It was a bit surreal to see Facebook founder and CEO Mark Zuckerberg traipsing around the F8 stage carrying an “engine pod” for a Facebook drone designed to beam the Internet to the one billion people Zuckerberg said could not be online due to a lack of access. Zuckerberg himself clearly felt the same way, remarking that “If you had told me 12 years ago that one day Facebook was going to build a plane, I would have told you that you were crazy.”

Still, it makes sense: Facebook has from day one been about getting people online.

Thefacebook

Twelve years ago Zuckerberg started Thefacebook — the company would switch its name a year later — at Harvard as the online version of the freshman facebook that Harvard distributed in print; to join you had to have a Harvard email address and use your own name. But of course you wanted to do exactly that: as Amelia Lester, who would go on to be the long-time managing editor of The New Yorker, wrote in a remarkably insightful column in The Harvard Crimson:

The thefacebook.com scene includes reams of carefully coiffed, immaculately manicured, evening-garbed Harvard students grinning eagerly on page after page as we present our own ideal image of selfhood to fellow browsers…every profile is a carefully constructed artifice, a kind of pixelated Platonic ideal of our messy, all-too organic real-life selves who don’t have perfect hair and don’t spend their weekends snuggling up with the latest Garcia Marquez…There are plenty of other primal instincts evident at work here: an element of wanting to belong, a dash of vanity and more than a little voyuerism probably go a long way in explaining most addictions (mine included). But most of all it’s about performing — striking a pose, as Madonna might put it, and letting the world know why we’re important individuals.

For the next several years, that’s all Thefacebook was: a collection of profile pages that gave individuals the opportunity to present their best selves for the perusal and approval of those in their network. And people could not get enough: Thefacebook methodically spread from college to college, usually signing up the vast majority of students in a matter of weeks if not days.

The phenomenon, according to The Facebook Effect author David Kirkpatrick, was surprisingly one that didn’t appeal that much to Zuckerberg. Kirkpatrick wrote:

Ironically, Zuckerberg was not a heavy user of Thefacebook. Nor, in fact, were any of its founders and early employees. [The summer of 2004] the interns, working with Moskovitz, started to gather data on how people actually used the site. They found that some users were looking at hundreds and even thousands of profiles every day. These were the users they were designing for.

Kirkpatrick noted that Zuckerberg was splitting his time between Thefacebook and a service called Wirehog that enabled peer-to-peer sharing amongst Thefacebook users, something that Zuckerberg was much more interested in personally. Zuckerberg would eventually be persuaded to give up the side project, but this would not be the last time Zuckerberg’s interest in sharing would seem to run counter to Thefacebook’s focus on enabling people to put themselves — their best selves — online.

The Power of Identity

As Lester astutely noted, the identity we build for ourselves on Facebook is our own projection of how we want others to see us, and it has been core to the service from the beginning. Kirkpatrick writes:

Perfecting the details of your own profile in order to make yourself a more attractive potential friend occupied a considerable amount of time for many of these newly networked Ivy Leaguers. Find exactly the right picture. Change it regularly. Consider carefully how you describe your interests. Since everyone’s classes were listed, some students even began selecting what they studied in order to project a certain image of themselves. And many definitely selected classes based on who Thefacebook indicated would be joining them there…Your “facebook,” as profiles on the service began to be called, increasingly became your public face. It defined your identity.

Moreover, Zuckerberg was insistent from the beginning that said identity not be split. Kirkpatrick again:

“You have one identity,” [Zuckerberg] says emphatically three times in a single minute during a 2009 interview. He recalls that in Facebook’s early days some argued the service ought to offer adult users both a work profile and a “fun social profile.” Zuckerberg was always opposed to that. “The days of you having a different image for your work friends or co-workers and for the other people you know are probably coming to an end pretty quickly.”

The power of this approach cannot be overstated: as Lester observed, from a product perspective both vanity and voyeurism are powerful drivers of engagement. It’s also a goldmine when it comes to advertising: the lead that Facebook has over everyone, including Google, when it comes to targeting advertisements is huge. The service knows exactly who you are, exactly what you like, exactly where you live, work, and went to school, all because you told them yourself. And yes, some of your “interests”, particularly in those early days, may have been more aspirational than realistic, but from an advertiser’s perspective, all the better: aspiration is exactly what they sell.

The News Feed Rubicon

It was ten years ago, in September 2006, that Facebook became the product we know today: that is when the News Feed was introduced. Now, instead of needing to proactively visit the profile pages of all your friends to discover what had changed, Facebook would use an algorithm to proactively tell you what changes you might be interested in.

The effect of the News Feed was massive: engagement immediately skyrocketed from already unseen levels, and I have previously argued that the algorithmic nature of Facebook’s feed was a core reason why the service squashed Twitter. Even more important is what the News Feed meant to the bottom line: a feed is the best place to place advertising, especially on mobile, and Facebook has spent the last several years drawing down its old display ad inventory even as News Feed ads continue to grow both in inventory and in price.

The News Feed, though, came at a cost: while Facebook information had always been public to your network,¹ the fact that what you posted was being pushed out to people who were “Facebook Friends” but not necessarily real friends was a wake-up call to Facebook users. There were immediate protests, which Facebook rather astutely tamped down, but the longer-term repercussions were real. Kirkpatrick notes:

When people can see what you are doing, that can change how you behave. The reason the News Feed evoked something as intrusive as stalking was that each individual’s behavior was now more exposed. It was as if you could see every single person you knew over your backyard fence at all times. Now they could more easily be called to account for their actions.

Over the next several years a rash of incidents in which people lost their jobs, were denied entry to college, or simply got in hot water with someone close to them were a common media trope. President Obama told a group of high school students in 2009, “I want everybody here to be careful about what you post on Facebook.”

Facebook’s Closed Door

The core of Facebook’s value is its ownership of identity of every person online. To that end, while a drone plane may have been unimaginable in 2004, it fits: the only thing lacking when it comes to Facebook’s role as the Internet phone book are the missing entries for the 4 billion people who are not yet online.

In fact, the most unbelievable part of Zuckerberg’s presentation came a few minutes later, when he discussed Live Video:

People love going live because it’s so unfiltered and person and you feel like you’re just there hanging out with your friends. In a funny way, we’ve found that Live takes some of the pressure off of having to find that perfect photo or video, because everyone knows that it’s live and it’s not curated.

There is, in the subtext of Zuckerberg’s description, an acknowledgment of the need to project your best self that has always been at the root of Facebook, something the News Feed changed from an incentive to an imperative. It is the very thing that fueled the rise of Snapchat, and make no mistake, the selfie-sharing app has Facebook spooked.

Last week The Information reported that Facebook was struggling to stop the decline in “original” sharing — content that users generate themselves, as opposed to sharing a link or a viral video. Bloomberg added a day later:

People have been less willing to post updates about their lives as their lists of friends grow…Instead, Facebook’s 1.6 billion users are posting more news and information from other websites. As Facebook ages, users may have more than a decade’s worth of acquaintances added as friends. People may not always feel comfortable checking into a local bar or sharing an anecdote from their lives, knowing these updates may not be relevant to all their connections.

According to one of the people familiar with the situation, Facebook employees working on the problem have a term for this decline in intimacy: “context collapse.” Personal sharing has shifted to smaller audiences on Snapchat, Facebook’s Instagram and other messaging services.

This is the price of owning identity — of owning all the value that Facebook generates from advertising in its News Feed — and there is no going back.

The Bifurcation of Social

It is increasingly clear that there are two types of social apps: one is the phone book, and one is the phone. The phone book is incredibly valuable: it connects you to anyone, whether they be a personal friend, an acquaintance, or a business. The social phone book, though, goes much further: it allows the creation of ad hoc groups for an event or network, it is continually updated with the status of anyone you may know or wish to know, and it even provides an unlimited supply of entertaining professionally produced content whenever you feel the slightest bit bored.

The phone, on the other hand, is personal: it is about communication between you and someone you purposely reach out to. True, telemarketing calls can happen, but they are annoying and often dismissed. The phone is simply about the conversation that is happening right now, one that will be gone the moment you hang up.

In the U.S. the phone book is Facebook and the phone is Snapchat; in Taiwan, where I live, the phone book is Facebook and the phone is LINE. Japan and Thailand are the same, with a dash of Twitter in the former. In China WeChat handles it all, while Kakao is the phone in South Korea. For much of the rest of the world the phone is WhatsApp, but for everywhere but China the phone book is Facebook.

This isn’t a bad thing; indeed, it is an incredibly valuable thing: Facebook’s status as a utility is exactly what makes the company so valuable. It has the data to target advertising and the feed in which to place it, and it is difficult to imagine any of the phone companies overtaking it in value.

This is why I wrote almost exactly a year ago that Facebook should embrace its position as being something more than just a social network. From Facebook and the Feed:

It’s not inconceivable that, at some point in the relatively near future, it is Facebook that is the default advertising medium, commanding dollars that exceed its already dominant share of attention. Still, this outcome depends on Facebook driving ever-more engagement, and I’m not convinced that more “content posted by the friends [I] care about” is the best path to success.

Everyone loves to mock Paul Krugman’s 1998 contention about the limited economic impact of the Internet:

The growth of the Internet will slow drastically, as the flaw in “Metcalfe’s law”–which states that the number of potential connections in a network is proportional to the square of the number of participants–becomes apparent: most people have nothing to say to each other!

It’s worth considering, though, just how much users value what their friends have to say versus what professional media organizations produce…Was Krugman wrong because he didn’t appreciate the relative worth people put on what folks in their network wanted to say, or because he didn’t appreciate that people in their network may not have much to say but a wealth of information to share?

