the accoutrements of a booming middle class: said middle class worked at those massive corporations, building everything from tanks to cars to washing machines, and spending their money on the same.

The implicit deal was this: the government created markets for the corporations, who in turn provided not just employment but also security for their employees, funding health insurance and pensions, while employees (and corporations) paid for the government: in 1960 the lowest income bracket paid 20%, while the highest paid 90%, and the corporate tax rate was 52%. Europe followed a similar model, but spared of the burden of a huge military, nationalized most social security programs, especially health care but also pensions. And, for two decades, the systems were in equilibria.

How Globalization Upended the System

Globalization is by no means a recent phenomena: the idea of trading goods with other groups, so as to realize the benefits of comparative advantage2 dates back to the earliest recorded human civilizations in the third millennium B.C.E. More pertinent to this discussion, the combination of the industrial revolution (which supercharged the idea of specialization) and steamships massively increased trade in the 19th century, where the freedom of movement of goods was primarily guaranteed by colonialism: colonies supplied the raw materials and bought the finished goods, giving colonial powers massive trade surpluses that could be used to fight intermittent wars with each other.

This system was utterly destroyed by two World Wars, resulting in the U.S.-dominated system above; still, though, the flow of goods was similar: the U.S., the world’s new superpower, was a net exporter, even as Europe and Japan in particular built up their own industrial base first with U.S. funds, and then by selling goods both to the U.S. and to each other. The deal was intact.

Then, in the years leading up to the 1970s, three technological advances completely transformed the meaning of globalization:

  • In 1963 Boeing produced the 707-320B, the first jet airliner capable of non-stop service from the continental United States to Asia; in 1970 the 747 made this routine
  • In 1964 the first transpacific telephone cable between the United States and Japan was completed; over the next several years it would be extended throughout Asia
  • In 1968 ISO 668 standardized shipping containers, dramatically increasing the efficiency with which goods could be shipped over the ocean in particular

These three factors in combination, for the first time, enabled a new kind of trade. Instead of manufacturing products in the United States (or Europe or Japan or anywhere else) and trading them to other countries, multinational corporations could invert themselves: design products in their home markets, then communicate those designs to factories in other countries, and ship finished products back to their domestic market. And, thanks to the dramatically lower wages in Asia (supercharged by China’s opening in 1978), it was immensely profitable to do just that.

It is difficult to overstate the positive impact of this particular period of globalization. Billions of people were lifted out of abject poverty, especially in China but also throughout Asia, and the United States and other western countries became significantly richer as well; trade is absolutely a win-win. Critically, though, while everyone benefited from cheaper goods, the profits were not shared equally: the managers of multinational corporations and their owners reaped the vast majority of the benefits, even as their employee base effectively shifted from their domestic markets to Asia.

This undid the post-World War II deal: middle class jobs began to disappear, and along with them the economic and social security that had been provided by corporations. It took time, to be sure, but the ascension of China to the WTO in 2001 dramatically accelerated this shift, and while its full effects were hidden by a massive expansion in credit fueled by a housing bubble, once that came crashing down in 2008 the former middle classes of developed countries came to realize just how deep was the hole they fell into.

The Inevitable Fallout

Remember, everything is a system. And, given the changes wrought by the post 1970s wave of globalization, it is foolish to think that a core component of society — labor — can be fundamentally changed without there being knock-on effects on the other components of that system. The first murmurs were the 2009 rise of the Tea Party on the right, and the 2011 Occupy Wall Street movement on the left. While the participants of the two groups couldn’t be more different — indeed, they loathe each other — both were outraged at “the System”.

Both movements have flowered this election cycle, both in the United States and the United Kingdom: an old-school leftist was elected the leader of the U.K.’s Labour Party, and another nearly nominated by the Democratic Party. On the right the Republican Party has nominated Donald Trump, aided in no small part by the dramatic weakening of media institutions, while the U.K., in a campaign led by Conservative Party insurgents and the far-right U.K. Independence party, has just voted to leave the European Union with the support of many traditional Labour voters. In both cases there is a new cleavage: less right versus left, and more elites who have benefited from globalization and a middle class that has been left behind.

Again, there are clear differences between the left and right: the former sees Wall Street or The City as the villain, while the latter blames immigration. Both, though, in their own way, want a return to the old deal: honest work for an honest wage, and an increasing sense of having nothing-to-lose until it happens.3

Tech and A New System

A return to the old deal won’t happen, of course, nor should we want it to: the last thirty years have made both the world generally and developed countries in particular richer than ever. What is needed, though, is a new system, and here the tech industry has a critical role to play.

