Snapchat Spectacles and the Future of Wearables

When it comes to the future, the tricky part is less the “what” than it is the “how.” For example:

ibm_simon

This is the Simon. It was a handheld phone with a touchscreen that could run 3rd party apps. IBM introduced it in 1992 before the world wide web even existed. It sent faxes.

I highlight faxing not to mock (mostly); rather, its inclusion gets to a fundamental reason why it took a full fifteen years for smartphones to truly take off: new categories not only need workable and affordable technology, but also ecosystems to latch onto and established use cases to satisfy.

Think about everything that happened between 1992 and 2007 that, at least at first glance, didn’t seem to have anything to do with smartphones:

  • The personal computer moved out of the office and into the home
  • The world wide web was invented and an entire ecosystem was built from scratch
  • Personal electronics proliferated: while by 1992 most people had or used calculators and Walkmans, the 90s saw the introduction of PDAs and digital cameras; the 00s brought handheld GPS devices and digital music players

The reason why we consider 2007 as the start of the smartphone era is that while there were plenty of smartphones released before then (most notably Nokia/Symbian in 1996, and Blackberry and Windows Mobile in 2003), it was the iPhone that, thanks to its breakthrough user interface and ahead-of-its-time hardware, was able to take advantage of all these developments.

Think back to this slide:

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Note that none of these features existed in a vacuum:

  • Telecom providers had been building out cellular networks for two decades, and mobile phones were well-established
  • iPods were hugely popular, with a well-established use case, as were the other personal electronic devices that first offered much of the iPhone’s other functionality (the aforementioned calculators, PDAs, digital cameras, and GPS devices)
  • The web had already developed into an entire universe of information that was accessible through a browser

A year later, Apple added the App Store that made it possible for the iPhone to add on all of the various computing capabilities that it was lacking; the result was a single device built on top of everything that came before:

stratechery-year-one-294

The critical point is this: even had it been technologically possible, the iPhone wouldn’t have been, well, the iPhone had the use cases it enabled and ecosystem it plugged into not been established first.

Wearables That Fail

Late last week Snap, the company formerly named after its original Snapchat app, somewhat unexpectedly unveiled a wearable:1

screen-shot-2016-09-27-at-11-52-09-pm

The Spectacles, as they are known, are sunglasses with a pair of cameras: tap the side and it will record a ten-second snippet of video.

Of course Snapchat isn’t the first company to release video-recording glasses: back in 2013 Google released Google Glass:

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Glass was a failure for all the obvious reasons: they were extremely expensive and hard to use, and they were ugly not just aesthetically but also in their ignorance of societal conventions. These problems, though, paled in the face of a much more fundamental issue: what was the point?

Oh sure, the theoretical utility of Glass was easy to articulate: see information on the go, easily capture interesting events without pulling out your phone, and ask and answer questions without fumbling around with a touch screen. The issue with the theory was the same one that plagued initial smartphones: none of these use cases were established, and there was no ecosystem to plug into.

A similar critique could be leveled at Apple’s initial take on the Watch. While the hardware was far more attractive than the Glass, and no one was offended by the prospect of wearing, well, a watch, what was most striking about the announcement was the absence of a rationale: what was the use case, and where was the ecosystem?

This lack of focus led to a device that probably shouldn’t have been launched when it was: because Apple didn’t know what the Watch should be used for it was larded up with an overly complicated user interface and an SDK that resulted in apps so slow that they were unusable; Apple was so eager for 3rd-party developers to solve its missing use case that the company destroyed the user experience that was their hallmark.

Wearables That Work

Contrast the first Apple Watch with the one that was unveiled last month: not only was the hardware improved with a faster processor, water-proofing, and GPS, but more importantly the use case was made very clear. Just look at the introductory video:

This video has 47 separate “shots”; 35 of them are health-and-fitness related (and that doesn’t count walking or breathing, both of which fit in a broader “wellness” categorization). The rest of the introduction followed the same theme, as did the product’s flagship partner: Nike. Finally the message was clear: Apple Watch was for health and fitness.

Now can an Apple Watch do so much more than health and fitness? Absolutely. But those new use cases — things like notifications, or Apple Pay, or controlling your smart home, all of which are relatively new use cases2 — now have an umbrella to develop under.

This focus also defines the Watch’s most obvious competitor: Fitbit. While the Watch may be far more capable than most Fitbit devices, both are competing for the same spot on the wrist, and both are positioned to do the same job.

What is interesting about Fitbit is that from a product development perspective it is the spiritual heir of Apple’s own iPod: it started out as a purposeful appendage to a computer that did one clearly defined thing — count steps. True, this was a new use case, but the original Fitbits in particular avoided all of the other problems with wearables: it was unobtrusive yet unique, and very easy to understand. It also laid the groundwork for the line expansion that has followed: once the use case was established Fitbit could create trackers that overcame challenges like wearing a strange device on your wrist or costing more than $100.

Apple’s introduction of its second wearable — AirPods — was also well done.3 The use case couldn’t be more obvious: they are wireless headphones for the headphone jack-less iPhone 7. You can’t get more clear than that! And yet the potential is quite obviously so much greater: as I noted two weeks ago the AirPods in conjunction with the Apple Watch are forming the outlines of a future Beyond the iPhone.

The Wearables Future

There’s that word I opened with: “future”. As awesome as our smartphones are, it seems unlikely that this is the end of computing. Keep in mind that one of the reasons all those pre-iPhone smartphone initiatives failed, particularly Microsoft’s, is that their creators could not imagine that there might be a device more central to our lives than the PC. Yet here we are in a world where PCs are best understood as optional smartphone accessories.

I suspect we will one day view our phones the same way: incredibly useful devices that can do many tasks better than anything else, but not ones that are central for the simple reason that they will not need to be with us all of the time. After all, we will have our wearables.

To be clear, that future is not here, and it’s probably not that close.4 That doesn’t mean these intervening years — and these intervening products — don’t matter though. Now is the time to build out the use cases and ecosystem that make wearables products the market demands, not simply technology made for geeks who don’t give a damn about social conventions — or how they look.

glass-collective1

Snapchat is Not Google Glass

To be fair, this wasn’t the official product image for Google Glass, although it quickly became the most famous.5 Certainly that was because of who was in it — Marc Andreessen, Bill Maris, and John Doerr are three of the most famous venture capitalists in the industry — but it also so perfectly captured what Google Glass seemed to represent: Silicon Valley’s insistence that its technology would change your life whether you wanted it to or not, for no other reason than the fact it existed.

Needless to say, the contrast with what already feel like iconic pictures for the Snap Spectacles could not be more profound:6

spectacles

With the caveat that no one has actually used these things — and that manufacturing physical products at scale is a lot more difficult than it looks — I suspect the outcome for Spectacles will be quite different from Glass as well. For one, they look so much better than Glass, and they are an order of magnitude cheaper ($130).

Much more significantly, though, Spectacles have the critical ecosystem and use case components in place: Snapchat has over 150 million daily active users sending over a billion snaps a day and watching an incredible 10 billion videos. All of them are exclusive to Snapchat. Making it easier to add videos — memories, according to Spiegel (and I’m sure it’s not an accident that Snapchat recently added a feature called exactly that) — is not so much strange as it is an obvious step on Snapchat’s Ladder.

Snapchat Versus Apple

Obvious. That’s another word I already used, in the context of Apple’s AirPods, and what is perhaps the most fascinating implication of Spectacles is what it says about the potential of a long-term rivalry between Snapchat and Apple. Snapchat CEO Evan Spiegel has said that Snap née Snapchat is a camera company, not a social network. Or, perhaps more accurately, the company is both: it is a fully contained ecosystem that is more perfectly optimized to the continual creation and circulation of content than even Facebook.7 What matters from Apple’s perspective is that Snapchat, like Facebook or WeChat or other apps that users live in, is one layer closer to their customers. For now that is not a threat — you still need an actual device to run those apps — but then again most people used Google on Windows, which made Microsoft a lot of money even as it froze them out of the future.

This is exactly why Apple is right to push forward into the wearable space even though it is an area, thanks to the important role of services like Siri, in which they have less of an advantage. Modern moats are not about controlling distribution but about owning consumer touch points — in the case of wearables, quite literally.