I suspect that Zuckerberg for one subscribes to the first idea: that people find what others say inherently valuable, and that it is the access to that information that makes Facebook indispensable. Conveniently, this fits with his mission for the company. For my part, though, I’m not so sure. It’s just as possible that Facebook is compelling for the content it surfaces, regardless of who surfaces it. And, if the latter is the case, then Facebook’s engagement moat is less its network effects than it is that for almost a billion users Facebook is their most essential digital habit: their door to the Internet.

In that piece I said that Facebook had a choice: try to restore its ownership of personal updates, or embrace its status as a utility. Here’s the funny thing about choices, though: all too often the choice is not about choosing one path or another, but about accepting reality sooner rather than later.

The truth is that Facebook chose its path way back in 2004, and cemented it in 2006: it was the place you publicly shared your identity with the world, and you had best take care exactly what that identity was. No amount of live video or original sharing prompts will change that reality, and that’s ok. If anything the real danger to Facebook is that the act of banging their collective head on a closed door will start to damage the utility of, well, their utility.

Clearly there are parts of Facebook that get this: David Marcus, for example, is pursuing a very smart strategy in his attempt to position Messenger as a transaction medium between businesses and individuals. It plays perfectly to Facebook’s strengths, and as WeChat has demonstrated in China, it can be very lucrative. Still, though, for all of the brilliance and strategic acumen he has shown to date, I worry about Zuckerberg. He opened his keynote with a surprisingly political plea to avoid the Trump-ian rhetoric around building walls:

If the world starts to turn inwards, then our community will just have to work even harder to bring people together. That’s why I think that the work that we’re all doing is so important, because we can actually give more people a voice. Instead of building walls we can help people build bridges, and instead of dividing people we can help bring people together. We do it one connection at a time; one innovation at a time; day after day after day. And that’s why I think the work that we’re all doing together is more important now than it’s ever been before.

Leaving aside the irony that Facebook has arguably played a role in Trump’s rise, the reality is that not everyone wants to build bridges all the time. Zuckerberg’s insistence that every individual on Facebook have one identity may have been a masterstroke when it comes to building value, but the truth is each of us contains multitudes: there are parts we want to show the world, and parts we want to show only our closest friends, and the sooner Facebook accepts they can’t have everything the more valuable the parts they own will become.

1. And Facebook actually included relatively granular privacy controls from the start [↩]

Let’s start with the caveats: no, Tesla did not sell 276,000 Model 3’s in three days;¹ that is the number of fully refundable pre-orders that required a deposit of “only” $1,000.² And yes, Tesla has a history of delivering cars late and with a higher price than expected. Moreover, given the fact that Tesla only delivered just over 50,000 cars last year, no matter how quickly Tesla scales it will almost certainly be years before this first week of reservations is fulfilled, and even then Tesla will only control a fraction of the car market.

With that out of the way, can we marvel at what Tesla and CEO Elon Musk have accomplished? Nearly 300,000 people have willingly parted with $1,000 despite the fact they will not have a chance to purchase a car for years; an astounding 115,000 of them sent in their deposit before they even knew what the car looked like. A friend got in line to make his reservation at 6:45am and there were 123 people in front of him. This is, no matter how you measure it, a phenomenon that is nearly unprecedented; the only possible comparison is Apple and its iPhone.

Long lines and fans committed to ordering new products sight-unseen are not the only things Tesla and Apple have in common: both companies have been doubted for allegedly not understanding Disruption Theory; both, though, are proving that Disruption Theory does not have all the answers, particularly when it comes to consumer markets.

The iPhone and Disruption

Back in 2013 I wrote What Clayton Christensen Got Wrong, specifically about Apple and the iPhone:

Christensen’s theory is based on examples drawn from buying decisions made by businesses, not consumers. The reason this matters is that the theory of low-end disruption presumes:

• Buyers are rational
• Every attribute that matters can be documented and measured
• Modular providers can become “good enough” on all the attributes that matter to the buyers

All three of the assumptions fail in the consumer market, and this, ultimately, is why Christensen’s theory fails as well…

My conclusion was that the iPhone was, contrary to the then-conventional wisdom, not likely to suffer from low-end disruption, and not only has that proven to be correct, Apple has in fact expanded its global marketshare. And now, with the iPhone SE, Apple is expanding the high end to a price point accessible to customers in developing markets who very much want an iPhone but simply don’t have the means to afford top-of-the-line prices.

It’s this latter point — that a high-end approach can drive growth at lower price points — that seems particularly pertinent to the Model 3.

Tesla’s Master Plan

During Thursday’s Model 3 introduction Musk referenced Tesla’s “secret master plan,” which he laid out in a blog post back in 2006. Musk wrote:

The initial product of Tesla Motors is a high performance electric sports car called the Tesla Roadster. However, some readers may not be aware of the fact that our long term plan is to build a wide range of models, including affordably priced family cars…Critical to making that happen is an electric car without compromises, which is why the Tesla Roadster is designed to beat a gasoline sports car like a Porsche or Ferrari in a head to head showdown. Then, over and above that fact, it has twice the energy efficiency of a Prius…

The strategy of Tesla is to enter at the high end of the market, where customers are prepared to pay a premium, and then drive down market as fast as possible to higher unit volume and lower prices with each successive model…The second model will be a sporty four door family car at roughly half the $89k price point of the Tesla Roadster and the third model will be even more affordable.

In keeping with a fast growing technology company, all free cash flow is plowed back into R&D to drive down the costs and bring the follow on products to market as fast as possible. When someone buys the Tesla Roadster sports car, they are actually helping pay for development of the low cost family car.

Leaving aside the fact that the “sporty four door family car” costs $25,000 more than Musk’s promise,³ the strategy seems to have worked: Tesla, with a detour to build the Model X crossover along the way, has moved down the cost curve culminating in the announcement of the affordable Model 3.

A closer look, though, suggests that Musk painted too rosy a picture when it comes to the Master Plan’s funding: while Tesla’s cars have, from 2009 on, been sold at a profit, the company has still lost significant amounts of money every year. The reality is the company’s significant research and development costs have been paid for by issuing stock and incurring debt, not the profits of high-end models.

Low End Dogma

Given Tesla’s finances, it’s tempting to ask why the company didn’t simply start with the low-end; indeed, researchers at Christensen’s Forum for Growth and Innovation argued last year that a better approach to the electric vehicle market would be exactly that. From a Harvard Business Review article entitled Tesla’s Not as Disruptive as You Might Think:

It [is] clear that Tesla is not a disrupter. It’s a classic “sustaining innovation” — a product that, according to Christensen’s definition, offers incrementally better performance at a higher price…because it’s a sustaining innovation, theory predicts that competitors will emerge. Our analysis concludes that a competitive response won’t happen until Tesla expands outside its current niche of people who prefer electric vehicles to gas-powered cars — but if it expands by creating more variety (such as SUVs) and more-affordable vehicles, competition will be fierce.

Instead the research team suggested the better route for electric vehicles would be “neighborhood electric vehicles”, which are pretty much the exact opposite of a Tesla: the article describes them as “a low-speed vehicle that resembles a souped-up golf cart.”

Don’t feel bad if you haven’t heard of neighborhood electric vehicles: Global Electric Motorcars, featured in the article’s sidebar, have only sold 50,000 vehicles in 17 years, despite the fact they cost around a tenth as much as a Model S. Tesla, meanwhile, sold over 50,000 Model S’s last year alone; its growth rate relative to its competitors was especially impressive. This table about large luxury vehicles in the U.S. is from the company’s February 2016 letter to investors:

One would think the other car companies in this table would be incentivized to respond, no? Yet Tesla is not being out-competed, and they sure as heck aren’t selling glorified golf carts:

The truth is that the HBS Growth and Innovation Forum team is right: Tesla is not disruptive. Rather, their error was a repeat of the mistake Christensen made with the iPhone; first, they don’t understand why people buy Teslas, and two, they assume that disruption is the only viable strategy to enter a new market.

The Power of Best

When it comes to the iPhone I have argued that Apple’s smartphone was, relative to the phones on the market, Obsoletive: the iPhone effectively reduced the phones that came before it to apps on a general purpose computer, justifying a higher price even as it made cheaper incumbents obsolete.⁴

This doesn’t quite work for Tesla: at the end of the day a Model S is still doing the same job as a traditional BMW or Mercedes-Benz. It just does it better: a Model S accelerates faster, it has more storage, it has innovative features like limited auto-pilot and a huge touch-screen interface, and you don’t have to stop at the gas station. Most importantly, though, it is a Tesla.

The real payoff of Musk’s “Master Plan” is the fact that Tesla means something: yes, it stands for sustainability and caring for the environment, but more important is that Tesla also means amazing performance and Silicon Valley cool. To be sure, Tesla’s focus on the high end has helped them move down the cost curve, but it was Musk’s insistence on making “An electric car without compromises” that ultimately led to 276,000 people reserving a Model 3, many without even seeing the car: after all, it’s a Tesla.

From Clean Slates to Free Passes

Last month Wired wrote an article entitled How GM Beat Tesla to the First True Mass-Market Electric Car:

The electric car business has taken the form of an old-fashioned race for a prize…but now it looks pretty clear who the winner will be. And it ain’t Tesla.

General Motors first unveiled the Chevy Bolt as a concept car in January 2015, billing it as a vehicle that would offer 200 miles of range for just $30,000 (after a $7,500 federal tax credit). Barring any unforeseen delays, the first Bolts will roll off the production line at GM’s Orion Assembly facility in Michigan by the end of 2016. As Pam Fletcher, GM’s executive chief engineer for electric vehicles, recently put it to me with a confident grin: “Who wants to be second?”