While the first twenty years of the modern tech industry (starting with the personal computer) primarily benefited corporations, the last fifteen years have dramatically improved the quality of life for consumers. The defining quality of technology, particular Internet-based companies, has been the generation of massive amounts of consumer surplus. How much is it worth to have access to all of the world’s information in the palm of your hand, or to be connected with friends and family wherever they are, or to make new connections with people you have never met? Far, far more than however much one pays for a smartphone and a data plan.

That this largesse is financially viable for tech companies is a testament to their tremendous scale. While the old order was about multinationals, Google and Facebook and the rest are supranational: their addressable market is the world.4 Moreover, consumers’ benefit is incumbents’ pain: as I detailed above the new world order is slowly but surely drowning the old one. The question is just how transformative will that new world order be?

If the old system was defined by the government, big corporations, and labor, the new system should be about government, technology, and individuals. It looks something like this:

stratechery Year One - 284

Government

The first implication of the supranational nature of technology is that unlike the old multinationals, there is no need for government support to open markets and guarantee trade; for the most part, the less government involvement the greater maximization there will be of the consumer surplus that is already being generated. Rather, it is the government that ought take a much more active role in supporting individuals.

At the most basic level this should include security: while universal health care would be ideal, for lots of reasons both practical and political it may not be viable in the U.S. Given that, Obamacare is a huge step in the right direction; other developed countries like the U.K. are obviously well ahead here.

Second, instead of trying to recreate a 1950s fantasy of employment for life on an assembly line, the goal should be to create a far more dynamic labor market with a defined floor and significantly greater upside than the old system:

  • First, a universal basic income, facilitated by the government, should be set at the lower bounds of what is necessary to escape poverty. Globalization may have been the first shoe to fall on the middle class, but automation is the other, and it will affect just as many jobs as manufacturing, including — especially — white collar ones
  • Second, the government should be loosening regulations on the “gig” economy: technology has dramatically increased the degree to which work can be segmented, and that’s a good thing. Moreover, these sorts of jobs provide the upside to a universal basic income’s floor: our goal should be to make it vastly easier for individuals to better themselves if they choose to do so (while the basic income provide protection against the gig economy’s inherent uncertainty)
  • Third, there should be a significant loosening of the regulations and taxation around business creation. One of the many benefits of technology and the Internet has been to make all kinds of new businesses far more viable than ever before, but it is far too hard to get started, and the bookkeeping requirements are far too onerous. This sort of loosening, combined with the reduction in risk resulting from a better safety net and basic income, plus the possibility of building working capital through gigs, could lead to an explosion in creativity and entrepreneurial activity

Each of these factors is critical: a universal basic income alone offers some degree of financial security, but it does not offer dignity to the recipient, or any return for society beyond a reduction in guilt. What is most important, and what offers the highest return, is enabling more and better ways to work and ultimately create: that requires fewer regulations and simpler taxation.

Individuals

I purposely changed the name of this part of the system from “labor” to “individuals”. While collective action was absolutely appropriate in a world where employment was dominated by massive corporations, collectiveness and the work it was appropriate for has its costs: a ceiling on the individual, both in terms of income and also creativity.

What makes today’s world so different than the 1950s are the means with which ambition and creativity can be realized. I can write a newsletter without owning a printing press; someone else can create jewelry without a physical storefront; another can make music without a recording studio, and distribute it without a record label. Those are the easy examples — who knows what sorts of products and services might result from an emboldened and secure middle class?

Young people in particular should relish this new world of opportunities: yes, the world of your parents is gone, but it does not automatically follow that the alternative is worse. Even with today’s mess there are far more entrepreneurial opportunities than ever before, and the younger one is the more one can accept the unnecessary risks that unfortunately still exist. And, on the flipside, opportunities predicated on the old system are themselves riskier than they have ever been.

Tech

It’s understandable why so many in tech are dismissive of the old order: beyond the consumer surplus being generated, and the systematic destruction of incumbents, the industry is increasingly the primary economic driver of the United States in particular, which offers a certain sense of invincibility. It would be against the self-interest of both consumers and politicians to hold tech back.

And yet, there is an aspect of that calculation not far removed from measuring computers based on speeds and feeds. Yes, any rational calculation about the impact of the tech industry shows how indispensable it is, but people are not always rational, especially when they are desperate. It is absolutely in the industry’s best interests to not only participate in but lead the creation of a new system that works to the benefit of all.

