Defining Aggregators

(Note: this is not a typical Stratechery article; there is no over-arching narrative or reference to current news. Rather, the primary goal is to provide a future point of reference)

Aggregation Theory describes how platforms (i.e. aggregators) come to dominate the industries in which they compete in a systematic and predictable way. Aggregation Theory should serve as a guidebook for aspiring platform companies, a warning for industries predicated on controlling distribution, and a primer for regulators addressing the inevitable antitrust concerns that are the endgame of Aggregation Theory.

Aggregation Theory was first coined in this eponymously-titled 2015 article. That article followed on the heels of a series of posts about Airbnb, Netflix, and web publishing that, I realized, fit together into a broader framework that was applicable to a range of Internet-enabled companies. Over the ensuing two years I have significantly fleshed out the ideas in that original article, yet subsequent articles necessarily link to an article that marked the beginning of Aggregation Theory, not the current state.

That noted, the original article is very much worth reading, particularly its description of how value has shifted away from companies that control the distribution of scarce resources to those that control demand for abundant ones; the purpose of this article is to catalog exactly what the latter look like.

The Characteristics of Aggregators

Aggregators have all three of the following characteristics; the absence of any one of them can result in a very successful business (in the case of Apple, arguably the most successful business in history), but it means said company is not an aggregator.

Direct Relationship with Users

This point is straight-forward, yet the linchpin on which everything else rests: aggregators have a direct relationship with users. This may be a payment-based relationship, an account-based one, or simply one based on regular usage (think Google and non-logged in users).

Zero Marginal Costs For Serving Users

Companies traditionally have had to incur (up to) three types of marginal costs when it comes to serving users/customers directly.

  • The cost of goods sold (COGS), that is, the cost of producing an item or providing a service
  • Distribution costs, that is the cost of getting an item to the customer (usually via retail) or facilitating the provision of a service (usually via real estate)
  • Transaction costs, that is the cost of executing a transaction for a good or service, providing customer service, etc.

Aggregators incur none of these costs:

  • The goods “sold” by an aggregator are digital and thus have zero marginal costs (they may, of course, have significant fixed costs)1
  • These digital goods are delivered via the Internet, which results in zero distribution costs2
  • Transactions are handled automatically through automatic account management, credit cards payments, etc.3

This characteristic means that businesses like Apple hardware and Amazon’s traditional retail operations are not aggregators; both bear significant costs in serving the marginal customer (and, in the case of Amazon in particular, have achieved such scale that the service’s relative cost of distribution is actually a moat).

Demand-driven Multi-sided Networks with Decreasing Acquisition Costs

Because aggregators deal with digital goods, there is an abundance of supply; that means users reap value through discovery and curation, and most aggregators get started by delivering superior discovery.

Then, once an aggregator has gained some number of end users, suppliers will come onto the aggregator’s platform on the aggregator’s terms, effectively commoditizing and modularizing themselves. Those additional suppliers then make the aggregator more attractive to more users, which in turn draws more suppliers, in a virtuous cycle.

This means that for aggregators, customer acquisition costs decrease over time; marginal customers are attracted to the platform by virtue of the increasing number of suppliers. This further means that aggregators enjoy winner-take-all effects: since the value of an aggregator to end users is continually increasing it is exceedingly difficult for competitors to take away users or win new ones.

This is in contrast to non-platform companies that face increasing customer acquisition costs as their user base grows. That is because initial customers are often a perfect product-market fit; however, as that fit decreases, the surplus value from the product decreases as well and quickly turns negative. Generally speaking, any business that creates its customer value in-house is not an aggregator because eventually its customer acquisition costs will limit its growth potential.

One additional note: the aforementioned Apple and Amazon do have businesses that qualify as aggregators, at least to a degree: for Apple, it is the App Store (as well as the Google Play Store). Apple owns the user relationship, incurs zero marginal costs in serving that user, and has a network of App Developers continually improving supply in response to demand. Amazon, meanwhile, has Amazon Merchant Services, which is a two-sided network where Amazon owns the end user and passes all marginal costs to merchants (i.e. suppliers).