To be clear, I am peering into a very hazy future; for one thing Snapchat still has to build an actual business on top of that awesome engagement, although I think the company’s prospects are bright. And it goes without saying that the technology still matters: chips need to get faster (a massive Apple advantage), batteries need to improve (also an Apple specialty), and everything needs to get smaller. This, though, is the exact path taken by every piece of hardware since the advent of the industry. They are hard problems, but they are known problems, which is why smart engineers solve them. What is more difficult to appreciate is that creating a market for that smart technology takes an even more considered approach, and right now it’s difficult to imagine a better practitioner than the one on Venice Beach, far from Silicon Valley.

  1. I discussed the odd timing of the announcement in yesterday’s Daily Update []
  2. Notifications obviously isn’t that new; relatedly, it’s one of the most compelling non—fitness-related reasons to buy the Watch []
  3. Except for the fact that it’s not yet available []
  4. If we follow the iPod timeline (the accessory that led to the iPhone), then we’re looking at 2020 or 2021, presuming the Watch is the next centerpiece, and that’s for the minimum viable product []
  5. I couldn’t ascertain what pictures were on the Google Glass page as Google has excluded it from the Internet Archive []
  6. And note the gender ratio []
  7. Facebook’s status as user’s public profile inhibits sharing; that is why the company is more dependent on 3rd-party content than most realize []

Oracle’s Cloudy Future

Everyone knows the story of how IBM gave away the castle to Microsoft (and Intel): besieged by customers demanding low-powered personal computers the vertically-integrated mainframe-centric company tasked a team in Boca Raton, Florida, far from the company’s headquarters in Armonk, New York, to create something quickly to appease these low-margin requests. Focused on speed and cost said team decided to outsource nearly everything, including the operating system and processor. The approach paid off, at least when it came to IBM’s goals: while IBM’s integrated products normally took half a decade to develop and launch, the Boca Raton team moved from concept to shipping product in only 12 months. However, the focus on standard parts meant that all of the subsequent value in the PC, which massively exceeded the mainframe business, went to the two exclusive suppliers: Microsoft and Intel.1

Fewer are aware that the PC wasn’t IBM’s only internal-politics-driven value giveaway; one of the most important software applications on those mainframes was IBM’s Information Management System (IMS). This was a hierarchical database, and let me pause for a necessary caveat: for those that don’t understand databases, I’ll try to simplify the following explanation as much as possible, and for those that do, I’m sorry for bastardizing this overview!

Database Types

A hierarchical database is, well, a hierarchy of data:

stratechery-year-one-291

Any particular piece of data in a hierarchical database can be found by either of two methods: either know the parent and find its children, or know the children and find its parent. This is the easiest sort of database to understand, and, at least for early computers, it was the easiest to implement: define the structure, enter data, and find that data layer by traversing the hierarchy until you find the relevant parent or child. Or, more realistically, leverage your knowledge of the hierarchy to go to a specific spot.

However, there were two big limitations with hierarchical databases: first, relationships were pre-determined; what was a parent and what was a child were decisions made before any data was actually entered. This made it extremely difficult to alter a database once it was in use. Secondly, queries analyzing the children of different parents are impractical: you would need to traverse the hierarchy to retrieve information for every potential item before discarding the vast majority to get the data set you wish to analyze.

In 1969, an IBM computer scientist named Edgar F. Codd wrote a seminal paper called A Relational Model of Data for Large Shared Data Banks that proposed a new approach. The introduction is remarkably lucid, even for laypeople:

Future users of large data banks must be protected from having to know how the data is organized in the machine (the internal representation). A prompting service which supplies such information is not a satisfactory solution. Activities of users at terminals and most application programs should remain unaffected when the internal representation of data is changed and even when some aspects of the external representation are changed. Changes in data representation will often be needed as a result of changes in query, update, and report traffic and natural growth in the types of stored information.

This paper was the foundation of what became known as relational databases: instead of storing data in a hierarchy, where the relationship between said data defines its location in the database, relational databases contain tables; every piece of data is thus defined by its table name, column name, and key value, not by the data itself (which is stored elsewhere). That by extension means that you can understand data according to its relationship to all of the other data in the database; a table name could also be a column name, just as a key value could also be a table name.

stratechery-year-one-292

This approach had several huge benefits: first, databases could be expanded with new data categories without any impact on previous data, or needing to completely rewrite the hierarchy; just add new tables. Two, databases could scale to accommodate arbitrary amounts and types of data because the data wasn’t actually in the database; remember it was abstracted away in favor of integers and strings of text. Third, using a “structured query language” (SQL) you could easily generate reports on those relationships (What were the 10 most popular books ordered by customers over 40?), and because said queries were simply examining the relationship between integers and strings you could ask almost anything. After all, figuring out the relationship between locations in the database is no longer scanning a tree — which is inherently slow and mostly blind, if you don’t know what you’re looking for — but is math. Granted, it was very hard math — many at the time thought it was too hard — but the reality of Moore’s Law was slowly being realized; it wouldn’t be hard math forever.

Phew. I’d imagine that was as painful to read as it was to write, but this is the takeaway: hierarchical databases are limited in both capability and scalability by virtue of being pre-defined; relational databases are far more useful and scalable by virtue of abstracting away the data in favor of easily computable values.

Oracle’s Rise

Dr. Codd’s groundbreaking idea was almost completely ignored by IBM for several years in part because of the aforementioned IMS; Codd was basically saying that one of IBM’s biggest moneymakers was obsolete for many potential database applications, and that was a message IBM’s management was not particularly interested in hearing. In fact, even when IBM finally did build the first-ever relational database in 1977 (it was called System R and included a new query language called SQL),2 they didn’t release it commercially; only in 1982 did the company release its first relational database software called SQL/DS. Naturally it only ran on IBM mainframes, albeit small ones; IMS ran on the big iron.

Meanwhile, a young programmer named Larry Ellison had formed a company called Software Development Laboratories, originally to do contract work, but quickly decided that selling packaged software was a far better proposition: doing the work once and reselling it multiple times was an excellent way to get rich. They just needed a product, and IBM effectively gave it to them; because the System R team was being treated as a research project, not a commercial venture, they happily wrote multiple papers explaining how System R worked, and published the SQL spec. Software Development Laboratories implemented it and called it Oracle, and in 1979 sold it to the CIA; a condition of the contract was that it run on IBM mainframes.3

In other words, IBM not only created the conditions for the richest packaged software company ever to emerge (Microsoft), they basically gave an instruction manual to the second.

The Packaged Software Business

The packaged software industry was a bit of a hybrid between the traditional businesses of the past and the pure digital businesses of the Internet era (after all, there was no Internet). On the one hand, as Ellison quickly realized, software had zero marginal costs: once you had written a particular program, you could make an infinite number of copies. On the other hand, distribution was as much a challenge as ever; in the case of Oracle’s relational database, Relational Software Inc. (née Software Development Laboratories; the company would name itself “Oracle Systems Corporation” in 1982, and then today’s Oracle Corporation in 1995) had to build a sales force to get their product into businesses that could use it (and then ship the actual product on tape).

The most economical way to do that was to build the sort of product that was mostly what most customers wanted, and then work with them to get it actually working. Part of the effort was on the front-end — Oracle was quickly rewritten in the then-new programming language C, which had compilers for most platforms, allowing the company to pitch portability — but even more came after the sale: the customer had to get Oracle installed, get it working, import their data, and only then, months or years after the original agreement, would they start to see a return.

Eventually this became the business model: Oracle’s customers didn’t just buy software, they engaged in a multi-year relationship with the company, complete with licensing, support contracts, and audits to ensure Oracle was getting their just dues. And while customers grumbled, they certainly weren’t going anywhere: those relational databases and the data in them were what made those companies what they were; they’d already put in the work to get them up-and-running, and who wanted to go through that again with another company? Indeed, given that they were already running Oracle databases and had that existing relationship, it was often easier to turn to Oracle for the applications that ran on top of those databases. And so, over the following three decades, Oracle leveraged their initial advantage to an ever-increasing share of their customers’ IT spend. Better the devil you know!

Amazon’s Optionality

The proposition behind Amazon Web Services (AWS) could not be more different: companies don’t make up-front commitments or engage in years-long integration projects. Rather, you sign-up online, and you’re off. To be fair, this is an oversimplification when it comes to Amazon’s biggest customers, who negotiate prices and make long-term commitments, but that’s a recent development; AWS’ core constituency has always been startups taking advantage of server infrastructure that used to cost millions of dollars to build minimum viable products where all of their costs are variable: use AWS more (because you’re gaining customers), pay more; use it hardly at all, because you can’t find product-market fit, and you’re out little more than the opportunity cost of not doing something else.