To that end, technology executives and venture capitalists should lead the campaign for the type of reforms I have listed above. More importantly, they should match their rhetoric with actions: companies like Apple and Google should strive to be technology leaders, not tax avoidance ones. Successful entrepreneurs and their investors should champion increased capital gains taxes with a bias towards much longer-term investment: this both encourages the long view even as it accounts for the massive return that comes to investors and shareholders in a winner-take-all world. VCs in particular should be willing to close the carried interest loophole, and everyone in the industry should be willing to shoulder higher tax rates.

The payoff is equilibrium: the chance to build fabulously successful businesses that go with the current, not against it. The alternative is far worse: once automation arrives, guess who is going to be the scapegoat?

Brexit: Wrong Reasons, Right Results?

To be clear, this is a package deal: higher tax rates to fuel a misguided attempt to recreate the 1950s would be just as much of a disaster as undoing the old deal has been for the middle class. The world has changed.

Indeed, this is why I’m not quite prepared to join in the panic over Brexit, although I understand and acknowledge the very real downsides. I keep coming back to the fact that the European Union is a product of the old order — a world where government entities existed to enable trade for multinationals and rules for everyone else. Small wonder the EU has been the most hostile to the changes wrought by tech! There is no question that undoing 40+ years of integration will be extremely painful — if indeed the U.K. leaves the EU at all — but given that the old order has already been disrupted, how much is to be gained by continuing to pretend that nothing has changed? Alternatively, might there be potential in building something new?

To be sure, there is no evidence that Brexit was driven by a vision of a new world order; quite the opposite in fact. And, unlike many Brexit voters, I am mindful of the elite consensus about the problems with a withdrawal: trade still matters, and the loss of access to the European market, plus the internal side effects with regards to Scotland and Northern Ireland, are huge problems (and I can read a stock ticker!). But then again, the very definition of who is elite, and why, is as much a part of the system as anything else, and the fact there are so few voices even acknowledging the increased restrictiveness of the EU, or its complete lack of economic growth, much less grappling with why it is the EU came to be and how deeply entwined that is with the old system,5 is to my mind a missed opportunity to at least think about how things could be different.

Everything is connected, everything is a system — and a crisis is a terrible thing to waste.

  1. The CIA financed nearly all the various organizations and individuals pushing for political integration []
  2. Comparative advantage is the idea that collective productivity can be maximized if every person/group/country specializes in what they are best at, and then trade for what else they need, as opposed to every person/group/country being entirely self-sufficient. This is one of the most important factors underlying economic progress; to take a very fundamental example, few of us grow our own food, as it is more efficient for farmers to do that at scale. We, in turn, sell our specialization to others giving us the means to buy food. []
  3. Is there a racial component to the opposition to immigration? Almost certainly. But I suspect the ugly manifestations of whatever darkness lies in people’s hearts would be much less common in a thriving economy []
  4. Except China, thanks to the Great Firewall []
  5. Above and beyond a desire to keep the peace, which is deeply meaningful []

Podcast: Exponent Episode 084 — A New World Order

On the newest episode of Exponent, the podcast I co-host with James Allworth:

Ben and James discuss how the TV industry and the companies that advertise on TV are interconnected, and how they will rise and fall together.

Links

  • Ben Thompson: TV Advertising’s Surprising Strength — and Inevitable Fall — Stratechery
  • Ben Thompson: The Cord Cutting Fantasy — Stratechery
  • Ben Thompson: Why Disney and ESPN Will Be OK — Stratechery
  • Ben Thompson: Old-Fashioned Snapchat — Stratechery
  • Ben Thompson: How Technology is Changing the World (P&G Edition) — Stratechery
  • Ken Doctor: The Macy’s Factor — Politico
  • Ben Thompson: Cars and the Future — Stratechery
  • Ben Thompson: Publishers and the Smiling Curve — Stratechery
  • Ben Thompson: The Changing — and Unchanging — Structure of TV — Stratechery
  • Ben Thompson: Netflix and the Conservation of Attractive Profits — Stratechery
  • Ben Thompson: The FANG Playbook — Stratechery
  • Ben Thompson: Aggregation Theory — Stratechery

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback

TV Advertising’s Surprising Strength — And Inevitable Fall

It’s been a good few months for TV executives, who are in the middle of upfront negotiations with advertisers for the 2016-2017 television season. Variety reports:

After several years of moving money out of TV ad budgets to experiment with new digital outlets and social media, several big advertisers are spending more on the boob tube – and the result, according to ad buyers and other executives familiar with the pace of this year’s “upfront” negotiations, are a series of rate increases that TV has not won since the end of the last U.S. recession.