Classifying Aggregators

Aggregation is fundamentally about owning the user relationship and being able to scale that relationship; that said, there are different levels of aggregation based on the aggregator’s relationship to suppliers:

Level 1 Aggregators: Supply Acquisition

Level 1 Aggregators acquire their supply; their market power springs from their relationship with users, but is primarily manifested through superior buying power. That means these aggregators take longer to build and are more precarious in the short-term.

The best example of a Level 1 Aggregator is Netflix. Netflix owns the user relationship and bears no marginal costs in terms of COGS, distribution costs,4 or transaction costs.5 Moreover, Netflix does not create shows, but it does acquire them (increasingly exclusively to Netflix); the more content Netflix acquires, the more its value grows to potential users. And, the more users Netflix gains, the more it can spend on acquiring content in a virtuous cycle.

Level 1 aggregators typically operate in industries where supply is highly differentiated, and are susceptible to competitors with deeper pockets or orthogonal business models.

Level 2 Aggregators: Supply Transaction Costs

Level 2 Aggregators do not own their supply; however, they do incur transaction costs in bringing suppliers onto their platform. That limits the growth rate of Level 2 aggregators absent the incursion of significant supplier acquisition costs.

Uber is a Level 2 Aggregator (and Airbnb in some jurisdictions due to local regulations). Uber owns the user relationship and bears no marginal costs in terms of COGS, distribution costs, or transaction costs. Moreover, Uber does not own cars; those are supplied by drivers who sign up for the platform directly. At that point, though Uber needs to undertake steps like background checks, vehicle verification, etc. that incur transaction costs both in terms of money as well as time. This limits supply growth which ultimately limits demand growth.

Level 2 aggregators typically operate in industries with significant regulatory concerns that apply to the quality and safety of suppliers.

Level 3 Aggregators: Zero Supply Costs

Level 3 Aggregators do not own their supply and incur no supplier acquisition costs (either in terms of attracting suppliers or on-boarding them).

Google is the prototypical Level 3 Aggregator: suppliers (that is, websites) are not only accessible by Google by default, but in fact actively make themselves more easily searchable and discoverable (indeed, there is an entire industry — search engine optimization (SEO) — that is predicated on suppliers paying to get themselves onto Google more effectively).

Social networks are also Level 3 Aggregators: initial supply is provided by users (who are both users and suppliers); over time, as more and more attention is given to the social networks, professional content creators add their content to the social network for free.

Level 3 aggregators are predicated on massive numbers of users, which means they are usually advertising-based (which means they are free to users). An interesting exception is the aforementioned App Stores: in this case the limited market size (relatively speaking) is made up by the significantly increased revenue-per-customer available to app developers with suitable business models (primarily consumable in-app purchases).

The Super-Aggregators

Super-Aggregators operate multi-sided markets with at least three sides — users, suppliers, and advertisers — and have zero marginal costs on all of them. The only two examples are Facebook and Google, which in addition to attracting users and suppliers for free, also have self-serve advertising models that generate revenue without corresponding variable costs (other social networks like Twitter and Snapchat rely to a much greater degree on sales-force driven ad sales).

For more about Super-Aggregators see this article.

Regulating Aggregators

Given the winner-take-all nature of Aggregators, there is, at least in theory, a clear relationship between Antitrust and Aggregation. However, traditional jurisprudence is limited by three factors:

  • The key characteristic of Aggregators is that they own the user relationship. Critically, the user chooses this relationship because the aggregator offers a superior service. This makes it difficult to make antitrust arguments based on consumer welfare (the standard for U.S. jurisprudence for the last 35 years).
  • The nature of digital markets is such that aggregators may be inevitable; traditional regulatory relief, like breaking companies up or limiting their addressable markets will likely result in a new aggregator simply taking their place.
  • Aggregators make it dramatically simpler and cheaper for suppliers to reach customers (which is why suppliers work so hard to be on their platform). This increases the types of new businesses that can be created by virtue of the aggregators existing (YouTube creators, Amazon merchants, small publications, etc.); regulators should take care to preserve these new opportunities (and even protect them).

These are guidelines for regulation; determining specifics is an ongoing project for Stratechery, as are the definitions in this article.