It’s the option value that makes AWS so valuable: need more capacity? Just press a button. Need to build a new feature? AWS likely has a pre-built service for you to incorporate. Sure, it can get expensive — a common myth is that AWS is winning on price, but actually Amazon is among the more expensive options — but how much is it worth to have exactly what you need when you need it?

Ellison, meanwhile, got up on stage at the company OpenWorld conference this week and declared that “Amazon’s lead is over” when it comes to Infrastructure-as-a-Service, all because Oracle’s top-of-the-line server instance was faster and cheaper than Amazon. Well sure, but hierarchical databases were faster than relational databases too; speed isn’t everything, nor is price. Optionality and scalability matter just as much as they always have, and in this case Oracle’s quite basic offering isn’t remotely competitive.

Ellison’s statement is even more ridiculous when you look at the number that really matters when it comes to cloud services: capital expenditures. Over the last twelve months Oracle has totaled $1.04 billion in capital expenditures; Amazon spent $3.36 billion in the last quarter,4 and $10.9 billion in the last twelve months.5 Infrastructure-as-a-Service is not something you build-to-order; it’s the fact that the infrastructure and all the attendant services that rest on top of that infrastructure are already built that makes AWS’s offering so alluring. Oracle is not only not catching up, they are falling further behind.

SaaS Focus

In his keynote Ellison argued that infrastructure spending wasn’t necessarily the place to gauge Oracle’s cloud commitment; instead he pointed out that the company has spent a decade moving its various applications to the cloud. Indeed, the company spent a significant 17% of revenues last quarter on research-and-development, and Ellison bragged that Oracle now had 30+ SaaS applications and that the sheer number mattered:

What is Oracle’s strategy: what do we think customers want, what do we do in in SaaS? It’s the same thing: if we can figure out what customers want and deliver that customers are going to pick our stuff and buy our stuff. And we think what they want is complete and integrated suites of products, not one-off products. Customers don’t want to have to integrate fifty different products from fifty different vendors. It’s just too hard. It’s simply too hard and the associated security risks and labor costs and reliability problems is just too much. So our big focus is not delivering one, two, three, four applications, but delivering complete suites of applications, for ERP, for human capital management, for customer relationship management, sometimes called customer experience, or CX. That’s our strategy in SaaS: complete and integrated suites.

What Ellison is arguing was absolutely correct when it came to on-premise software; I wrote about exactly this dynamic with regards to Microsoft in 2015:

Consider your typical Chief Information Officer in the pre-Cloud era: for various reasons she has bought in to some aspect of the Microsoft stack (likely Exchange). So, in order to support Exchange, the CIO must obviously buy Windows Server. And Windows Server includes Active Directory, so obviously that will be the identity service. However, now that the CIO has parts of the Microsoft stack in place, she is likely to be much more inclined to go with other Microsoft products as well, whether that be SQL Server, Dynamics CRM, SharePoint, etc. True, the Microsoft product may not always be the best in a vacuum, but no CIO operates in a vacuum: maintenance and service costs are a huge concern, and there is a lot to be gained by buying from fewer vendors rather than more. In fact, much of Microsoft’s growth over the last 15 years can be traced to Ballmer’s cleverness in exploiting this advantage through both new products and also new pricing and licensing agreements that heavily incentivized Microsoft customers to buy ever more from the company.

As noted above, this was the exact same strategy as Oracle. However, enterprise IT decision-making is undergoing dramatic changes: first, without the need for significant up-front investment, there is much less risk in working with another vendor, particularly since trials usually happen at the team or department level. Second, without ongoing support and maintenance costs there is much less of a variable cost argument for going with one vendor as well. True, that leaves the potential hassle of incorporating those fifty different vendors Ellison warned about, but it also means that things like the actual quality of the software and the user experience figure much more prominently in the decision-making — and the point about team-based decision-making makes this even more important, because the buyer is also the user.

Oracle in the Middle

In short, what Ellison was selling as the new Oracle looks an awful lot like the old Oracle: a bunch of products that are mostly what most customers want, at least in theory, but with neither the flexibility and scalability of AWS’ infrastructure on one side nor the focus and commitment to the user experience of dedicated SaaS providers on the other. To put it in database terms, like a hierarchical database Oracle is pre-deciding what its customers want and need with no flexibility. Meanwhile, AWS and dedicated SaaS providers are the relational databases, offering enterprises optionality and scalability to build exactly what they need for their business when they need it; sure, it may not all be working yet, but the long-term trends couldn’t be more obvious.

It should be noted that much of this analysis primarily concerns new companies that are building out their IT systems for the first time; Oracle’s lock on its existing customers, including the vast majority of the largest companies and governments in the world, remains very strong. And to that end its strategy of basically replicating its on-premise business in the cloud (or even moving its cloud hardware on-premise) makes total sense; it’s the same sort of hybrid strategy that Microsoft is banking on. Give their similarly old-fashioned customers the benefit of reducing their capital expenditures (increasing their return on invested capital) and hopefully buy enough time to adapt to a new world where users actually matter and flexible and focused clouds are the best way to serve them.

  1. IBM did force Intel to share its design with AMD to ensure dual suppliers []
  2. Amazingly, IBM kept Codd separate from the engineering team []
  3. To be fair to IBM, SQL/DS and their later mainframe product, DB2, were far more reliable than Oracle’s earliest versions []
  4. Specifically, Amazon spent $1.7 billion in capital expenditures and $1.7 billion in capital lease commitments []
  5. This expenditure includes distribution centers for the retail business; however, no matter how your split it, Amazon is spending a lot more []

Facebook Versus the Media

Facebook found itself in the middle of another media controversy last week. Here’s the New York Times:

The image is iconic: A naked, 9-year-old girl fleeing napalm bombs during the Vietnam War, tears streaming down her face. The picture from 1972, which went on to win the Pulitzer Prize for spot news photography, has since been used countless times to illustrate the horrors of modern warfare.

But for Facebook, the image of the girl, Phan Thi Kim Phuc, was one that violated its standards about nudity on the social network. So after a Norwegian author posted images about the terror of war with the photo to Facebook, the company removed it.

The move triggered a backlash over how Facebook was censoring images. When a Norwegian newspaper, Aftenposten, cried foul over the takedown of the picture, thousands of people globally responded on Friday with an act of virtual civil disobedience by posting the image of Ms. Phuc on their Facebook pages and, in some cases, daring the company to act. Hours after the pushback, Facebook reinstated the photo across its site.

This, like many of Facebook’s recent run-ins with the media, has been like watching an old couple fight: they are nominally talking about the same episode, but in reality both are so wrapped up in their own issues and grievances that they are talking past each other.

Facebook Owns Facebook.com

Start with the media. Aftenposten Editor-in-chief Espen Egil Hansen wrote an open-letter to Facebook CEO Mark Zuckerberg that was, well, pretty amazing, and I’m not sure that’s a compliment:

Facebook has become a world-leading platform for spreading information, for debate and for social contact between persons. You have gained this position because you deserve it. But, dear Mark, you are the world’s most powerful editor. Even for a major player like Aftenposten, Facebook is hard to avoid. In fact we don’t really wish to avoid you, because you are offering us a great channel for distributing our content. We want to reach out with our journalism.

However, even though I am editor-in-chief of Norway’s largest newspaper, I have to realize that you are restricting my room for exercising my editorial responsibility. This is what you and your subordinates are doing in this case.

Actually, no, that is not what is happening at all. Aftenposten is not Facebook, and Facebook is not “Norway’s largest newspaper”. Accordingly, Facebook — and certainly not Mark Zuckerberg — did not take the photo down from Aftenposten.no. They did not block the print edition. They did not edit dear Espen. Rather, Facebook removed a post on Facebook.com, which Aftenposten does not own, and which Hansen admits in his own open letter is something freely offered to the newspaper, one that they take because it is “a great channel for distributing our content.”

Let me foreshadow what I will say later: Facebook screwed this up. But that doesn’t change the fact that Facebook.com is a private site, and while Aftenposten is more than happy to leverage Facebook for its own benefit that by no means suggests Aftenposten has a single iota of ownership over its page or anyone else’s.