“It’s all about money coming back into the marketplace,” said one media buying executive, noting that consumer packaged goods companies, quick-service restaurant chains and pharmaceutical companies are moving money into TV’s annual upfront market, when the nation’s big media companies try to sell the bulk of their ad inventory for the coming programming cycle. Some of the money is coming back from digital spending, and some of it is being moved from TV’s so-called “scatter” market, when advertisers pay for commercials much closer to their air date.

Reports indicate those rate increases are running between 7% and 12%, and follow on a 2015-2016 season that saw scatter advertising — advertising purchased closer to the airing date — up 16% year-over-year. Apparently all that digital advertising hype was just a fad, right?

I wouldn’t be so sure.

Advertising and Attention

Despite all of the upheaval caused by the Internet, there are two truths about advertising that have remained constant:

  1. Advertising’s share of GDP has remained consistent for 100 years1
  2. TV’s share of advertising, after growing for 40 years, has also remained consistent at just over 40% for the last 20 years

Those twenty years have seen the emergence of digital advertising generally, and, over the last five years, mobile advertising: while this emergence is likely responsible for the halt in growth for TV, the real victims have been radio, magazines, and especially newspapers, which have shrunk from a nearly 40% advertising share to about 10%.

Still, digital and mobile’s 33% share of advertising falls well short of the amount of attention attracted. Digital accounted for 47% of time spent with media in 2015, up from 32% in 2011, while TV has fallen from 41% in 2011 to 35% in 2015.2 This decline, though, is not evenly distributed: this jarring chart from Redef about the change in hours spent watching TV by age group shows that the situation for TV is much worse than the top-line numbers suggest:

REDEF_Feeds_v1.2

The three age groups with the biggest declines — millennials, basically — are the most attractive to the brand advertisers that dominate TV advertising: for one, the younger you are the less likely you are to have developed affinity for a particular brand, and for another, the younger you are the more years a brand has to earn back the money spent building said affinity. Small wonder brands have been so eager to jump on new digital platforms where said millennials are actually spending their time.

So why is money suddenly flowing back to TV?

The Relationship Between TV and Advertisers

The most obvious reason for TV’s enduring appeal to advertisers is that it is a pretty fantastic advertising medium: relaxed viewers, immersive experience, etc. The appeal, though, goes deeper: the very institution of television advertising is intertwined with the kinds of advertisers that use it the most, the products they sell, and the way they are bought-and-sold. And what should be terrifying to television executives is that all of those pieces that make television advertising the gold mine that it has been are under the exact same threat that TV watching itself is: the threat of the Internet.

Start with the top 25 advertisers in the U.S. The list is made up of:

  • 4 telecom companies (AT&T, Comcast, Verizon, Softbank/Sprint)
  • 4 automobile companies (General Motors, Ford, Fiat Chrysler, Toyota)
  • 4 credit card companies (America Express, JPMorgan Chase, Bank of America, Capital One)
  • 3 consumer packaged goods (CPG) companies (Procter & Gamble, L’Oréal, Johnson & Johnson)
  • 3 entertainment companies (Disney, Time Warner, 21st Century Fox)
  • 3 retailers (Walmart, Target, Macy’s)
  • 1 from electronics (Samsung), pharmaceuticals (Pfizer), and beer (Anheuser-Busch InBev)

Notice that the vast majority of the industries on on this list are dominated by massive companies that compete on scale and distribution. CPG is the perfect example: building a “house of brands” allows a company like Procter & Gamble to target demographic groups even as they leverage scale to invest in R&D, bring down the cost of products, and most importantly, dominate the distribution channel (i.e. retail shelf space). Said retailers, meanwhile, are huge in their own right, not only so they can match their massive suppliers at the bargaining table but also so they can scale logistics, inventory management, store development, etc. Automobile companies, meanwhile, are not unlike CPG companies: they operate a “house of brands” to serve different demographics while benefitting from scale in production and distribution; the primary difference is that they make money through one large purchase instead of over many smaller purchases over time.

Similar principles apply to the other companies on this list: all are looking to reach as many consumers as possible with blunt targeting at best, all benefit from scale, and all are looking to earn significant lifetime value from consumers. And, along those lines, all can afford the expense of TV. In fact, the top 200 advertisers in the U.S. love TV so much that they make up 80% of television advertising, despite accounting for only 51% of total advertising (and 41% of digital).