  1. And yes, in the very long run, all fixed costs are marginal costs; that said, while the amount of capital costs for aggregators is massive, their userbase is so large that even over the long run the fixed costs per user are infinitesimal, particularly relative to revenue generated []
  2. In terms of the marginal customer; in aggregate there are of course significant bandwidth costs, but see the previous footnote []
  3. Credit card fees are a significant transaction cost that do limit some types of businesses, but will generally be ignored in this analysis []
  4. Obviously bandwidth in the aggregate is a particularly large cost of Netflix []
  5. In all cases, credit card fees excepted []

Books and Blogs

A book, at least a successful one, has a great business model: spend a lot of time and effort writing, editing, and revising it up front, and then make money selling as many identical copies as you can. The more you sell the more you profit, because the work has already been done. Of course if you are successful, the pressure is immense to write another; the payoff, though, is usually greater as well: it is much easier to sell to customers you have already sold to before than it is to find customers for the very first time.

There is, though, at least from my perspective, a downside to this model: a book, by necessity, is a finished object; that is why it can be printed and distributed at scale. The problem is that one’s thoughts may not be final; indeed, the more vital the subject, the more likely a book, with its many-month production process, is to be obsolete the moment it enters its final state of permanence.

When I started Stratechery four years ago, with my 384 Twitter followers and little else, the thought of writing a book never crossed my mind; not only did I not have a contract, I didn’t even have a topic beyond the business and strategy of technology, a niche I thought was both under-served and that I had the inklings of a point of view on.

Since then it has been an incredible journey, especially intellectually: instead of writing with a final goal in mind — a manuscript that can be printed at scale — Stratechery has become in many respects a journal of my own attempts to understand technology specifically and the way in which it is changing every aspect of society broadly. And, it turns, out, the business model is even better: instead of taking on the risk of writing a book with the hope of one-time payment from customers at the end, Stratechery subscribers fund that intellectual exploration directly and on an ongoing basis; all they ask is that I send them my journals of said exploration every day in email form.

To put it another way, at least in my experience, the lowly blog has fully disrupted the mighty book: the former was long thought to be an inferior alternative, or at best, a complementary piece for an author looking to drum up an audience; slowly but surely, though, the tools have gotten better, everything from social media for marketing to Stripe for payments to WordPress for publishing to tools like Memberful for subscriber management. It became increasingly apparent, to me anyways, that while books remained a fantastic medium for stories, both fiction and non, blogs were not only good enough, they were actually better for ideas closely tied to a world changing far more quickly than any book-related editorial process can keep up with.

To be sure, I had discovered in 2015 what might have been a worthy book topic: Aggregation Theory. That, though, makes my point: the biggest problem I have with Aggregation Theory is that that old article I keep linking to is incomplete. My thinking on what Aggregation Theory is, what its implications are, and how that should affect strategy both inside and outside of technology and, particularly over the last year, potential regulation, has evolved considerably.

To that end, it is with relief I write the following article: Defining Aggregators. I’ll be honest: it’s more for me than for you; my thinking has evolved, and clarified, and I want to link to something that represents my point of view in 2017, not just 2015. That I can do so by merely hitting ‘Publish’ is a great thing: these ideas are very much alive, and I don’t really see the point of trees that are dead, literally or virtually.

Note: This article is meant as an introduction to Defining Aggregators; it is posted as a separate article as I plan to link to that article many times in the future

The Super-Aggregators and the Russians

In August 2011, just a day or two into my career at Microsoft, I sat in on a monthly review meeting for Hotmail (now known as; the product manager running the meeting was going through the various geographies and their relevant metrics — new users, churn, revenue, etc. — and it was, well, pretty boring. It was only later that I realized just how astounding “boring” was; a small group of people in a conference room going over numbers that represented hundreds of millions of people and dollars in revenue, and most of us cared far more about what was on the menu for lunch.

I’ve reflected on that meeting often over the years, particularly when it comes to Facebook and controversies like censoring too much, censoring too little, or “fake news”, and I was reminded of it again with this tweet:

Mark Warner, the senior Senator from Virginia, is referring to a Russian company, thought to be linked to the Kremlin’s propaganda efforts, having bought $100,000 worth of political ads on Facebook, some number of which directly mentioned 2016 presidential candidates Donald Trump and Hillary Clinton. Facebook has released limited details about the ads, likely due to its 2012 consent decree with the FTC, which bars the company from unilaterally making private information public, as well as the problematic precedent of releasing information without a clear order compelling said release. To that end, it was reported over the weekend that special counsel Robert Mueller received a much more comprehensive set of data from Facebook after obtaining a search warrant.