The Freedom of the Internet

Unfortunately, Hansen’s letter gets worse:

The media have a responsibility to consider publication in every single case. This may be a heavy responsibility. Each editor must weigh the pros and cons. This right and duty, which all editors in the world have, should not be undermined by algorithms encoded in your office in California…

The least Facebook should do in order to be in harmony with its time is introduce geographically differentiated guidelines and rules for publication. Furthermore, Facebook should distinguish between editors and other Facebook-users. Editors cannot live with you, Mark, as a master editor.

I’ll be honest, this made me mad. Hansen oh-so-blithely presumes that he, simply by virtue of his job title, is entitled to special privileges on Facebook. But why, precisely, should that be the case? The entire premise of Facebook, indeed, the underpinning of the company’s success, is that it is a platform that can be used by every single person on earth. There are no gatekeepers, and certainly no outside editors. Demanding special treatment from Facebook because one controls a printing press is not only nonsensical it is downright antithetical to not just the premise of Facebook but the radical liberty afforded by the Internet. Hansen can write his open letter on aftenposten.no and I can say he’s being ridiculous on stratechery.com and there is not a damn thing anyone, including Mark Zuckerberg, can do about it.1

Make no mistake, I recognize the threats Facebook poses to discourse and politics; I’ve written about them explicitly. There are very real concerns that people are not being exposed to news that makes them uncomfortable, and Hansen is right that the photo in question is an example of exactly why making people feel uncomfortable is so important.

But it should also not be forgotten that the prison of engagement-driving news that people are locking themselves in is one of their own making: no one is forced to rely on Facebook for news, just as Aftenposten isn’t required to post its news on Facebook. And on the flipside, the freedom and reach afforded by the Internet remain so significant that the editor-in-chief of a newspaper I had never previously read can force the CEO of one of the most valuable companies in the world to accede to his demands by rousing worldwide outrage.

These two realities are inescapably intertwined, and as a writer who almost certainly would have never been given an inch of space in Aftenposten, I’ll stick with the Internet.

Facebook is Not a Media Company

One more rant, while I’m on a roll: journalists everywhere are using this episode to again make the case that Facebook is a media company. This piece by Peter Kafka was written before this photo controversy but is an excellent case-in-point (and, sigh, it is another open letter):

Dear Mark, We get it. We understand why you don’t want to call Facebook a media company. Your investors don’t want to invest in a media company, they want to invest in a technology company. Your best-and-brightest engineers? They don’t want to work at a media company. And we’re not even going to mention Trending Topicgate here, because that would be rude.

But here’s the deal. When you gather people’s attention, and sell that attention to advertisers, guess what? You’re a media company. And you’re really good at it. Really, really good. Billions of dollars a quarter good.

Let’s be clear: Facebook could call themselves a selfie-stick company and their valuation wouldn’t change an iota. As Kafka notes later in the article Facebook gets all their content for free, which is a pretty big deal.

Indeed, I think one of the (many) reasons the media is so flummoxed with Facebook is that the company has stolen their business model and hugely improved on it. Remember, the entire reason why the media was so successful was because they made massive fixed cost investments in things like printing presses, delivery trucks, wireless spectrum, etc. that gave them monopolies or at worst oligopolies on local attention and thus advertising. The only fly in the ointment was that actual content had to be created continuously, and that’s expensive.

Facebook, like all Internet companies, takes the leverage of fixed costs to an exponentially greater level and marries that with free content creation that is far more interesting to far more people than old media ever was, which naturally attracts advertisers. To put it in academic terms, the Internet has allowed Facebook to expand the efficient frontier of attention gathering and monetization, ruining most media companies’ business model.

In other words, had Kafka insisted that Facebook is an advertising company, just like media companies, I would nod in agreement. That advertising, though, doesn’t just run against journalism: it runs against baby pictures, small businesses, cooking videos and everything in between. Facebook may be everything to the media, but the media is one of many types of content on Facebook.

In short, as long as Facebook doesn’t create content I think it’s a pretty big stretch to say they are a media company; it simply muddies the debate unnecessarily, and this dispute with Aftenposten is a perfect example of why being clear about the differences between a platform and a media company is important.

The Facebook-Media Disconnect

The disconnect in this debate reminds me of this picture:

12719113_10102665120179591_3471165635858509622_o-1200x799

Ignore the fact that Facebook owns a VR company; the point is this: Facebook is, for better or worse, running a product that is predicated on showing people exactly what they want to see, all the way down to the individual. And while there is absolutely editorial bias in any algorithm, the challenge is indeed a technical one being worked out at a scale few can fully comprehend.

That Norwegian editor-in-chief, meanwhile, is still living in a world in which he and other self-appointed gatekeepers controlled the projector for the front of the room, and the facts of this particular case aside, it is awfully hard to avoid the conclusion that he and the rest of the media feel entitled to individuals’ headsets.

Facebook’s Mistake

Still, the facts of this case do matter: first off, quite obviously this photo should have never been censored, even if the initial flagging was understandable. What is really concerning, though, was the way Facebook refused to back down, not only continuing to censor the photo but actually barring the journalist who originally posted it from the platform for three days. Yes, this was some random Facebook staffer in Hamburg, but that’s the exact problem! No one at Facebook’s headquarters seems to care about this stuff unless it turns into a crisis, which means crises are only going to continue with potentially unwanted effects.

The truth is that Facebook may not be a media company, but users do read a lot of news there; by extension, the company may not have a monopoly in news distribution, but the impact of so many self-selecting Facebook as their primary news source has significant effects on society. And, as I’ve noted repeatedly, society and its representatives may very well strike back; this sort of stupidity via apathy will only hasten the reckoning.2

  1. It should be noted that this is exactly why the Peter Thiel-Gawker episode was so concerning. []
  2. And, I’d add, this is exactly why I think Facebook should have distanced itself from Thiel []

Beyond the iPhone

I enjoy the writing of Farhad Manjoo, tech columnist at The New York Times, but I was prepared for the hottest of hot takes when I saw his latest column, penned just hours after Apple’s latest product unveiling, was titled What’s Really Missing From the New iPhone: Dazzle.1 Once I read it, though, I found a lot to agree with:

Apple has squandered its once-commanding lead in hardware and software design. Though the new iPhones include several new features, including water resistance and upgraded cameras, they look pretty much the same as the old ones. The new Apple Watch does too. And as competitors have borrowed and even begun to surpass Apple’s best designs, what was iconic about the company’s phones, computers, tablets and other products has come to seem generic…

It’s not just that a few new Apple products have been plagued with design flaws. The bigger problem is an absence of delight.

Indeed, it sure seemed to me while watching yesterday’s keynote that the level of excitement and, well, delight peaked early and gradually ebbed away as Apple CEO Tim Cook and his team of presenters got deeper into the details of Apple’s new hardware. Of course a lot of that had to do with the shocking appearance of the legendary Shigeru Miyamoto of Nintendo, on hand to announce Super Mario Run exclusively for iOS.2

The Nintendo news was certainly a surprise,3 but it actually fit in quite well thematically with the opening of the keynote: first was a video of Tim Cook and Carpool Karaoke creator James Corden in a funny skit and a not too subtle reminder that Apple recently bought the upcoming Carpool Karaoke series as an exclusive for Apple Music. That was followed by touting the success of Apple Music and the fact it has “content no one else has” — i.e. more exclusives. Following that up with Mario sure seemed to suggest that Apple was increasingly going to leverage its war chest to differentiate its “good-enough” phones.

The Threat of “Good Enough”

It has been clear for many years that the threat to iPhone growth was not modular Android but the iPhones people already have. The hope with last year’s iPhone 6S launch was that new features like 3D Touch and Live Photos would be compelling enough to drive upgrades, but it turned out that many would-be upgraders had already bought the iPhone 6 and the rest didn’t care; the result was the first iPhone that sold less than a previous model.

At first glance, as Manjoo noted, the iPhone 7 doesn’t seem like it will do much to reverse that trend: it’s mostly the same as the two-year-old iPhone 6 people bought instead of the iPhone 6S, and folks still using older iPhones may very well upgrade — if they upgrade at all — to the cheaper iPhone SE or the newly discounted 6S. After all, as multiple commentators have noted, the most talked-about feature of the iPhone 7 is what it doesn’t have — the headphone jack. Surely no headphone jack + no dazzle = no growth, right?

Well, probably. I have been and remain relatively pessimistic about this iPhone cycle (perhaps because I was overly optimistic last year). However, I was actually very impressed by what Apple introduced yesterday: many of the products and features introduced didn’t make for flashy headlines, but they laid the foundation for both future iPhone features and, more importantly, a future beyond the iPhone.