Good for GM, but I’m afraid the company — and Wired — missed the plot; as the article notes an optimistic goal for the Bolt is 50,000 units a year, and I’d bet the under: at the end of the day the company is still selling a relatively slow and ugly Chevrolet. Brand and reputation matters far more than being “first” to a product category where every model on the market has fallen short of expectations — except for Tesla.

To that end, the significance of electric to Tesla is that the radical rethinking of a car made possible by a new drivetrain gave Tesla the opportunity to make the best car: there was a clean slate. More than that, Tesla’s lack of car-making experience was actually an advantage: the company’s mission, internal incentives, and bottom line were all dependent on getting electric right.

Again the iPhone is a useful comparison: people contend that Microsoft lost mobile to Apple, but the reality is that smartphones required a radical rethinking of the general purpose computer: there was a clean slate. More than that, Microsoft was fundamentally handicapped by the fact Windows was so successful on PCs: the company could never align their mission, incentives, and bottom line like Apple could.

To be sure, what Tesla and Apple have accomplished is not easy, and ongoing success is not guaranteed, particularly at lower price points. I think, though, Tesla, like Apple before them, has more control of their destiny than it may appear. Writing about Apple in an article called Best I said:

As nearly every other consumer industry has shown, as long as there is a clear delineation between the top-of-the-line and everything else, some segment of the user base will pay a premium for the best. That’s the key to Apple’s future: they don’t need completely new products every other year (or half-decade); they just need to keep creating the best stuff in their categories. Easy, right?

It is, in fact, devilishly hard; indeed Apple’s software quality has, in the eyes of many observers, declined the last few years. The company, though, has been synonymous with “best” for so long that they have time to get it right, and millions of new customers who can’t wait to buy their first iPhone; Tesla will likely receive similar grace when and if the Model 3 comes in late and over its promised price. After all, it will still be a Tesla.

1. Elon Musk has promised an update on first week reservations tomorrow [↩]
2. Obviously $1,000 is a fairly substantial amount of money; it is, though, a mere 3% of the promised base price of $35,000 (before any applicable tax credits) [↩]
3. Although the Model S was originally available for $59,900, “only” $15,000 more than Musk’s promise; then again, the Tesla Roadster ended up costing $20,000 more too [↩]
4. Yes, smartphones were disruptive to PCs, as Christensen later acknowledged; this, though, does not explain why Nokia and Blackberry in particular were so devastated [↩]

The idea that Asian messaging apps are a model for Western social media companies is widespread at this point.¹ As I noted two years ago in Messaging: Mobile’s Killer App:

While the home telephone enabled real-time communication, and the web passive communication, messaging enables constant communication. Conversations are never ending, and friends come and go at a pace dictated not by physicality, but rather by attention. And, given that we are all humans and crave human interaction and affection, we are more than happy to give massive amounts of attention to messaging, to those who matter most to us, and who are always there in our pockets and purses.

This, by extension, dictates that messaging is incredibly valuable: in a world of effectively infinite content and zero distribution costs the only scarce resource is attention, and if messaging is indeed the recipient of “massive amounts of attention” it has massive value.

That excerpt may look familiar: I used it just a few months ago to discuss Slack. In the enterprise the application where workers live has an excellent opportunity to be the layer that ties increasingly disparate cloud services together, and there’s even an outside chance Slack could be the rare enterprise product that crosses over into the consumer space. Unless, of course, Snapchat gets there first.

Messaging in the United States

I wrote about Snapchat’s huge market opportunity just over a year ago in a piece called Old-Fashioned Snapchat. At that point Snapchat was already very entrenched with teens in the United States in particular, but over the last year — particularly the last few months — it seems the service has started to cross-over to a broader audience.

The big challenge in getting a messaging service off the ground in the United States is that, unlike the rest of the world, text messaging has long been free. The reason this matters is that while it is very difficult to get even one person to change their habit or workflow, it is exponentially harder to get a critical mass of people to change all at the same time. However, if there is a fantastic benefit that appeals to everyone the challenge is a lot easier, and there is no better benefit than offering for free a service that used to cost money.

This, above all, is why WhatsApp in particular was able to become the fastest growing social network of all time, even with a skeletal team of engineers: the company basically offered text messaging for free just as people were getting their first smartphones,² which was a delta of improvement that significantly exceeded the cost of changing how you and your family and friends communicated. LINE and Kakao did the same in parts of Asia³, and WeChat quickly came to dominate China. Note too that the latter three services offer significantly more functionality than WhatsApp, but in fact little has changed when it comes to which service dominates which countries: whatever improvements the Asian apps offered relative to WhatsApp weren’t significant enough to overcome the barrier of changing people’s habits en masse.

Meanwhile, as I noted, the United States had free text messaging: it is not a coincidence that none of the messaging services have made much of an impact. Except, of course, Snapchat. You know, the teen sexting app.

Snapchat’s Opening

I obviously say “teen sexting app” tongue-in-cheek, but it’s worthwhile to understand just how it was that Snapchat got off the ground. In a world dominated by Facebook (and to a smaller extent Twitter) Snapchat offered something unique that couldn’t be easily copied by the existing services: chats that disappeared immediately.

Beyond the fact this is much more akin to how we actually talk in the real world, disappearing messages were particularly attractive to teens put off by the prospect of their parents, future admissions officers, future employers, and whoever else spying on what they said.

Moreover, the primary means of communication was not text but rather a picture, usually a selfie. Again, this more closely corresponded to how people actually communicate — non-verbal communication with our face is even more important than verbal — and also appealed particularly strongly to teenagers: while everyone is ultimately mostly concerned about themselves, teenagers don’t even bother to pretend otherwise!

These two factors worked together to magnify Snapchat’s initial differentiation: the fact snaps disappeared removed whatever reticence teenagers may have had about sending their selfies, and the result was messaging that was far more personal than Facebook’s preening or Twitter’s broadcasting.

The problem, as pundits far and wide would tell you, is that disappearing chats do not an advertising platform make. Snapchat’s entire point was in not tracking you like Facebook, and who was going to put up with advertisements stuffed in your selfies?

This brings me to Netflix. You know, the DVD-by-mail company.

Netflix and the Ladder-Up Strategy

In January, when Netflix expanded its service to an additional 130 countries with the flip-of-a-switch, I wrote how the company had expertly executed a “ladder-up” strategy:

Netflix started by using content that was freely available (DVDs) to offer a benefit — no due dates and a massive selection — that was orthogonal to the established incumbent (Blockbuster). This built up Netflix’s user base, brand recognition, and pocketbook

Netflix then leveraged their user base and pocketbook to acquire streaming rights in the service of a model that was, again, orthogonal to incumbents (linear television networks). This expanded Netflix’s user base, transformed their brand, and continued to increase their buying power

With an increasingly high-profile brand, large user base, and ever deeper pockets, Netflix moved into original programming that was orthogonal to traditional programming buyers: creators had full control and a guarantee that they could create entire seasons at a time

Each of these intermediary steps was a necessary prerequisite to everything that followed, culminating in yesterday’s announcement: Netflix can credibly offer a service worth paying for in any country on Earth, thanks to all of the IP it itself owns. This is how a company accomplishes what, at the beginning, may seem impossible: a series of steps from here to there that build on each other. Moreover, it is not only an impressive accomplishment, it is also a powerful moat; whoever wishes to follow has to follow the same time-consuming process.

Back when Netflix first got traction it was easy to dismiss it: DVDs were not long for this world, and the company had a nice niche but would ultimately fade away. But that was to focus on the first rung of the ladder, even as founder and CEO Reed Hastings was thinking several rungs ahead.

Snapchat’s Ladder

What is so impressive about Snapchat’s rise has been how founder and CEO Evan Spiegel has shepherded the service along a similar path: today’s Snapchat, which received a major update yesterday, is a far different and richer product than it was when it launched, one that is appealing to far more people, that demands far more attention, and, critically, is far better placed to capture the value it generates.

There have been three major rungs to date:

Rung 1: Stories

In October 2013, two years after the company’s founding, Snapchat added “Stories.” These collections of snaps (or short videos, added in 2012) were not exactly ephemeral — they lasted for 24 hours — but they weren’t permanent either: they were user-generated “shows” that forced you to use the app daily to not miss, and they could be private or public.

Much like Netflix’s initial streaming service, stories were a natural extension of Snapchat’s original value proposition, but a fundamental change in the nature of the service all the same: whereas chats were reactive, based on notifications, consuming stories was more of a “sit-back” experience. I explained why these sorts of experiences are so valuable in The Facebook Epoch:

Mobile is a great market. It is the greatest market the tech industry, or any industry for that matter, has ever seen, and the reason why is best seen by contrasting mobile with the PC: first, while PCs were on every desk and in every home, mobile is in every pocket of a huge percentage of the world’s population. The sheer numbers triple or quadruple the size, and the separation is increasing. Secondly, though, while using a PC required intent, the use of mobile devices occupies all of the available time around intent. It is only when we’re doing something specific that we aren’t using our phones, and the empty spaces of our lives are far greater than anyone imagined.

Stories fill that void, and as I further recounted in that article, that void is particularly attractive to brand advertisers; add on the fact that, as I recounted last year, advertisers are desperate to reach teenagers, and suddenly Snapchat had the outline of a real money-making opportunity.

Rung 2: Discover

Fast forward a year-and-a-half and Snapchat launched Discover, a place for media companies to post professionally-produced content, specifically tailored for Snapchat. This too was a natural extension of what came before: Stories were by users, and Discover was by the professionals. Moreover, Discover doubled-down on the benefits brought by Stories: first, they were another way to occupy more and more attention, and second, they were an even more natural advertising vehicle.

Both of these points were important for similar reasons: first, Discover provided instant benefit for new users who didn’t yet have friends on the service. In this respect Discover resembled Instagram’s filters: they gave a reason to use the app without a network in place. Secondly, Discover was a natural place to experiment with the brand advertising that is Snapchat’s future: professional content has long been associated with professional ads.