Even with all that context, though, I found Senator Warner’s tweet puzzling: how else would the propaganda group have paid? Facebook’s self-service ad portal lets you buy ads in 55 different currencies, including the Russian Ruble:1

That, though, brought me back to that Hotmail meeting: that I, and probably many more in the tech industry, find the idea of Facebook selling ads in rubles to strangers to be utterly unremarkable, even as thousands find it equally outrageous and damning, is a reminder of just how unprecedented and misunderstood aggregators like Facebook continue to be, and what a challenge it will be to regulate them.

The Cellular Network Company

Senator Warner, it should be noted, is considered one of the most technologically literate people in the entire Senate — and the richest. Warner originally made his fortune by facilitating the sale of cellular phone licenses; he then co-founded Columbia Capital, a venture capital firm which specialized in cellular businesses: the firm’s early investments included Nextel, BroadSoft, and MetroPCS.

A cellular network company is certainly a new kind of business that is similar to today’s tech giants in many respects:

  • At a fundamental level, cellular network companies are about the movement of information — voice and text, in Warner’s era — not physical goods. Moreover, because this information is digital, there are no marginal distribution costs in its transfer. This is the same characteristic of companies like Google and Facebook.
  • A cellular network company has massive fixed costs and minimal marginal costs; one more minute of talk time costs practically nothing to provide, unless the network is saturated, at which point significant capital investment is necessary. Today’s internet services are similar: marginal usage is effectively free, although significant capital investments in data centers are necessary (as well as significant ongoing bandwidth costs, which are effectively zero to serve any one individual but huge in aggregate).
  • A cellular network company is, quite obviously, a network. That means the value of the service increases as the number of customers increases. This produces a powerful virtuous cycle in which new customers increase the value of the network such that it becomes attractive to new marginal customers, further increasing the value of the network for the next set of marginal customers; this “network effect” is the most common driver of the sort of “scalable advantage in customer acquisition costs” that I discussed in the case of Uber, and is a hallmark of Facebook in particular (but also Google and all of the aggregators).
  • Cellular network companies have direct relationships with their customers.

These four characteristics may seem familiar: they are all parts of Aggregation Theory, and I’ve written about each of those components in the two years since I first wrote about the theory.2 There is one more piece, though, that I have only mentioned in passing: zero transaction costs. This is the piece that apparently sets Facebook beyond Senator Warner’s understanding,3 and it is perhaps the key reason why Facebook and other aggregators are unlike any other company we have seen before; oh, and it explains this Russian ad buy.

Transaction Costs

Go back to the generic cellular network company I discussed above, and think about what is entailed in adding a new customer (and leaving aside the marketing expenditure to make them aware of and desirous of the service in the first place):

  • Talk with the customer on the phone or in person
  • Collect identifying details and run a credit check
  • Provision a SIM card and/or a phone
  • Receive payment
  • Manage contract renewals and cancellations and other customer service

While some of these activities could be automated, the reality is that the cost of customer management had a linear curve: more customers meant more costs. Moreover, these costs accumulated, limiting the natural size of any company; at some point the complexity of managing some finite number of customers across some finite number of geographic areas cost more than the marginal profit of adding one more customer, and that limited how big a company could grow (which, to be clear, could be very large indeed!).

What makes aggregators unique, though, is that thanks to the Internet they have zero transaction costs: for Google, or Airbnb, or Uber, or Netflix, or Amazon, or the online travel agents, adding one more customer is as simple as adding one more row in a database. Everything else is automated, from sign-up to billing to the delivery of the service in question. This is why all of these companies are global, often from day one, and, as I explained in Beyond Disruption, why they start at the high end of a market and work their way down.

Note that aggregators can deal with the physical world and still have zero transaction costs, at least on the consumer side: Airbnb deals with rooms, but bears no transaction costs when it comes to signing up new customers; Amazon and Uber are similar with regards to e-commerce and transportation, respectively. Netflix doesn’t deal in physical goods (beyond its old DVD business), although it does bear significant transaction costs when it comes to sourcing content (in addition to actually paying for the content), but when it comes to customers there are no marginal costs at all.