The iPhone 7 Plus Camera

The annual camera upgrade is always one of the best reasons to upgrade an iPhone, especially if you have little kids creating irreplaceable memories that you want to capture in as high a fidelity as possible. And, as usual, Apple and its suppliers have delivered a better lens, a better sensor, and a better image processor, along with image stabilization on both the iPhone 7 and the iPhone 7 Plus (the iPhone 6S did not have image stabilization, while the iPhone 6S Plus did).

The iPhone 7 Plus, though, retains a photographic advantage over its smaller sibling thanks to the fact it actually has two cameras:

iPhone7Plus-JetBlk-34BR-LeanForward_PR-PRINT

One camera uses the familiar 28mm-equivalent lens found on the iPhone 7, while the second has a 56mm-equivalent lens for superior zooming capabilities (2x optical, which also means digital zooming is viable at longer distances). Apple also demonstrated an upcoming software feature that recreates the shallow depth-of-field that is normally the province of large-sensored cameras with very fast lenses:

Screen Shot 2016-09-08 at 7.30.45 PM

This effect is possible because of those two lenses; because they are millimeters apart, each lens “sees” a scene from a slightly different perspective. By comparing the two perspectives, the iPhone 7 Plus’ image processor can build a depth map that identifies which parts of the scene are in the foreground and which are in the background, and then artificially apply the bokeh that makes a shallow depth-of-field so aesthetically pleasing.

Bokeh, though, is only the tip of the iceberg: what Apple didn’t say was that they may be releasing the first mass-market4 virtual reality camera. The same principles that make artificial bokeh possible also go into making imagery for virtual reality headsets. Of course you probably won’t be able to use the iPhone 7 Plus camera in this way — Apple hasn’t released a headset, for one — but when and if they do, the ecosystem will already have been primed, and you can bet FaceTime VR would be an iPhone seller.

Apple’s willingness and patience to lay the groundwork for new features over multiple generations remains one of its most impressive qualities. Apple Pay, for example, didn’t come until the iPhone 6, but the groundwork had already been laid by the introduction of Touch ID and the secure element in the iPhone 5S. Similarly, while Apple introduced Bluetooth beacons in 2013 and the Apple Watch in 2014, the company had actually been shipping the necessary hardware since 2011’s iPhone 4S.5 I wouldn’t be surprised if we look back at the iPhone 7 Plus’ dual cameras with similar appreciation.

The Headphone Jack

In one of the more tone-deaf moments in Apple keynote history, Senior Vice President of Worldwide Marketing Phil Schiller justified the aforementioned removal of the headphone jack this way:

The reason to move on — I’m going to give you three of them — but it really comes down to one word: courage. The courage to move on, do something new, that betters all of us, and our team has tremendous courage.

Schiller should have stuck to the three reasons: the superiority of Lightning (meh), the space gained by eliminating the headphone jack, and Apple’s vision for audio on mobile devices.

Start with the space: getting rid of the headphone jack fits with the multi-year feature creation I detailed above; current rumors are that next year’s 10th-anniversary iPhone will be nothing but a screen. Making such a phone, though, means two fundamental changes to the iPhone: first, the home button needs, well, a new home; last year’s introduction of 3D Touch and the iPhone 7’s force touch home button lay the groundwork for that. That headphone jack, though, is just as much of an impediment: try to find one phone or music player of modern thinness that has the headphone jack under the screen (the best example of the space issues I’m referring to: the 6th generation iPod nano).

Still, that’s speculation; Apple insists iPhone 7 users will see the benefits right away. Apple executives told BuzzFeed that removing the headphone jack made it possible to bring that image stabilization to the smaller iPhone 7, gave room for a bigger battery, and eliminated a trouble-spot when it came to making the iPhone 7 water-resistant. It’s a solid argument, albeit one not quite worth Schiller’s hubris.

That said, the third reason — Apple’s vision of the future — is such a big deal for Apple in particular that I just might be willing to give Schiller a pass.

AirPods and the Future

Jony Ive, in his usual pre-recorded video, introduced the AirPods like this:

We believe in a wireless future. A future where all of your devices intuitively connect. This belief drove the design of our new wireless AirPods. They have been made possible with the development of the new Apple-designed W1 chip. It is the first of its kind to produce intelligent, high efficiency playback while delivering a consistent and reliable connection…

The W1 chip enables intelligent connection to all of your Apple devices and allows you to instantly switch between whichever one you are using. And of course the new wireless AirPods deliver incredible sound. We’re just at the beginning of a truly wireless future we’ve been working towards for many years, where technology enables the seamless and automatic connection between you and your devices.

Putting aside the possibility of losing the AirPods — and the problem that not everyone’s ears can accommodate one shape6 — and it really looks like Apple is on to something compelling. By ladling a bit of “special sauce” on top of the Bluetooth protocol, Apple has made the painful process of pairing as simple as pushing a button. Even more impressive is that said pairing information immediately propagates to all of your Apple devices, from MacBooks to Watch. As someone who has long since moved to Bluetooth headphones almost exclusively7 I can absolutely vouch for Apple’s insistence that there is a better way than wires,8 and the innovations introduced by the AirPod (which are also coming to Beats) help the headphone jack medicine go down just a bit more easily.

What is most intriguing, though, is that “truly wireless future” Ive talked about. What happens if we presume that the same sort of advancement that led from Touch ID to Apple Pay will apply to the AirPods? Remember, one of the devices that pairs with AirPods is the Apple Watch, which received its own update, including GPS. The GPS addition was part of a heavy focus on health-and-fitness, but it is also another step down the road towards a Watch that has its own cellular connection, and when that future arrives the iPhone will quite suddenly shift from indispensable to optional. Simply strap on your Watch, put in your AirPods, and, thanks to Siri, you have everything you need.

Ah, but there is the catch: I have long held up this vision, of pure voice computing, as Apple’s Waterloo. I wrote about it when the the Watch came out:

I also think that when the Watch inevitably gains cellular functionality I will carry my iPhone far less than I do today. Indeed, just as the iPhone makes far more sense as a digital hub than the Mac, the Watch will one day be the best hub yet. Until, of course, physical devices disappear completely:

her-movie-poster

That is the ultimate Apple bear case.

The truly wireless future that Ive hinted at doesn’t just entail cutting the cord between your phone and your headphones, but eventually a future where phones may not even be necessary. Given that Apple’s user experience advantages are still the greatest when it comes to physically interacting with your device, and the weakest when it comes to service dependent interactions like Siri, that is a frightening prospect.

And that is why I ultimately forgive Schiller for his “courage” hubris. To Apple’s credit they are, with the creation of AirPods, laying the foundation for a world beyond the iPhone. It is a world where, thanks to their being a product — not services — company, Apple is at a disadvantage; however, it is also a world that Apple, thanks to said product expertise, especially when it comes to chips, is uniquely equipped to create. That the company is running towards it is both wise — the sooner they get there, the longer they have to iterate and improve and hold off competitors — and also, yes, courageous. The easy thing would be to fight to keep us in a world where phones are all that matters, even if, in the long run, that would only defer the end of Apple’s dominance.

  1. The story has since been updated to have the headline “What’s Really Missing From the New iPhone: Cutting-Edge Design” []
  2. Although an Android version will come at some point in the future []
  3. I will cover this news from Nintendo’s perspective in a future Daily Update []
  4. Sorry Lucid []
  5. That the Apple Watch required the iPhone 5 or later was likely a strategic decision to drive upgrades, although I don’t know for certain []
  6. 😢 []
  7. Beats PowerBeats around town, and the new Bose QC35 noise-cancelling headphones for trips []
  8. That said, the Beats in particular are terrible for music, but I mostly listen to podcasts []

Google, Uber, and the Evolution of Transportation-as-a-Service

In the eight months since I wrote Cars and the Future, there has been an explosion in news about the future of transportation, much of it in the last few weeks:

These five bits of news are presented in roughly the order they matter; Uber and Google matter most of all.

From UberX to Google’s Self-Driving Cars

When thinking about the future of transportation-as-a-service, it’s tempting to draw a straight line from UberX to Google self-driving cars:

stratechery Year One - 287

Uber CEO Travis Kalanick can certainly see the connection; he told Bloomberg earlier this month:

“The minute it was clear to us that our friends in Mountain View were going to be getting in the ride-sharing space, we needed to make sure there is an alternative [self-driving car],” says Kalanick. “Because if there is not, we’re not going to have any business.” Developing an autonomous vehicle, he adds, “is basically existential for us.”