Rung 3: Feeds and Optionality

This brings us to yesterday’s release: Snapchat added (better) video chat, including an innovative one-way option; audio calls; audio notes; and stickers. The latter is particularly notable given that Snapchat just bought Bitmoji, an app that creates stickers that look like you.

First off, many of the features Snapchat added build on the sort of functionality the company has added on previous rungs: specifically, video and audio calling not only cement Snapchat’s hold on communication but are also much more accessible to a much broader audience than inscrutable teenagers.

Stickers, meanwhile, are a much bigger deal than people realize:

• Stickers are a fantastic money-maker in their own right. LINE, the most famous sticker purveyor (and for good reason: they are fantastic) made around $212 million in revenue from sticker sales last year, including nearly $100 million from its “Creators Market” selling 3rd-party created sticker packs
• Secondly, as I described in the afore-linked Messaging: Mobile’s Killer App article, the potential for stickers goes beyond direct sales. LINE made significantly more (~$318 million) from sponsored stickers, in which advertisers sponsor free sticker packs that can be acquired by following the company in question, thus establishing a direct marketing channel

Granted, these revenue numbers are relatively small, but then again LINE is smaller than Snapchat already (in Daily Active Users), and its markets have significantly fewer advertising dollars available. On the other hand, no company has mastered stickers like LINE has (including Kakao and WeChat), but this is why the Bitmoji acquisition is so intriguing: from day one Snapchat has tapped into the fact that our perspective is fundamentally selfish,⁴ and the potential to create stickers that are predicated on the same idea could be a lot more powerful than folks realize.

Regardless, rung three has further increased Snapchat’s optionality, both in regards to its potential user base and its revenue stream.

Snapchat versus Facebook

All of these rungs are climbing to a very lucrative destination: owning messaging in the United States. As I recounted above, unlike the rest of the world, there were no shortcuts to this market, which meant Snapchat has had to ladder its way up: first, by delivering an orthogonal product that appealed to an underserved market, and then leveraging that position into an array of products that have both expanded the addressable market and increased the service’s monetization potential.

That’s not to say success is guaranteed: the development of the Snapchat product has been far more impressive than the development of Snapchat as a business. As I snarked a few weeks ago “‘turnover’ in the context of Snapchat has been more about executives than it has been about revenue.” Does Spiegel have the discipline and commitment to build a real business around his deeply considered app?

It is here the parallel to Facebook is particularly interesting. What has made CEO Mark Zuckerberg’s leadership so exemplary is the degree to which the founder has been willing to not only surround himself with experienced executives but also learn and grow in areas in which he has no experience. The result is a company that not only delivers compelling products but is also deeply committed to its advertising business and, by extension, the success of those using Facebook to reach consumers.

There’s no question Snapchat is a threat to Facebook: both trawl for attention, and that is a zero-sum game. Facebook, though, has become much more than a social network: it is the front-door to the Internet for one, and, as Alex Muir put it, the new Excel for any number of online activities. Anyone who uses Snapchat will also use Facebook, however begrudgingly, and that, in conjunction with Facebook’s already good and still improving targeting and tracking capabilities, ensures Facebook’s revenue potential is still in its adolescence.

Moreover, Facebook is far stronger internationally than is Snapchat: all of those countries dominated by WhatsApp (a Facebook property) and LINE are equally dominated by Facebook;⁵ it seems there is a role for communications, a role for general browsing (which Facebook dominates), and a role for escapism (and here Instagram, another Facebook property, is a strong contender, albeit challenged by Snapchat).

Still, that doesn’t make me bearish on Snapchat: as TV moves inexorably to a subscription-based on-demand model more and more advertising will move online, including lucrative brand advertising. Both Facebook and Snapchat will capture their fair share, and I’m with Zuckerberg: I’d love to own both.

1. Although the concept was rather new when I first wrote about it in 2013 [↩]
2. And, to the company’s credit, it bent over backwards to support non-iOS and non-Android devices as well [↩]
3. LINE in Japan, Thailand, and Taiwan, and Kakao in South Korea [↩]
4. This isn’t a criticism! [↩]
5. Japan is a bit of an exception here [↩]

Andy Grove died yesterday. He is widely considered the greatest CEO in tech history.

The Andy Grove Impact

Grove’s remarkable backstory certainly plays a role in his reputation: a survivor of the Holocaust and the Soviet occupation of Hungary, Grove née Gróf arrived in the United States a penniless refugee and taught himself English while studying chemistry at the City College of New York; he later received his Ph.D. in chemical engineering from the University of California-Berkeley and then moved across the Bay to join Fairchild Semiconductor. When Robert Noyce and Gordon Moore (originally part of the Traitorous Eight who left transistor-inventor William Shockley) resigned from Fairchild Semiconductor to found Intel, Grove was their first hire¹ and it fell to Grove to build the culture and processes that would scale to support the memory business upon which Intel would be built. And so it was that the Hungarian refugee became the poster child for Silicon Valley’s idealized view of itself: a place where anyone can make it thanks to nothing more than their talent and determination.

Beyond Grove’s personal background, the importance of Intel to the technology industry — and, by extension, to the world — cannot be overstated. While Moore is immortalized for having created “Moore’s Law”, the truth is that the word “Law” is a misnomer: the fact that the number of transistors in an integrated circuit doubles approximately every two years is the result of a choice made first and foremost by Intel to spend the amount of time and money necessary to make Moore’s Law a reality. This choice, by extension, made everything else in technology possible: the PC, the Internet, the mobile phone. And, the person most responsible for making this choice was Grove (and, I’d add, his presence in management was the biggest differentiator between Intel and its predecessors, both of which included Noyce and Moore).

That wasn’t Intel and Grove’s only contribution to Silicon Valley, either: Grove created a culture predicated on a lack of hierarchy, vigorous debate, and buy-in to the cause (compensated with stock). In other words, Intel not only made future tech companies possible, it also provided the template for how they should be run, and how knowledge workers broadly should be managed. Grove also helped establish the idea of “paying it forward”: the CEO was famous for his willingness to mentor young founders (most famously Steve Jobs), and he wrote multiple books as CEO focused on how to manage and dealing with strategic inflection points.

Grove’s Most Famous Decision

The basis of that latter book was Grove’s most famous decision and, by extension, the greatest contributor to his legendary status. Intel was founded as a memory company, and the company made its name by pioneering metal-oxide semiconductor technology in first SRAM² and then in the first commercially available DRAM.³ It was memory that drove all of Intel’s initial revenue and profits, and the best employees and best manufacturing facilities were devoted to memory in adherence to Intel’s belief that memory was their “technology driver”, the product that made everything else — including their fledgling microprocessors — possible. As Grove wrote in Only the Paranoid Survive, “Our priorities were formed by our identity; after all, memories were us.”

The problem is that by the mid-1980s Japanese competitors were producing more reliable memory at lower costs (allegedly) backed by unlimited funding from the Japanese government, and Intel was struggling to compete. Grove wrote:

We tried a lot of things. We tried to focus on a niche of the memory market segment, we tried to invent special-purpose memories called value-added designs, we introduced more advanced technologies and built memories with them. What we were desperately trying to do was to earn a premium for our product in the marketplace as we couldn’t match the Japanese downward pricing spiral…as memories became a uniform worldwide commodity.

Grove soon persuaded Moore, who was still CEO⁴ to get out of the memory business, and then proceeded on the even more difficult task of getting the rest of Intel on board; it would take nearly three years for the company to fully commit to the microprocessor, even though said microprocessor was already a smashing success thanks to IBM’s decision to use it in their first PC.

Over the next two decades Intel would not only reap the benefits of IBM’s decision but also greatly increase their profits through more shrewd moves by Grove. As part of selecting Intel in the first place IBM insisted that Intel share their design with another chip manufacturer called Advanced Micro Devices (AMD) to ensure multiple suppliers, but once IBM’s position was weakened through the rise of IBM-compatible manufacturers like Compaq, Intel reneged and eventually renegotiated the deal, allowing the company to leverage its technical superiority⁵ into the sort of differentiation it had not been able to achieve in memory.

Equally important was the groundbreaking “Intel Inside” campaign that recognized end users were increasingly the market for computer manufacturers, and that they could be persuaded to care more about who made their computer’s processor than who made the computer itself. It was again a move that resulted in increased differentiation and, by extension, increased profits. By the time Grove stepped down as CEO in 1998 Intel was earning $6.9 billion profit on $25.0 billion in revenue, thanks to a gross margin of 60.3%.

Intel’s Big Miss

Intel today is still a very profitable company: last year the chip-maker earned $11.4 billion on $55.4 billion in revenue, with a gross margin of 62.6%. There is a sense, though, that the company’s strategic position is much less secure than its financials indicate, thanks to Intel’s having missed mobile.⁶

The critical decision came in 2005; Apple had just switched its Mac lineup to Intel x86 processors, but Steve Jobs was interested in another Intel product: the XScale ARM-based processor.⁷ The device it would be used for would be the iPhone. Then-CEO Paul Otellini told Alexis Madrigal at The Atlantic what happened:

“We ended up not winning it or passing on it, depending on how you want to view it. And the world would have been a lot different if we’d done it,” Otellini told me in a two-hour conversation during his last month at Intel. “The thing you have to remember is that this was before the iPhone was introduced and no one knew what the iPhone would do…At the end of the day, there was a chip that they were interested in that they wanted to pay a certain price for and not a nickel more and that price was below our forecasted cost. I couldn’t see it. It wasn’t one of these things you can make up on volume. And in hindsight, the forecasted cost was wrong and the volume was 100x what anyone thought.”