Facebook and Google, though are a special case: they are (and yes, I know this is the least imaginative term ever) super-aggregators.


What makes Facebook and Google unique is that not only do they have zero transaction costs when it comes to serving end users, they also have zero transaction costs when it comes to both suppliers and advertisers.

Start with supply: not only is the vast majority of online content accessible to Google’s search engine (unsurprisingly, the biggest exception is Facebook), but in fact that content wants to be discovered by Google. Nearly every site on the web has a sitemap that is intended not for humans but for web crawlers, Google’s in particularly, and there is an entire industry dedicated to search engine optimization (SEO). Netflix is on the opposite side of the spectrum here (unlike YouTube, it should be noted): the company has to actively source content and pay for it. Uber and Airbnb and Amazon are in the middle: theoretically there is an open platform for suppliers but there are costs involved in bringing them online.

Facebook takes this to another level: its users are its most important content providers, and they do it for free. Professional content providers aren’t far behind, not only linking to all of their content but increasingly putting said content on Facebook directly (to the extent Facebook is paying for content it is to juice this cycle of self-interested content production on Facebook).

That said, there are a few more companies that have a similar content model: Twitter, Snapchat, LinkedIn, Yelp, etc. All run on user-generated content augmented by professional content placing links or original material on their services. However, there is still one more thing that separates Facebook and Google from the rest: advertisers.

Super-aggregators not only have zero transaction costs when it comes to users and content, but also when it comes to making money. This is at the very core of why Google and Facebook are so much more powerful than any of the other purely information-centric networks. The vast majority of advertisers on both networks never deal with a human (and if they do, it’s in customer support functionality, not sales and account management): they simply use the self-serve ad products like the one pictured above (or a more comprehensive tool built on the companies’ self-serve API).

This is the level that the other social networks have not reached: Twitter grew revenue, but primarily through its sales team, which meant that costs increased inline with revenue; the company never gained the leverage that comes from having a self-serve ad platform (specifically, the self-serve platform costs are fixed but the revenue is marginal).

Snap is following in Twitter’s footsteps: to date the vast majority of the company’s revenue has come from its sales team; the company has a perfunctory API for self-serve ads, but most of the volume springs from the aforementioned deals made by its sales team. Similar stories can be told about LinkedIn, Yelp, and other advertising-based businesses.

This, then, is a super-aggregator: zero transaction costs not just in terms of user acquisition, but also supply acquisition, and most importantly, revenue acquisition, and Google and Facebook are the ultimate examples.

Facebook and the Russians

This is why I was confused that Senator Warner made a big deal out of the fact Facebook was paid in Russian Rubles: the entire premise of the company’s revenue model is that anyone can run an ad without having to talk to another human, and obviously a key component of such a model is supporting multiple currencies.

Again, though, this is the first such model in economic history: it seems I am the one who was blinded by my having experienced the meaning of scale. In that Hotmail meeting everyone and everything was reduced to a number on a spreadsheet: the United States, Japan, Brazil, Russia, all were simply another row. So I naturally assume it is in the case of Facebook ads: that some advertisers buy in dollars, some in Yen, some in Real, others in Rubles is unremarkable to me, and, I suspect, many of the folks working at these companies.

And yet, it is not at all unrealistic that this be very remarkable to everyone else, even someone with the technical and business background of Senator Warner. It would immediately be eyebrow-raising should any of the companies he managed or was invested in suddenly started transacting in Russian Rubles! For a super-aggregator, though, it is not only unremarkable, it is the system working as designed.

This applies to the content of those ads, too: last week, when ProPublica reported that Facebook enabled anti-Semitic targeting, I told a friend that a similar story would come out about Google within a week; it only took one day. When you makes something frictionless — which is another way of describing zero transaction costs — it becomes easier to do everything, both good and evil.