The problem for Uber is that their dominant position in the ride-sharing market is predicated on the two-sided market of riders and drivers, which I explained two years ago in Why Uber Fights:

Driver and rider markets do interact, and it’s that interaction that creates a winner-take-all dynamic…In the case of Uber and Lyft, ride-sharing is (theoretically) habitual, both companies will ensure the prices are similar, and the primary means of differentiation is car liquidity, which works in the favor of the larger service. Over time it is reasonable to assume that the majority player will become dominant.

That is indeed how the ride-sharing market has played out: as of earlier this year Uber provided over 80% of rides in the United States (the only market Lyft competes in), despite Lyft’s determination to spend hundreds of millions in subsidies and free rides. And, on the flipside, Uber left China earlier this month, tired of spending their own billions in a futile attempt to displace the dominant Didi.

Self-driving cars change these market dynamics in two important ways: first, drivers are no longer a scarce resource, which means there are no longer two-sided market forces at play. Second, the single best way to change consumer habits and preferences is through lower prices, and eliminating drivers is the most obvious way to do just that.

Small wonder then that Uber is investing so heavily in self-driving cars, including hiring a huge number of Carnegie Mellon researchers (thus the Pittsburgh location of the self-driving trial), as well as paying ~$680 million for Otto.

Kalanick told Business Insider that Uber is still behind:

I think we’re catching up. Look at some of the folks and how long they’ve been working on it. Lots of respect for an area that they’ve pioneered, and we’ve got to do some catch-up. And that’s OK, but it means we gotta wake up early and we’re going to bed late.

I’ll take Kalanick at his word; Uber, though, still has some very important advantages that make this race a bit more complicated than it seems, and the journey I depicted above a lot less linear than it may appear.

The Five Components of Transportation-as-a-Service

Drivers and riders are important to understanding the future of transportation-as-a-service (TaaS), but they are not the only pieces that matter — and not the only areas where Uber still has an advantage. I see five components that really matter:

  • Drivers
  • Cars
  • Mapping
  • Routing
  • Riders

The shift from an UberX model to self-driving cars will require changes in every component.

TaaS 1.0: UberX

It’s clear why drivers and riders are the most important pieces here: drivers bring their own cars, existing mapping solutions are good enough, and routing is relatively simple. To be sure, that relatively modifier is important: managing millions of matches a day between drivers and riders is a hugely complicated undertaking, and the fact that Uber has been working on the underlying algorithms for years is a big advantage. It’s also an advantage that will become ever more critical.

TaaS 1.5: UberPool

UberPool is arguably the most important service Uber has launched to date, and looking at the pieces that go into it explain why:

  • Drivers: the same as UberX
  • Cars: the same as UberX
  • Mapping: the same as UberX
  • Routing: massive increase in complexity over UberX
  • Riders: change in expectations (and behavior with regard to pick-up and drop-off points) relative to UberX

It’s the routing piece that is the most important; Uber investor Bill Gurley has called the development of the necessary algorithms to make UberPool a success a BHAG: Big Hairy Audacious Goal, and it’s an investment that will be critical for Uber going forward.

First, as Gurley’s title suggests, getting the algorithms behind UberPool right is an incredibly complex problem. It’s basically the traveling salesman problem on steroids, and the only real way to solve it is to slowly but surely work out heuristics that work in real world situations.1 Combine that reality with the fact that Uber has a dominant share of drivers and riders, giving the company sufficient liquidity to offer UberPool in multiple markets, and the result is that Uber is undoubtedly far ahead of competitors — present and potential — in solving these problems.

The reason this matters is that building a self-driving car is like building a smartphone: it’s a hard problem, to be sure, but it’s only half of the equation when it comes to transportation-as-a-service. After all, just how useful would an iPhone or Android device be without the cloud? Similarly, a transportation-as-a-service company built around self-driving cars not only needs cars that can drive themselves, but an entire infrastructure on the back-end that tells those cars exactly where to go in a way that maximizes what will undoubtedly be a massive capital investment in the cars themselves.

This is likely the motivation behind Google’s Waze-based ride-sharing service. Kalanick may be right that Google is ahead when it comes to self-driving cars, but they have a lot of catching up to do when it comes to telling those cars where to go.

TaaS 2.0: Human Self-Driving Cars

One of the more interesting facts about the new Waze service is that it is true ride-sharing: Google is capping the price at 54 cents a mile, which means it’s impossible to make money by simply driving-for-hire. More prosaically, that happens to be the IRS standard mileage rate, which means Google can plausibly claim their service is facilitating, well, ride-sharing and the sharing of gas money without all of the complications of hiring contractors.

Still, true ride-sharing is itself an important transportation-as-a-service evolution that I wrote about last year. In the short to medium-term, catching a ride with someone already headed in your direction actually has even better economics than self-driving cars, given that the car is a sunk cost and the driver is going that way anyways. In that article I called this sort of car-pooling service “human-powered self-driving cars.”

Note that this again marks an important shift in the components in transportation-as-a-service:

  • Drivers: because they are already headed in that direction, they are effectively free
  • Cars: because they have already been bought for the purpose of transporting the driver, they are effectively free
  • Mapping: the same as UberX
  • Routing: slightly more complex than UberPool
  • Riders: similar experience to UberPool

Uber launched UberCommute just a few weeks after that article; given that the economics of UberCommute are approaching those of self-driving cars, that means the company is ahead when it comes to figuring out the business model as well.

TaaS 3.0: Self-Driving Cars

Whenever self-driving cars do arrive, nearly every piece in the transportation-as-a-service puzzle will be different from today’s UberX:

  • Drivers: non-existent!
  • Cars: self-driving, which means they will likely be very expensive at least at the beginning, requiring significant capital costs
  • Mapping: massively more detailed
  • Routing: similar complexity to UberPool
  • Riders: similar economics to UberCommute/Waze

Note that there are two critical leaps that need to be made: cars and maps. Google is clearly well ahead in maps, but Uber is investing $500 million to catch up, even as it does the same for self-driving technology.

The point of this analysis, though, is to highlight that for all the work Uber has to do, they are by no means doomed because of Google’s entry, because there isn’t a straight line from UberX to Google’s self-driving cars:

stratechery Year One - 288

Indeed, Uber has their own advantages in routing, business model, and customer attachment, and those are just as formidable and potentially more defensible than Google’s tech leadership.

Handicapping the Future

With this framework in mind it’s easier to understand why I ranked those five pieces of news the way I did:

  • Ford certainly knows how to build cars, but self-driving technology is a software problem; there is no evidence to suggest that Ford has the capability to leap ahead of Google or Uber. Moreover, while Ford’s relatively slim margins may make a ride-sharing service attractive, nearly every aspect of the company would need to transform itself from a product model to a service model, and that is even less likely than the company leading the way in self-driving technology. I think it is much more likely Ford will eventually partner with Google or Uber as an OEM.
  • Tesla is a much more technologically advanced company than Ford and is already in the mindset of building computers on wheels. Moreover, it has thousands of cars on the road today both capturing data and beta-testing self-driving technology (for better or worse). However, Tesla faces several significant obstacles in building a service business: it has no routing capability; it sells its cars as products, not as a service; and, frankly, it has its hands full building the Model 3 before its negative cash flow catches up to it.2
  • Nutonomy is very interesting, not only because of their technology, but also because of the smart way they are dealing with perhaps the most important piece of transportation-as-a-service: the government. I have argued for years that Singapore was likely to be the first place where self-driving cars take off: the technology already works as long as you get rid of those pesky human drivers, while Singapore has placed strict limits on automobiles for years, and, to put it delicately, Singapore has the government structure to get rid of non-self-driving cars completely. By starting there Nutonomy has a big advantage when it comes to real-world experience and iteration, and could springboard from Singapore to other urban areas.

That leaves Google and Uber, and, despite yesterday’s news, I still like Uber’s chances.

First, it matters that the development of self-driving cars is, in Kalanick’s words, “existential” for the company. Never underestimate the motivating power of simple survival, and, on the flipside, keep in mind how poorly Google has done in any business that is not advertising-based.

Second, I suspect Uber’s routing advantage (as infuriating as it may be when you are matched with a driver who is going the wrong way) is a real one: telling cars where to go at scale is an incredibly difficult problem and Uber has a multi-year head start.