It was the opposite of Grove’s memory-to-microprocessor decision: Otellini prioritized Intel’s current business (x86 processors) instead of moving to what was next (Intel would go on to sell XScale to Marvell in 2006), much to the company’s long-term detriment.

And yet, for all of the deserved praise that Grove has received over the years, and as difficult as his memory-to-microprocessor decision may have been, Otellini’s decision was in my estimation far more difficult. Grove had to change Intel’s culture and perception of itself, and that is incredibly difficult, but at the end of the day he was making the choice that made financial sense: microprocessors were already more profitable and offered far greater potential for sustainable differentiation. Otellini, on the other hand, was choosing between maintaining Intel’s margins and pursuing unknown volume, and while it’s easy to sit here in 2016 and say he got it wrong, it’s only right to wonder who in 2005 would have gotten it right.

The Intel-Apple Parallel

Coincidentally Grove passed away the same day that Apple held one of its oddest events in some time: the company introduced two new devices, both derivatives of products that are already on the market. The new 9.7″ iPad Pro is better than its larger sibling when it comes to the camera and display, but from the perspective of most consumers it’s the same device in a form factor that has been around for a while; the iPhone SE, meanwhile, is a clone of the two-and-a-half year-old 5S with mostly-iPhone 6S innards.

There are definite parallels between Apple and Intel, particularly when it comes to Grove’s fateful decision: Apple’s biggest business shifted from computers to iPods, and shifted again from iPods to iPhones; the company even changed its name from Apple Computer to simply Apple. Both shifts are impressive in their own right: focusing on the iPod was to in some sense abandon Apple’s founding identity, while making the iPhone meant the cannibalization of Apple’s most profitable product ever.

Still, just as Grove’s decision to abandon memory and focus on microprocessors was in some senses “easy” given the fact microprocessors was a growing business that offered more margin, not less, Apple’s shift to the iPhone has been an “easy” one as well: the iPhone is nearly as profitable on a gross margin basis as Intel’s processors are. Make no mistake, overruling internal culture and hierarchies is hard, but giving away margin tends to be a lot harder.

The Celeron and the iPhone SE

That’s why the Grove decision that actually impresses me the most is Intel’s launch of the Celeron processor in 1998.⁸ Grove had been introduced to a then-relatively-unknown Harvard Business School professor named Clayton Christensen, who told him about research for an upcoming book (The Innovator’s Dilemma) that explained how companies in their pursuit of margin allowed themselves to be beat on the low-end. Grove took the lesson to heart and directed Intel to create a low-end processor (Celeron) that certainly cannibalized Intel’s top-of-the-line processor to an extent but also dominated the low-end, quickly gaining 35% market share.

To date Apple has declined to make a similar move; the iPhone 5C was thought, particularly before launch, to be the fabled “low-price iPhone,” but it turns out it was simply a substitute for an iPhone 5 that had significant manufacturing problems. It certainly wasn’t low-price: it started at $549, exactly where the year-old iPhone 5 would have been, and like every iPhone before it stepped down to $449 the following year before being discontinued.

To me the pricing made perfect sense, and unlike Christensen, I wasn’t worried about the iPhone being disrupted by the low-end. Indeed, I’m still not worried: the iPhone’s hold on the top-end of the market is as strong as ever.

The problem is growth: specifically, how many high-end customers are there, and how many of those customers find their current iPhones to be good-enough? And, if Apple believed their market to be increasingly saturated, would the company be willing to cannibalize its high-margin iPhone?

The iPhone SE suggests the answer is yes, and that fact alone made yesterday’s event far more important than it seems.⁹ Specifically, Apple is offering top-of-the-line specs for an unprecedented price of $399. In other words, the SE is no 5C. In fact, it seems likely Apple learned some inadvertent lessons from the 5C: I am not at all surprised that the SE looks identical to a 5S;¹⁰ when an integral part of the iPhone value proposition is status what customer wants to advertise that they bought a model that was never a flagship?

This price point will likely expand the market in the developed world, particularly given the replacement of subsidies with installment plans, but it’s most interesting in developing markets, especially India. It’s tempting to compare the second-largest phone market in the world to China, but in fact the latter is significantly richer and has a much larger high-end that primarily values status; the former, meanwhile, is very well-informed about things like processor and camera specifications, and is likely to be particularly appreciative of the SE’s aggressive feature set. I’m not at all surprised that the SE is going on sale in India only a week after the U.S., which is noteworthy considering the 6S launched in India in very limited quantities a full four weeks after the U.S.¹¹

The implications for Apple, though, are more profound than any one phone or any one market: the real long-term danger of occupying the high-end is falling in love with margin or average selling price at the expense of what makes sense strategically. Grove is to be admired for avoiding that trap, and it is encouraging that Apple CEO Tim Cook seems to be doing the same. And, fortunately for the Apple CEO, he, like Grove, can likely leave the truly devastating but ultimately understandable mistake for a successor.

1. Due to an administrative error Grove was given employee number 4 instead of 3 which reportedly rankled Grove for years, not unlike Steve Jobs’ irritation at being employee number 2 behind Steve Wozniak [↩]
2. Static Random Access Memory, which is faster and more reliable than DRAM but more expensive, and is today used for on-processor cache [↩]
3. Dynamic Random Access Memory, which is simple and cheap relative to SRAM and is still used as the main memory for computers [↩]
4. It speaks of Grove’s influence on Intel that he is widely credited for this decision even though he was not yet CEO [↩]
5. Which AMD briefly interrupted by being the first to introduce a 64-bit extension to the x86 instruction set [↩]
6. This isn’t entirely fair: Intel supplies the overwhelming majority of server processors which power the cloud; the cloud is an integral part of mobile [↩]
7. Which was derived from one of Grove’s last deals as CEO (the acquisition via settlement of StrongARM from DEC) [↩]
8. The Celeron launched a month before Grove stepped down as CEO, although obviously the decision was made well before then [↩]
9. To be clear, I’m not saying the SE is a Celeron; the smartphone market is different. I’m just noting Apple is undercutting itself to a degree [↩]
10. Except for the matte-chamfered edges [↩]
11. The India pricing is interesting: in a rather bizarre screwup Apple first announced that the SE would cost Rs 30,000, only to issue a new press release correcting the cost to Rs 39,000. This seems unusually high given the fact the 6S is widely available at only Rs 49,500.

    In fact, though, the 6S official price is Rs 62,500, which is 1.44x as expensive as the U.S. retail price; Rs 39,000 is 1.46x the U.S. retail price for the SE, so that makes sense.

    What I suspect happened is that, given India’s unique retail market that is dominated by small shops, Apple has built in a cushion to the official retail price that it expects to disappear in the market. As I noted, the 6S is widely available for Rs 49,500, which translates to $742 US; this is 1.14x the U.S. price (which pays for import duties, sales taxes, etc.). It turns out that 1.14x the U.S. price for the SE is Rs 30,419, almost exactly what Apple first put in its press release.

    In other words, I think Apple is saying that the SE will cost Rs 39,000, but they expect to sell it for Rs 30,000; they just accidentally put the latter number in the press release [↩]

Ten years ago yesterday Amazon evangelist Jeff Barr posted a 222-word post on the Amazon Web Services Blog¹ that opened:

Earlier today we rolled out Amazon S3, our reliable, highly scalable, low-latency data storage service.

Until then Amazon Web Services had primarily been about providing developers with a way to tap into the Amazon retail store; S3, though, had nothing at all to do with retail,² at least not directly.

The Origin of AWS

As Brad Stone detailed in The Everything Store, by the early 2000s Amazon was increasingly constrained by the fact the various teams in the company were all served by one monolithic technical team that had to authorize and spin up resources for every project. Stone wrote:

At the same time, Bezos became enamored with a book called Creation, by Steve Grand, the developer of a 1990s video game called Creatures that allowed players to guide and nurture a seemingly intelligent organism on their computer screens. Grand wrote that his approach to creating intelligent life was to focus on designing simple computational building blocks, called primitives, and then sit back and watch surprising behaviors emerge.

The book…helped to crystallize the debate over the problems with the company’s own infrastructure. If Amazon wanted to stimulate creativity among its developers, it shouldn’t try to guess what kind of services they might want; such guesses would be based on patterns of the past. Instead, it should be creating primitives — the building blocks of computing — and then getting out of the way. In other words, it needed to break its infrastructure down into the smallest, simplest atomic components and allow developers to freely access them with as much flexibility as possible.

The “primitives” model modularized Amazon’s infrastructure, effectively transforming raw data center components into storage, computing, databases, etc. which could be used on an ad-hoc basis not only by Amazon’s internal teams but also outside developers:

This AWS layer in the middle has several key characteristics:

• AWS has massive fixed costs but benefits tremendously from economies of scale
• The cost to build AWS was justified because the first and best customer is Amazon’s e-commerce business
• AWS’s focus on “primitives” meant it could be sold as-is to developers beyond Amazon, increasing the returns to scale and, by extension, deepening AWS’ moat

This last point was a win-win: developers would have access to enterprise-level computing resources with zero up-front investment; Amazon, meanwhile, would get that much more scale for a set of products for which they would be the first and best customer.

The AWS Tax

To say that AWS succeeded in its mission is a wild understatement: the impact on developers is exactly what AWS head Andy Jassy wrote in his vision statement. Stone summarized thusly:

The paper laid out the expanded AWS mission: “to enable developers and companies to use Web services to build sophisticated and scalable applications”…

“We tried to imagine a student in a dorm room who would have at his or her disposal the same infrastructure as the largest companies in the world,” Jassy says. “We thought it was a great playing-field leveler for startups and smaller companies to have the same cost structure as big companies.”

It was, and nearly every startup of note to be founded in the last several years has started on AWS or one of its competitors. The true measure of AWS’ impact, though, was the way it transformed the ecosystem around developers, including venture capital.