Note, though, that many of the companies on this list are threatened by the Internet:

  • CPG companies are threatened on two fronts: on the high end the combination of e-commerce plus highly-targeted and highly-measurable Facebook advertising have given rise to an increasing number of boutique CPG brands that deliver superior products to very targeted groups. On the low end, meanwhile, e-commerce not only reduces the shelf-space advantage but Amazon in particular is moving into private label in a big way.
  • Relatedly, big box retailers that offer few advantages beyond availability and low prices are being outdone by Amazon on both counts. In the very long run it is hard to see why they will continue to exist.
  • The automobile companies, meanwhile, are facing three separate challenges: electrification, transportation-as-a-service (i.e. Uber), and self-driving cars. The latter two in particular (and also the first to an extent) point to a world where cars are pure commodities bought by fleets, rendering advertising unnecessary.

The other companies face less of a long-term threat, some because they are already commoditized — telecoms, credit cards, electronics — and others because they will probably grow: big movies are only getting bigger (entertainment), and the population is getting older (pharmaceuticals). Still, the inescapable reality is that TV advertisers are 20th century companies: built for mass markets, not niches, for brick-and-mortar retailers, not e-commerce. These companies were built on TV, and TV was built on their advertisements, and while they are propping each other up for now, the decline of one will hasten the decline of the other.

TV Advertising’s Dead Cat Bounce

I also suspect the nature of the biggest TV advertisers explains TV’s dead cat bounce: brands uniquely suited to TV are probably by definition less suited to digital advertising, which at least to date has worked much better for direct response marketing. No one is going to click a link in their feed to buy a car or laundry detergent, and a brick-and-mortar retailer doesn’t want to encourage shopping to someone already online. So after a bit of experimentation, they’re back with TV.

Still, I think Facebook and Snapchat in particular will figure brand advertising out: both have incredibly immersive advertising formats, and both are investing in ways to bring direct response-style tracking to brand advertising, including tracking visits to brick-and-mortar retailers. It wouldn’t surprise me if brand advertising on digital is following the hype cycle:

stratechery Year One - 282

This is the story of most things Internet-related, not just narrowly but broadly: it’s no accident many of today’s startups are repeating ideas from the dot com era; it’s not that they were wrong but that they were too early. And, when it comes to old world companies, if you turn that graph upside down, the “trough of disillusionment” looks a lot like a bounce-back!

Ultimately, given the shift in attention, the threats faced by their best advertisers, and the oncoming train that is Facebook and Snapchat, were I a TV executive I wouldn’t get too excited about one nice week of ad sales. Indeed, the industry has been shifting to subscriptions for years, and while advertising will hold up for a while, the big drama is who will be left without a chair when the music stops.3

Coda: Aggregation Theory

One more thing: I wrote a piece earlier this year called The Fang Playbook that posited that Facebook, Amazon, Netflix, and Google (plus Uber) were structurally very similar companies: all leveraged zero distribution costs and zero transaction costs to own users at scale via a superior experience that commoditized suppliers and let them skim off the middle, either through fees, subscriptions, or ads.4

What I described above is the opposite side of the coin: linear television and its advertisers were all predicated on owning distribution and thus owning customers. The Internet has or is in the process of destroying their business models for broadly similar reasons; for now the intertwinement of these models is keeping everyone afloat, but that only means that when the end comes it will come more swiftly and broadly than anyone is expecting.

  1. Although this may be slowing; more on this tomorrow []
  2. Note that the advertising-free Netflix is categorized as digital; although the streaming service still serves a minority of U.S. households, its subscribers watch an average of 1 hour and 33 minutes a day, and are responsible for a good deal of TV’s fall-off. []
  3. Viacom, for example []
  4. Aka Aggregation Theory []

Podcast: Exponent Episode 083 — Microsoft & LinkedIn versus Apple & WWDC

On the newest episode of Exponent, the podcast I co-host with James Allworth:

Ben and James discuss Microsoft’s acquisition of LinkedIn and Apple’s WWDC announcements, and figure out why they feel so differently about the two of them.

Links

  • James Allworth: Who’s going to be having sleepless nights after Microsoft’s LinkedIn deal? — Medium
  • Ben Thompson: Microsoft and Apple Double Down — Stratechery
  • Ben Thompson: How Satya Nadella Killed Windows Phone — Stratechery
  • Microsoft’s Nadella Manages Legacy of Ballmer-Board Split — Bloomberg
  • Ben Thompson: The Deal That Makes No Sense — Stratechery
  • Ben Thompson: The Curse of Culture — Stratechery
  • Ben Thompson: Apple’s Organizational Crossroads — Stratechery
  • James Allworth: The Blessing of Failure — Medium
  • Ben Thompson: Apple Watch: Asking Why and Saying No — Stratechery

Listen to the episode here

Podcast Information: Feed | iTunes | SoundCloud | Twitter | Feedback