Third, any discussion of the threat self-driving cars poses to Uber tends to imagine a world where there are magically tens of thousands if not millions of self-driving cars everywhere immediately. That simply isn’t practical from a pure logistics standpoint; the time it will take to build all of those cars — and, crucially, get government approval — is time Uber has to catch up.

Moreover, it’s not at all clear that Google will be willing to make the sort of investment necessary to build a self-driving fleet that could take on Uber. The company’s recent scale-back of Google Fiber is instructive in this regard: it is very difficult for a company built on search advertising margins to stomach the capital costs entailed in building out a fleet capable of challenging Uber in more than one or two markets.

Finally, as the incumbent in the transportation-as-a-service space Uber has the advantage of only needing to be good-enough. To the degree the company can build out UberPool and UberCommute, they can ensure that their own self-driving cars get first consideration from consumers trained to open their app whenever they are out and about.

Needless to say, the next few years will be fascinating to watch. The only sure thing is that the Uber-Google battle in particular will be quite the ride.

  1. Machine learning is relatively ineffective at solving this specific type of problem []
  2. One company I haven’t mentioned is Apple, but I put them in the same category as Tesla: they are a product company with legitimate questions about their cloud capabilities []

The Sports Linchpin

In an interview over the weekend with Richard Deitsch of Sports Illustrated, Chairman of the NBC Sports Group Mark Lazarus declared himself very satisfied with how the Rio Olympics have gone for NBC:

“I’m obviously biased but I believe once again we have created a masterful production job, from the quality of production, the quality of storytelling, our preparedness for whatever stories developed as evidenced by what people are seeing on all of their screens,” says Lazarus.

“Everyone is talking about these Olympics versus London. London was an A+ and Rio is an A. It’s been really good for us, and as media habits as evolved, we have evolved and are leading with some of the ways we are structuring our programming.”

The London comparison has been a tough one for NBC, at least in the ratings department. Even with the benefit of showing Usain Bolt live in prime time for the first time, NBC’s Sunday night telecast earned a 14.9 rating and 26.7 million viewers, down from a 17.5 rating and 31.3 million viewers for the same night four years ago, and a 16.0 rating and 27.2 million for the Beijing Olympics eight years ago. In fact, it was the lowest rated middle Sunday since 1984 (the addition of streaming and alternate channels improved the numbers somewhat, but they were still less than either of the last two Olympics); nearly every night of coverage has seen similar declines, resulting in an average of 17% fewer viewers than four years ago.

And yet, Lazarus has good reason to be pleased: NBC sold $1.2 billion worth of ads before the Olympics even started, 20% over London’s pace, and while NBC may need to offer some “make-good” spots to those advertisers to make up for lower ratings, the total amount of advertising1 is expected to surpass London’s $1.33 billion, leading Lazarus to declare on a conference call that “this will be our most economically successful Games in history.”

This bifurcation between viewership and profitability is a fascinating one: how is it that NBC can sell more ads for more money for fewer viewers? The answer is very much in line with what has become a theme for Stratechery this summer: NBC’s advertisers have nowhere else to go.

The Symbiosis of TV and Its Advertisers

In TV Advertising’s Surprising Strength — And Inevitable Fall I noted that TV’s biggest advertisers were all (unsurprisingly) predicated on scale and serving the mass market; the list was dominated by industries like consumer packaged goods, telecoms, automobiles, retailers, and credit card companies. Those same industries dominate Olympic advertising; according to Kantar Media the top ten Olympic advertisers include General Motors and BMW (automobiles), P&G (CPG), AT&T (telecoms), and Visa (credit cards), and while no retailer cracks the top ten, the retailer category is the second biggest spender overall.

The big takeaway from that article was not only that the traditional TV industry is intertwined with its advertisers, but that the forces chipping away at TV viewership, particularly amongst young people, were acting on TV’s advertisers’ as well; the next few weeks gave several examples, including Unilever’s relatively cheap acquisition of Dollar Shaving Club and Walmart’s (expensive) acquisition of Jet.com. Yes, there are digital ad dollars to be had from the old guard, but maybe less than expected; probably the biggest opportunity for Facebook et al will be companies predicated on the social network’s existence.

Still, the symbiosis of TV and its advertisers paradoxically meant that both would likely stay stronger longer than you might expect; it’s easy to envision a future of fully on-demand streaming and digital advertising from niche products delivered via e-commerce, but less clear is what will be the triggering event that gets us from today’s post-war landscape to that future. That’s why I’m so interested in these ratings.

The Sports Linchpin

The importance of sports to TV is well known, but perhaps not fully appreciated; when I wrote three years ago that live sports were perhaps the most irreplaceable “job” done by TV the context was the sustainability of the cable bundle. Pressure on said bundle continues to grow, yet so do the affiliate fees charged by sports networks: last year ESPN had by far the highest fees and the biggest increase, followed by TNT (basketball) and the NFL Network. The story is even starker when you include regional sports networks.

That said, the secular shift to a subscription model for television (whether affiliate fees or direct subscriptions) is a broad-based one; what makes sports unique is that it is also the most important category for TV’s other big revenue stream — advertising. For broadcast networks, sports accounts for 37% of ad revenue, up from 29% five years ago; this despite the fact sports only makes up between 10%-12% of programming. Sports-focused cable channels make big bucks off of advertising as well, led by ESPN with $2.4 billion (plus $360 million for ESPN2) and $407 million for the NFL Network. Basically, sports advertising is growing for everyone (from a 4% compound annual growth rate for Fox to 15% for NBC), while non-sports advertising has decreased by a 1% rate over the same five year period.

The reason to point out all of these facts that you probably already know, at least in broad strokes, is this: I would argue sports are the linchpin holding the entire post-war economic order together. Because sports are consumed live, with significantly higher advertising load and viewer retention, sports are increasingly the only viable place for mass-market consumer companies to reach customers at scale and fight off niche e-commerce companies slicing off their customer base. That in turn helps preserve retailers, themselves both big advertisers and big targets for internet-based companies, particularly Amazon, and so on down the line. This effect is magnified by sports’ role in preserving the cable bundle, which keeps more channels — and thus more inventory — viable (not to mention that some of TV’s biggest advertisers — entertainment companies — also own the cable channels).

This raises big questions about NBC’s disappointing Olympic numbers: if sports are losing their hold on the population broadly then entire industries are at risk, not just NBC.

Good and Bad News

That said, it’s probably too soon to panic: the easiest explanation for these numbers is that NBC is violating the biggest precept underlying sports’ continued strength, which is being live. In 2005 14% of the top 100 programs watched lived were sports; last year, thanks to the rise of first DVRs and later streaming, that percentage had risen to an incredible 93%.2 I certainly understand that a sport like gymnastics is difficult to show live even if it took place in primetime instead of the afternoon, but getting a push notification about the results hours before it airs can’t help but depress viewership; true, the Internet has been around for a while and NBC has used tape delay for decades, but over the last four and especially eight years it has become exponentially more difficult to avoid the results of events you didn’t even know you wanted to watch until NBC stuck them in front of you. Certainly this new reality is bad news for NBC, and calls into question Lazarus’ description of NBC’s production as “masterful”,3 but everyone else dependent on sports can breathe easier.

Not too easy though: NBC’s numbers are far worse amongst younger viewers. That 17% ratings slump over the first 10 days is 25% when you consider only 18-49 years olds, echoing a pattern seen amongst other major sports including the most important sport of all in the U.S., American football. Yes, the NFL has record ratings, but over the last ten years the average viewer has increased in age from 43 to 47 (admittedly, that’s not nearly as bad as baseball’s increase from 46 to 53; basketball has stayed steady at 37), while streaming alternatives like Twitch (8.5 million daily users in 2015, mostly 18-49 males) are skyrocketing in popularity. In short, it’s not clear why over the long run sports should be exempt from the explosion in alternatives that have fractured markets for every other post-war institution.

Young people are still following the Olympics: NBC’s streaming is up significantly, and 50 million people are watching Olympics highlights on Snapchat. The latter data point, though, indicates a deeper weakness: the demotion of sports from mass media centerpiece to just another bit of content available on an aggregator. That’s why this was the most worrisome thing Lazarus said on the aforementioned conference call:

[The] NBC broadcast is not the only way people are consuming the Olympics, just as newspapers and magazines are not only consumed in print. While primetime broadcast TV viewing on NBC will remain the biggest way that people consume the Olympics, we also understand that to millenials and younger viewers, primetime is really, quote/unquote, “my time”. They want to watch on their terms, and that’s why moving forward we’ll continue to adapt to viewer behavior with our coverage on multiple platforms.