The effect on Amazon has been equally significant: I detailed last year how the revelation of AWS’ financial results was effectively a Facebook-level IPO, and subsequent earnings reports in which AWS has demonstrated the power of scale — increased revenue plus increased margins — have only solidified the fact that AWS will be a substantial driver of Amazon’s revenue and (eventual!) profits for a long time to come. Social+Capital Founder Chamath Palihapitiya, when asked what company he would invest in if he could only choose one, responded on Quora:

AWS is a tax on the compute economy. So whether you care about mobile apps, consumer apps, IoT, SaaS etc, more companies than not will be using AWS vs building their own infrastructure. Ecommerce was AMZN’s way to dogfood AWS, and continue to do so so that it was mission grade. If you believe that over time the software industry is a multi, deca-trillion industry, then ask yourself how valuable a company would be who taxes the majority of that industry? 1%, 2%, 5% — it doesn’t matter because the numbers are so huge — the revenues, profits, profit margins etc. I don’t see any cleaner monopoly available to buy in the public markets right now.

The monopoly Palihapitiya is referring to is based on the scale effects I noted above: the larger AWS becomes, the greater advantage Amazon has in pricing AWS’ services, which means they can earn ever more business, which increases their advantage even more. The net result is that for all but the largest cloud-based companies³ this advantage, combined with the flexibility AWS affords (which is critical both operationally and financially), will lead to the inevitable conclusion that Amazon ought to service all their infrastructure needs; the payments they make for this service are Palihapitiya’s “tax”.

What is worth considering, though, is the possibility that just as AWS’ effect on developers spread out into the broader startup ecosystem, it increasingly seems that AWS’ impact on Amazon itself goes far beyond its already substantial contribution to the bottom line. Amazon may have started as, to use Stone’s title, “The Everything Store,” but its future is to be a tax collector for a whole host of industries that benefit from the economies of scale, and AWS is the model.

The Transformation of Amazon’s E-Commerce Business

Longtime readers will recall that I went through my Amazon bear phase⁴ back in 2014; it was AWS that led me to recant. Even when I recanted, though, I argued that my bearish analysis about Amazon’s e-commerce business had been sound:

• Amazon’s “Media” business of books, CDs, DVDs, and video games was providing the vast majority of “profits”, but this business was shrinking as a percentage of Amazon’s total sales and, given secular trends in media, likely to continue to shrink on an absolute basis
• “Electronics and General Merchandise”⁵ was growing rapidly, but the nature of goods being sold meant there was relatively little margin to be had

What, though, if Amazon is content with making no margin on the sale of “Electronics and General Merchandise”? I don’t mean this in the Mathew Yglesias sense, that Amazon “is a charitable organization being run by elements of the investment community for the benefit of consumers”; rather, what if the business model of Amazon’s e-commerce business has changed to “tax” collection?

Consider Costco: last year the wholesale retailer had net income of $2.3 billion on sales of $114 billion to its over 81 million members; the total sum of membership fees was $2.5 billion. In other words, Costco’s 11% gross margin didn’t even quite cover the cost of running the business; the difference, along with all of the profit, came from a “tax” levied on Costco customers.

I would contend Prime memberships play the same role for Amazon: the non-AWS parts of the business last year generated $2.6 billion in operating profit;⁶ meanwhile, Consumer Intelligent Research Partners (CIRP) estimates that Amazon now has 54 million Prime members, which at $99/member would generate $5.3 billion in revenue; the difference in profitability for Amazon’s e-commerce business, such as it is, comes from a “tax” levied on Amazon’s best customers.

In fact, though, I think even this analysis is too narrow: e-commerce is inexorably taking over more and more of the U.S. retail sector in particular, and Amazon is taking over 50% of that e-commerce growth. Combine this reality with the growth in Prime and Amazon is effectively on its way towards collecting a tax on all of retail.

Again, though, just as is the case with AWS, this tax is one that consumers willingly embrace: Prime is a super experience with superior prices and superior selection, and it too feeds into a scale play. The result is a business that looks like this:

That is, of course, the same structure as AWS — and it shares similar characteristics:

• E-commerce distribution has massive fixed costs but benefits tremendously from economies of scale
• The cost to build-out Amazon’s fulfillment centers was justified because the first and best customer is Amazon’s e-commerce business
• That last bullet point may seem odd, but in fact 40% of Amazon’s sales (on a unit basis) are sold by 3rd-party merchants; most of these merchants leverage Fulfilled-by-Amazon, which means their goods are stored in Amazon’s fulfillment centers and covered by Prime. This increases the return to scale for Amazon’s fulfillment centers, increases the value of Prime, and deepens Amazon’s moat

The “tax” analogy extends beyond Prime; for example, Amazon is taking a portion of these 3rd-party sales, and a greater portion of revenue from goods they sell directly. The effect, though, is consistent: Amazon is collecting a “tax” on a massive industry and no one minds because Amazon’s scale ensures the best prices and the best experience.

Logistics and the Echo

It seems increasingly clear that Amazon intends to repeat the model when it comes to logistics: after experimenting with six planes last year the company recently leased 20 more to flesh out its private logistics network; this is on top of registering its China subsidiary as an ocean freight forwarder. No surprise that, as the Wall Street Journal noted:

In a securities filing, Amazon for the first time identified “companies that provide fulfillment and logistics services for themselves or for third parties, whether online or offline” as competition. And it referred to itself as a “transportation service provider.” In both cases, it marked the first time Amazon included such language in its annual report, known as a 10-K.

So how might this play out?

Well, start with the fact that Amazon itself would be this logistics network’s first-and-best customer, just as was the case with AWS. This justifies the massive expenditure necessary to build out a logistics network that competes with UPS, Fedex, et al, and most outlets are framing these moves as a way for Amazon to rein in shipping costs and improve reliability, especially around the holidays.

However, I think it is a mistake to think that Amazon will stop there: just as they have with AWS and e-commerce distribution I expect the company to offer its logistics network to third parties, which will increase the returns to scale, and, by extension, deepen Amazon’s eventual moat.⁷

The much-buzzed about Echo fits this model too: all of the usual suspects can build out the various pieces of the connected home; Amazon will simply provide the linchpin, the Echo’s cost a “tax” on the connected home.

A Primitive Organization

Bezos’ famed 1997 shareholder letter makes clear the roots of this model were in place from the beginning. Specifically, Bezos is very focused on the power of scale:

The stronger our market leadership, the more powerful our economic model. Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital…we choose to prioritize growth because we believe that scale is central to achieving the potential of our business model.

It’s equally clear, though, that Bezos didn’t then fully appreciate that his model would extend far beyond e-commerce; that, though, is why Amazon’s internal organization is such a strength. The company is organized with multiple relatively independent teams, each with their own P&L, accountabilities, and distributed decision-making. Stone explains an early Bezos initiative (emphasis mine):

The entire company, he said, would restructure itself around what he called “two-pizza teams.” Employees would be organized into autonomous groups of fewer than ten people — small enough that, when working late, the team members could be fed with two pizza pies. These teams would be independently set loose on Amazon’s biggest problems…Bezos was applying a kind of chaos theory to management, acknowledging the complexity of his organization by breaking it down to its most basic parts in the hopes that surprising results might emerge.

Stone later writes that two-pizza teams didn’t ultimately make sense everywhere, but as he noted in a follow-up article the company remains very flat with responsibility widely distributed. And there, in those “most basic parts”, are the primitives that lend themselves to both scale and experimentation. Remember the quote above describing how Bezos and team arrived at the idea for AWS:

If Amazon wanted to stimulate creativity among its developers, it shouldn’t try to guess what kind of services they might want; such guesses would be based on patterns of the past. Instead, it should be creating primitives — the building blocks of computing — and then getting out of the way.

Steven Sinofsky is fond of noting that organizations tend to ship their org chart, and while I began by suggesting Amazon was duplicating the AWS model, it turns out that the AWS model was in many respects a representation of Amazon itself (just as the iPhone in many respects reflects Apple’s unitary organization): create a bunch of primitives, get out of the way, and take a nice skim off the top.

1. Hosted on Typepad [↩]
2. Contrary to popular myth, Amazon was not selling excess capacity [↩]
3. I will discuss Dropbox’s recent announcement that they are moving away from AWS in tomorrow’s Daily Update [↩]
4. It’s like puberty for tech analysts [↩]
5. This nomenclature is from Amazon’s financial reports [↩]
6. This isn’t comparable to the Costco number which was net income [↩]
7. To be sure, UPS, Fedex, et al have a big head start, but their networks and cost structures are focused on businesses; Amazon will focus on consumers [↩]

The Bitcoin community is in a bit of a civil war; I hope readers whose eyes glaze over at the crypto-currency’s mention will bear with me as I explain what is going on, and why some of the fundamental ideas in question matter broadly.

The Block Size Debate

Briefly — and let me say up front, I am both simplifying and not taking sides — Satoshi Nakamoto, the mysterious creator of Bitcoin, added a 1MB size limitation to “blocks”, which, if you think of the Bitcoin blockchain as a ledger, are individual pages. This, as you might expect, limits the number of transactions that can be verified per block (there is a new block created about every ten minutes or so).

The current “war” is about whether or not this transaction size should be increased in the near future. Bitcoin Classic supporters are, contra their implementation’s name, advocating a “hard fork” of Bitcoin that would simply double the block size limit to 2MB; it’s called a “hard fork” because it is not backwards compatible. Meanwhile, Bitcoin Core supporters, which, naturally, include the core developers of Bitcoin, advocate a solution called “Segregated Witness” that would be a “soft fork”, i.e. backwards compatible, although it would take more development work not only for the core but for many other companies in the Bitcoin ecosystem.

What makes this brouhaha so interesting is there in the word “fork”: after all, the solution to a dispute in most open-source communities like, say, Linux, is to simply fork the project and build your own version. That is why there are a seemingly endless number of Linux distributions with names like Mint, Debian, and Ubuntu.¹ And indeed, there are scores of Bitcoin-like crypto-currencies like Ethereum, Ripple, and Dogecoin.

Unitary Bitcoin

Crucially, though, none of these “forks” work with Bitcoin; unlike an effectively self-contained Linux distribution that uses widely accepted protocols to communicate with other computers, Bitcoin is the network and all the component pieces of that network. This is why, even if a Bitcoin alternative may be technically superior, Bitcoin’s “market cap”² is more than 8x that of the next most valuable crypto-currency: Satoshi’s creation benefits from the network effects of hundreds of thousands³ of Bitcoin owners, miners, node operators, wallet providers, exchanges, etc.

It is this quality that makes this current dispute so charged: the loser in the block size debate can’t simply up and start their own currency without giving up millions of dollars in collective value. In short, the outcome is zero sum: one side will win, and the other will lose.

In this the debate about Bitcoin mirrors what it is that makes Bitcoin and the blockchain technology on which it is based so interesting: the entire idea is that there is one — and only one — record of all transactions; said record is added to by miners (incented by Bitcoin and transaction fees) and stored by nodes (wallet-holders, although the number of nodes is decreasing as people increasingly use centralized services), each of which, through a delicate balance of incentives, continually agrees on what is in the master ledger and what is not. And, when it comes to adding to the blockchain, only one block will win.

There are other parallels between Bitcoin broadly and this debate in particular. For example, while everyone agrees that the idea of the blockchain is brilliant and a real breakthrough in computer science (digital scarcity was thought to be impossible), there is a lot of disagreement about exactly what blockchains generally and Bitcoin specifically are good for: currency is the most cited application, but things like smart contracts and micro-exchanges are just as (if not more) interesting.

Similarly, there are a surprisingly wide array of opinions surrounding the block size debate, many of which are directly linked to underlying beliefs of what Bitcoin’s purpose is. Some want faster or more transactions, others are worried about ensuring nodes remain distributed (bigger blocks need more bandwidth), still others have security concerns. And, just as some Bitcoin adherents see a digital currency as a desirable alternative to traditional fiat currencies, some of those opposing a change are simply opposed to change period, at least to changing anything specifically designed by Satoshi.

Appealing to “Rules”

When the block size debate was first heating up last summer, Bitcoin Core developer Gregory Maxwell put his finger on the philosophy of Bitcoin issue:

Fundamentally this question exposes ideological differences between people interested in Bitcoin. Is Bitcoin more of a digital gold or is it more of a competitor to Square? Is Bitcoin something that should improve personal and commercial autonomy from central banks? From commercial banks? Or from just the existing status-quo commercial banks? What are people’s fundamental rights with Bitcoin? Do participants have a right to mine? How much control should third parties have over their transactions? How much security must be provided? Is there a deadline for world domination or bust? Is Bitcoin only for the developed world? Must it be totally limited by the most impoverished parts of the world? Bitcoin exists at the intersection of many somewhat overlapping belief systems.

What I found most interesting, though, was what Maxwell stated in the previous paragraph:

We’re talking about tuning one of the fundamental scarcities of the Bitcoin Economy and cryptosystem — leaving the comfort of “rule by math” — and venturing into the space of political decisions.

Maxwell has made similar comments elsewhere, including in this forum thread:

The rules are Bitcoin. The stability of Bitcoin’s rules is the soundness of the currency. If the rules can be easily rewritten against the will of some users by others according to political whim then what can be trusted? Is the supply fixed? Will coins be confiscated and awarded to others? If that gate is crossed then there is almost always some excuses which is “good enough” — as was lamented in some of Bitcoin’s earliest announcements…

I think governance is incredibly hard and that the development history of fiat currencies shows that mankind is ill-equipped to create a strong and sound system via human governance — not through lack of trying, but because mankind is fundamentally not cut out for it: there is always some excuse that makes people feel justified in compromising the property rights of some for the benefit of (potentially many) others. Bitcoin was specifically created and promoted to replace that kind of subjectivity with machines, but it can’t do it if we go around undermining it.

I find this perspective fascinating,⁴ and for reasons that have nothing to do with the block size debate (which, again, I’m not stating an opinion on!). I can certainly see the allure of a system that seeks to take all decision-making authority out of the hands of individuals: it’s math!

The problem, though, is that the consequence of embracing this sort of “Them’s the rules” philosophy is itself the sort of political statement that Maxwell is so eager to avoid. After all, in the case of the block size, the implication of not changing Satoshi’s “rules” is to limit the number of transactions and support the “Bitcoin is digital gold” worldview. If humans made the rules, then appealing to the rules can never be non-political. Indeed, it’s arguably worse, because an appeal to “rules” forecloses debate on the real world effects of said rules.

The Diversity Blind Spot

Today is International Women’s Day; I’m tempted to cynically pretend that it was my idea all along to use this fact as a segue, but the fact of the matter is I’m an oblivious male who found out via Facebook:

Facebook has over the last few years self-documented just how unrepresentative they are when it comes to demographic diversity: only 16% of technical jobs and only 23% of senior positions are held by women, and only 9% of the work-force is not white or Asian. Other Silicon Valley giants are barely better — women hold 20% of technical jobs at Apple, 17% at Google and LinkedIn — while Twitter is significantly worse: only 10% of technical employees are women.⁵

It was Twitter that exposed me to fact that I, despite my expressed support for women and diversity, had my own blind spots. Last spring in Twitter Needs New Leadership I painstakingly laid out how the service’s minuscule growth and seeming inability to evolve the product were a significant problem necessitating change; the next day I was called out on Twitter for not even mentioning Twitter’s abuse problem.

The criticism was absolutely fair: a platform that is inhospitable for 50% of the world’s population will by definition have a growth problem, and while I still don’t think it’s the primary reason Twitter’s growth has stalled, to not even acknowledge the effect of abuse was a pretty bad oversight on my part that falls uncomfortably close to my International Women’s Day observance: being a male I had to be hit over the head by it.

You could certainly say the same thing about Twitter the company: Dick Costolo, the CEO I was criticizing, did finally admit Twitter had an abuse problem, and current CEO Jack Dorsey has taken some steps to address it, but said problem may be intractable thanks to decisions made in the earliest days of Twitter, particularly the allowance of anonymous accounts that can @-mention anyone on the service.⁶ Does it come as any surprise that, if Nick Bilton’s Hatching Twitter is to be believed, the internal Odeo team that first developed Twitter was all male, and the first female on the service had spent her first few months at work fending off Dorsey despite her repeated protestations that she had a boyfriend?

This is why diversity matters — and it arguably matters even more at new companies that are right now creating the “rules” of their products that, should they be successful, will be all but impossible to change. For years Twitter ignored that it had a problem, insisting it represented the “free speech wing of the free speech party”, ignorant of just how much speech was being suppressed by allegedly neutral “rules” that, by virtue of who made them, were blind to the impact they would have on women.⁷

There Is No Neutral

The importance of understanding the inherently political nature of rules goes deeper than simply saying diversity is important; it also gets at how we as an industry should think about solutions. It is tempting to argue that companies should simply double-down on meritocracy and ensure they are selecting the best possible candidate; remove human judgment to the greatest degree possible. But then it must be asked, on what criteria would hiring decisions be made? Specifically, who would be making these neutral “rules”?

I get the allure of simply declaring that from now on everything is equal: men and women will be treated the same, we will be color-blind, etc. It’s neat, like math.⁸ It’s also unserious: foreclosing on measures that address past injustices ensures the effects of those injustices become cemented in place; to be “color-blind” or “gender-neutral” is neutral in language but fundamentally political when it comes to its effect.

Ultimately, I don’t know what will happen to Bitcoin, but I’m skeptical of folks who are attracted to it because it allegedly removes humans from the equation: that is and always has been an idea that only makes sense in the very narrowest view of a single Bitcoin transaction, as we are seeing all too clearly in the community’s inability to address a relatively minor issue.⁹

More broadly, I hope that the fundamental humanity that goes into any decision — product, policy, or otherwise — is appreciated by everyone in tech. Just as products and companies are either growing or dying, so too efforts to make the technology industry more accurately reflect, and thus better serve (and better monetize!) the diversity of the human race, are either explicitly improving the status quo or implicitly embracing it. There are no neutral “rules.”

1. There are theoretically thousands if not millions of distributions, and effectively hundreds that are actively maintained [↩]
2. The value of all of the Bitcoins in your fiat money of choice [↩]
3. Probably not millions [↩]
4. To be clear, I completely disagree with it [↩]
5. Data from this article [↩]
6. I am aware that forcing real names has its own problems, including in cases of domestic abuse, stalkers, and more [↩]
7. This problem isn’t limited to GamerGate. Check out this story in Sports Illustrated about what women in the sports world have to deal with [↩]
8. I mean it when I say I sympathize with this position: in my younger years I used to write exactly that [↩]
9. And, I’d add, a relatively small number of miners actually have nearly complete power when it comes to deciding this [↩]

Stratechery is not a political blog, and this is not a political post. Rather, my focus is the business and strategy of technology, something that is inextricably linked with the effect technological change has and will have on society broadly — and that includes politics.