Here’s a rule of thumb: anytime you compare your situation to newspapers and magazines, you have a big problem; yes, publishers of all types have a far bigger audience than ever before, but their business is no longer a canvas for advertisers but content for Facebook. One of the biggest questions in my mind — and what should be the biggest question in the mind of executives everywhere — is whether or not sports broadly is on the same path: must-see TV today, just another stream on Snapchat tomorrow. The implications of the latter for industries everywhere cannot be overstated.

  1. Including digital and affiliate advertising []
  2. Via Nielsen []
  3. To be fair, NBC is streaming all events live []

Walmart and the Multichannel Trap

In February 1991, the very month that Walmart overtook the most iconic American retailer in sales, Sears spokesman Jerry Buldak told the Philadelphia Inquirer that the companies couldn’t really be compared:

“We feel the mission of Sears is to be an integrated, powerful specialty merchant, with brand names and our own lines of exclusive merchandise,” company spokesman Jerry Buldak said. “We feel that distinguishes us from other retail specialty stores or discount chains.”

No other retailer, he said, offers customers as much under one roof: insurance and other financial services, Sears’ own credit-card operation, with more than 28 million customers, and a nationwide repair network to service merchandise.

Twenty-five years later the solipsism of Buldak’s statement remains remarkable, especially since Sears’ demise had been set in motion 29 years earlier.

1962 was perhaps the most consequential year in retailing history: in Ohio the five-and-dime retailer F.W. Woolworth Company created a new discount retailer called Woolco; S.S. Kresge Corporation created Kmart in Michigan; the Dayton Company opened the first Target in Minnesota; and Sam Walton founded the first Walmart. All four were based on the same premise: branded goods didn’t need the expensive overhead of mass merchandisers, which meant prices could be lower. Lower prices served in turn as a powerful draw for customers, driving higher volumes, which meant more inventory turns, which increased profitability.

Sears, which had introduced a huge number of those brands to America’s middle class,1 first through their catalog and then through a massive post-World War II expansion into physical retail, was stuck in the middle: higher prices than the discounters, but much less differentiation than high-end department stores. By the time Buldak gave his statement the company’s fate as an also-ran was sealed, even though no one at Sears had a clue: Buldak’s stated mission of being “an integrated, powerful specialty merchant, with brand names and our own lines of exclusive merchandise” failed to consider whether customers gave a damn.

Walmart in the Middle

There is certainly an echo of history in Amazon’s rise; over time the one-time bookseller has developed a dominant strategy that resembles Sears in its heyday: lower prices and better selection, and over the past few years especially, incredible convenience. Walmart has felt the pain for a while, at least in its stock price: Amazon overtook the largest retailer in market cap last summer, just in time for Walmart’s sales to flatten or even drop; in May the company reported a 1.1% decline in year-over-year same store sales in the U.S., the fourth poor quarter in a row.

Walmart is stuck in a new middle, surrounded not just by old competitors like Target, but new ones like Kroger (groceries have provided much of Walmart’s recent sales growth), deep discounters like Aldi, club-based retailers like Costco, and convenience-focused drugstores. Looming above all of them, though, is Amazon.

Walmart, which launched its first online site back in 1999, has consistently told investors it can handle the threat. In the clearest articulation of a strategy that has been repeated on earnings calls ad nauseum, then-CEO of Walmart.com in the U.S. Joel Anderson told investors on a 2011 analyst call:

One of our key pillars of digital success and differentiation will be about building a continuous channel approach. Specifically, I’d like to share with you the progress we have made in 3 areas to leverage our multichannel for the U.S. business.

The first of those areas is around the idea of assortment. It is our role online to extend that shelf in the stores. The offline merchants here in Bentonville set the strategy, and then it’s our job to broaden that assortment…

Secondly, I want to focus on access. Several pilots are currently in place to leverage our ship-from-store capabilities. We will offer next-day delivery at a very economical price. We will use these capabilities to reach customers in urban areas that we have not yet penetrated.

The third area is fulfillment. We already have unlimited assets in place, nearly 4,000 stores, over 150 DCs. This will give us the flexibility to offer our customers best-in-class delivery options.

For example, last week, we transitioned several disparaged shipping offers into one comprehensive fulfillment program. We are now offering 3 compelling free shipping programs. This is an excellent example of multichannel strategy beginning to come to life.

The fulfillment program Anderson went on to describe was ridiculously complex: “fast” shipped anything online to your local store, “faster” shipped a smaller selection to your house, while “fastest” made an even smaller selection available for pickup the same day. Anderson concluded:

“Fast, faster, fastest. What a great example of a continuous channel experience that cannot easily be replicated.”

What a positively Buldakian statement! Of course such an experience “cannot easily be replicated”, because who would want to? It was, like Sears’ “socks-to-stocks” strategy, driven by solipsism: instead of starting with customer needs and working backwards to a solution, Walmart started with their own reality and created a convoluted mess. Predictably it failed.

The Multichannel Trap

The problems with Walmart’s original approach were threefold:

  • It was confusing: “Fast faster fastest” and its various iterations put all of the onus on customers to figure out what worked best for them, and for which items. Why, though, should customers bother? If they want to buy something in person, go to Walmart. If they want it delivered, go to Amazon. You know exactly what you will get from both experiences (which, by extension, favors Amazon in the long run).

  • It was complicated: Much of Walmart’s economic might derived from a logistics system that included distribution centers serving clusters of stores, connected by Walmart’s own trucking fleet (and before the Internet, the world’s largest private satellite communication network). That seems on the surface like a useful tool for e-commerce, until you get into the reality that shipping individual items at all hours is a very different problem than shipping pallets to stores once a day (I would analogize it to Microsoft trying to port the Start menu from the desktop to a mobile phone), and solving for one business increases costs and complexity for the other.

  • It was confined: This is where the Sears story comes full circle: Walmart spent decades building stores in smaller cities, not only killing off less efficient local retailers but also removing the need to visit mass merchandisers in the big city. The company still has not fully penetrated some urban areas, but more than enough urbanites drive out to Walmart and its competitors to have all but killed Sears, JC Penney, etc.

    Now Amazon is doing the same to Walmart, but in this case the encirclement has been multidimensional: delivery of just about anything everywhere at prices that are usually hard to beat (and again, Prime customers aren’t even checking), and, over the last few years, within two days at worst, two hours at best.

Walmart is finally responding in a meaningful way, buying Jet.com for $3.3 billion, and I laid out on Thursday why the deal makes sense for Walmart, Jet.com, and especially the latter’s investors. Said investors were made whole, Jet.com has access to Walmart’s deep pockets and a much more cost-effective way than advertising to get customers’ attention, while Walmart finally has the executives, technology, and infrastructure to do e-commerce properly — with laser focus.

Amazon’s Inevitability

Still, chances of success are low, because both Walmart and Jet have a business model problem, not unlike the one Walmart imposed on Sears. In that case Walmart cut margins and made up for it with inventory turns; still, at the end of the day their profitability came from their markup margin on 3rd-party goods.

Amazon, meanwhile, is transitioning to a new model completely. As I laid out in March the vast majority of Amazon’s products are increasingly sold with little to no margin at all: profitability comes from fees paid by third-party merchants and Prime subscriptions. It is a model that is completely dependent on scale, and the lower the margin and thus prices, the higher Amazon’s volume, which means ever more leverage from Amazon’s massive fixed costs in infrastructure and logistics.

Unfortunately for Walmart, Jet.com, and any other would be competitors, it’s starting to pay off in a major way: while AWS has been demonstrating the power of scale for a while, it is just this year that Amazon Retail is showing the same sort of returns. Amazon Retail’s operating margin in the second quarter was 2.09%, which sounds minuscule until you realize that is a 181% increase over the year-ago quarter; the first quarter operating margin was 1.73%, a 499% increase.

True, that’s not nearly as good as Walmart’s 4.6% first quarter operating margin, but for Jeff Bezos said margin was plenty of opportunity; for Walmart, led astray by the all-too-natural instinct to start with the model you have instead of with the customer, it represented too much of a liability.

  1. In addition to building their own []