To that end I read with interest Hans Noel’s op-ed in The New York Times on Tuesday. Noel is, along with Marty Cohen, David Karol and John Zaller, the author of the 2008 book The Party Decides, one of the most influential books in U.S. political science, and Noel opened his piece by summarizing the book’s central thesis:

We argued that the leaders of party coalitions have great influence over the selection of a presidential nominee. Before [we wrote The Party Decides], the conventional wisdom was that such broad and diverse coalitions of politicians, activists and interest groups within parties were largely shut out of the nominating process by primaries and caucuses in the 1970s. This led to a free-for-all among narrowly factional candidates. In 1976, Jimmy Carter emerged from a crowded field to win the nomination despite having no connections to most leaders in the national party.

We argued that since that 1976 contest, party leaders had been exerting influence by coordinating on their choice during the “invisible primary” — the period before any voting when the leaders observed, met with and vetted candidates — then supporting that candidate throughout the process. When party leaders work together, they nearly always win, we said…

This year’s election has not followed our script. Mr. Trump is the clear front-runner, but is loathed by the party establishment.

To Noel’s credit, the reason for writing the op-ed is to self-critically examine what he and his co-authors may have gotten wrong; he has three potential theses (beyond noting that the Republican establishment may yet rally, and that Democrats have largely fallen into line):

• Maybe the political environment has changed
• Maybe the party is falling apart
• Maybe Mr. Trump just got in the way

I think Noel’s scope is too narrow: politics is just the latest industry to be transformed by the Internet.

The Evolution of Politics and the Web

A few weeks ago Clay Shirky wrote a tweetstorm that is worth reading in full; for this post, though, I wanted to highlight the parts describing how the Internet has, election-by-election, fundamentally reshaped presidential campaigns:

Social media is breaking the political ‘Overton Window’ — the ability of elites to determine the outside edges of acceptable conversation (link). These limits were enforced by party discipline, and mass media whose economics meant political centrism was the best way to make money (link). This was BC: Before Cable. One or two newspapers per town, three TV stations; all centrist, white, pro-business, respectful of authority (link). Cable changed things, allowing outsiders to campaign more easily. In ’92, Ross Perot, 3rd party candidate, campaigned through infomercials (link).

After Cable but Before Web lasted only a dozen years. Cable added a new stream of media access. The web added a torrent (link). This started with Howard Dean (the OG) in ’03. Poverty was the mother of invention; Dean didn’t have enough $ to buy ads, even on cable (link) but his team had Meetup & blogs… (link). After webifying Perot’s media tactics, Dean pioneered online fundraising. Unfortunately for him, his Get Out The Vote operation didn’t (link). That took Obama. Obama was less of an outsider than Dean (though still regarded as unelectable in ’07) but used most of Dean’s playbook (link). And then there was vote-getting. Facebook and MyBarackObama let the Obama campaign run their own vote-getting machine out of Chicago (link).

The new scale Facebook introduces into politics is this: all registered American voters, ~150M people, are now a medium-sized group (link). Reaching & persuading even a fraction of the electorate used to be so daunting that only two national orgs could do it. Now dozens can (link). This set up the current catastrophe for the parties. They no longer control any essential resource, and can no longer censor wedge issues (link)

There are a few key concepts at the foundation of this analysis:

• Previously information was gated by newspapers and TV stations with geographic monopolies; this began to break down with cable and was completely swept away by the web
• The Internet made it possible to connect directly with voters to share information, collect money, and drive get-out-the-vote (GOTV) efforts
• All of those voters are reachable via just a handful of platforms, especially Facebook

Long-time readers should recognize the tell-tale signs of Aggregation Theory.

Aggregation Theory Redux

Facebook and newspapers is an excellent example of how Aggregation Theory plays out:

• Previously newspapers integrated editorial and advertising copy into a bundle that was delivered to a geographically captive audience. Said newspapers’ market dominance was secured by their control of production and distribution, but their growth was capped by the challenges of scaling said production and distribution beyond said geographic area.
• Facebook (like Google before it) built a powerful relationship directly with users by delivering content users cared the most about. This, then, made Facebook the front door to the Internet for most users.
• Facebook’s direct connection with users was a double-whammy for newspapers: first, Facebook is better-positioned to serve advertising, and second, users increasingly find all their news and entertainment via Facebook

The end result of this process is that newspapers have been modularized and commoditized into effective Facebook-filler, competing on an equal basis with everything from new media startups like BuzzFeed to personal blog posts to pictures of your cousin’s new baby. It’s hard for publishers to break through with content, and publisher-centric advertising is dying: better for ad buyers to get as close to the customer as possible and buy space on the service that has aggregated users on one side and leveraged that into commoditizing and modularizing suppliers on the other.

There certainly is room for all the ads: thanks to the Internet reality of zero distribution costs and zero transaction costs, an aggregator can scale nearly perfectly to effectively every user on Earth, as we’ve seen with Google, Facebook, Amazon, and increasingly Netflix and Uber.

Parties and Voters

For a moment, though, step back to the world as it was: the one where newspapers (and TV stations, etc.) were gatekeepers thanks to their ownership of production and distribution. In this world any viable political campaign had to play nicely with those who ran the press in the hopes of gaining positive earned media, endorsements, etc. Just as important, though, was the need to buy advertising, as that was the only way to reach voters at scale. And advertising required lots of money, which meant donors. And then, once the actual election rolled around, a campaign needed an effective GOTV effort, which took not only money but also the sort of manpower that could only be rustled up by organizations like labor unions, churches, etc.

It is all these disparate pieces: partisan media members, advertisers, donors, large associations, plus consultants and specialists to manage them that, along with traditional politicians, made up the “party” in The Party Decides. Noel and company asked in Chapter 1:

Why tie parties so closely to party leadership as such? Why not view parties as larger coalitions that include not only top leaders but activists, fund-raisers, interest groups, campaign technicians, and others? Certainly the larger set of actors has great influence on party behavior. We therefore propose to theorize parties, and to study them in practice, as coalitions of the larger set of actors. Politicians will be important but not necessarily dominant; interest groups, activists, and other policy demanders will be permitted large roles in party decisions. Our theory will focus on why diverse political actors might attempt to form parties and what kinds of candidates they might seek to nominate.

What is critical to understand when it comes to this more broad-based definition of a “party” is that its goals are not necessarily aligned with a majority of voters. The authors explain in Chapter 2 (emphasis mine):

The most important party business is the nomination and election of office seekers who will serve the interests of the party’s intense policy demanders. The italicized phrase marks the key difference between our theory and most other contemporary theorizing about parties. In our theory, parties — that is, the groups that constitute parties — do not care about winning for the sake of winning office. They care about the policy gains. And they make those gains not simply by the election of someone nominally affiliated with their party. They make them by the election of someone committed to the maximum feasible achievement of group goals…

It is natural to think of parties in a two-party system as majoritarian. Ours, however, are not. They want to win elections, but they do not necessarily wish to represent a majority of voters. As a by-product of their wish to govern, parties must offer a degree — perhaps a large degree — of responsiveness to popular majorities, but responsiveness to voters is not why parties exist. They exist to achieve the intense policy demands of their constituent groups. One might criticize parties for lack of deference to majority will, but their groups would not much care. Intense policy demanders nearly always believe their demands are just and that it is their duty to work for these demands whether or not most voters agree with them.

To summarize: parties are not just politicians, but coalitions of actors who care intensely about certain policy outcomes. These actors work together to get politicians elected who will serve their interests; voter interests are a means, not an ends. And, according to Noel and company, such parties succeed because they control all of the apparatus necessary to win elections.

Aggregation and Politics

This brings us back to today’s world, and admittedly, the leap from a description of Facebook and Aggregation Theory to politics is not an obvious one: I’m not proposing that Donald Trump or anyone else is an aggregator. Indeed, given their power over what users see Facebook could, if it chose, be the most potent political force in the world. Until, of course, said meddling was uncovered, at which point the service, having so significantly betrayed trust, would lose a substantial number of users and thus its lucrative and privileged place in advertising, leading to a plunge in market value. In short, there are no incentives for Facebook to explicitly favor any type of content beyond that which drives deeper engagement; all evidence suggests that is exactly what the service does.

Said reticence, though, creates a curious dynamic in politics in particular: there is no one dominant force when it comes to the dispersal of political information, and that includes the parties described in the previous section. Remember, in a Facebook world, information suppliers are modularized and commoditized as most people get their news from their feed. This has two implications:

• All news sources are competing on an equal footing; those controlled or bought by a party are not inherently privileged
• The likelihood any particular message will “break out” is based not on who is propagating said message but on how many users are receptive to hearing it. The power has shifted from the supply side to the demand side

This is a big problem for the parties as described in The Party Decides. Remember, in Noel and company’s description party actors care more about their policy preferences than they do voter preferences, but in an aggregated world it is voters aka users who decide which issues get traction and which don’t. And, by extension, the most successful politicians in an aggregated world are not those who serve the party but rather those who tell voters what they most want to hear.

In my initial description of Aggregation Theory I noted:

This has fundamentally changed the plane of competition: no longer do distributors compete based upon exclusive supplier relationships, with consumers/users an afterthought. Instead, suppliers can be aggregated at scale leaving consumers/users as a first order priority. By extension, this means that the most important factor determining success is the user experience: the best distributors/aggregators/market-makers win by providing the best experience, which earns them the most consumers/users, which attracts the most suppliers, which enhances the user experience in a virtuous cycle.

The term “user experience” obviously refers to a product; in the case of politics it is, apparently, at least in the case of some substantial number of Republican voters, “telling it like it is”, aka what voters, not parties, believe.¹

And so, without any of the apparatus traditionally provided by parties, much of it obsoleted by the Internet, and thanks to the ability to connect directly with voters (because of aggregation), Donald Trump is marching on in direct defiance of the Republican Party’s decision.²

Voters (and users) decide.

1. Note that this too is why the media covers Trump to such a significant degree: they are just as subservient to what their viewers want [↩]
2. And yes, Trump primarily communicates via Twitter, but he is dominating Facebook [↩]