Regulating the Super-Aggregators

This should probably be another article — indeed, it’s an article I’ve been working towards for a long time now — but this appreciation of what Super-Aggreagators are, and how it is a Russian propaganda outfit could buy Facebook ads that likely broke the law, gives insight into a number of principles that should guide people like Senator Warner as they consider potential regulation:

  • Don’t Force the Super-Aggregators to Make Editorial Decisions: It has been distressing to see how quickly some folks have resorted to insisting that Google and Facebook start having a point-of-view on content on their platforms. The problem is not that they might be effective, but rather that it is inevitable that they will be. I wrote in Manifestos and Monopolies:

    My deep-rooted suspicion of Zuckerberg’s manifesto has nothing to do with Facebook or Zuckerberg; I suspect that we agree on more political goals than not. Rather, my discomfort arises from my strong belief that centralized power is both inefficient and dangerous: no one person, or company, can figure out optimal solutions for everyone on their own, and history is riddled with examples of central planners ostensibly acting with the best of intentions — at least in their own minds — resulting in the most horrific of consequences; those consequences sometimes take the form of overt costs, both economic and humanitarian, and sometimes those costs are foregone opportunities and innovations. Usually it’s both.

    The best solution in my estimation is enforced neutrality; to the extent limitations are put in place they should be enforced by another entity with far more accountability to the people than either of these Super-Aggregators. That probably means the government (with the obvious caveat that authoritarian governments would certainly prefer to use Facebook for their own ends).

  • Focus on Transparency: The personalization afforded by Super-Aggregators means their advertising is simply not comparable to anything that has come before: television commercials, radio jingles, newspaper ads, all are publicly disseminated and thus can be tracked (the one possible exception is direct mail, which, unsurprisingly, has been the home of the foulest sort of political advertising in particular). Digital ads, on the other hand, can be shown to a designated audience without anyone else knowing. It is worth debating whether this level of secrecy should be allowed in general; it seems without question, in my mind, that it should not be allowed for political ads. Of course, that begs the question of what is a political ad, which again points towards regulation (which, per point one, is preferable to the unaccountable Google and Facebook deciding).

  • Remember the Benefits of Zero Transaction Costs: The biggest beneficiaries of zero transaction costs on the super-aggregators are not traditional advertisers, whether that be companies like CPG conglomerates or presidential campaigns. Both have the resources to advertise anywhere and everywhere, and indeed, often find that the fine-tooth targeting on super-aggregators isn’t worth the effort required. The folks that do benefit, though, are those that wouldn’t have a voice otherwise: startups and niche offerings, both in terms of business and politics. Google and Facebook have opened the field to far more entrants, and while that means there are more folks with bad intentions, there are also a whole lot more folks with ideas that were shut out by the significant transaction costs inherent in pre-Internet platforms.

There’s one final consideration that should apply to regulation, broadly: given that Google and Facebook are already well-established with businesses that serve users, suppliers, and advertisers in a virtuous cycle, it is unlikely that regulation of any kind will have meaningful effects on their bottom lines. Indeed, I expect Google and Facebook to be mostly cooperative with whatever regulation comes from these recent revelations.

Rather, the companies that will be hurt are those seeking to knock Google and Facebook off their perch; given that they are not yet super-aggregators, they will not have the feedback loops in place to overcome overly prescriptive regulation such that they can seriously challenge Google and Facebook.

For example, consider the much-touted General Data Protection Regulation (GDPR) set to take effect in the European Union next year. There is lot of excitement about how this regulation will limit Google and Facebook in particular, by, for example, limiting the use of personal data and enforcing data portability (and not just a PDF of your data — services will be required to build API access for easy export).

The reality, though, is that given that Google and Facebook make most of their money on their own sites, they will be hurt far less than competitive ad networks that work across multiple sites; that means that even more digital advertising money — which will continue to grow, regardless of regulation — will flow to Google and Facebook. Similarly, given that the data portability provisions explicitly exclude your social network — exporting your friends requires explicit approval from your friends — it will be that much harder to bootstrap a competitor.

This is the reality of regulation: as much as the largest incumbents may moan and groan, they are, in nearly all cases, the biggest beneficiaries. To be sure, that doesn’t mean regulation isn’t appropriate — it should be far more obvious to everyone that Russians were purchasing election-related ads on Facebook — but rather that it be expressly designed to limit the worst abuses and enable meaningful competitors, even if they accept payment in Russian Rubles.

  1. For what it’s worth, Stratechery has never actually taken out a Facebook ad, or any ad for that matter []
  2. Yes, I’m writing about Aggregation Theory again; I explain why I do so often here []
  3. Presuming his tweet was not as cynical as it very well might have been []

The Lessons and Questions of the iPhone X and the iPhone 8

It’s tempting — and easy — to be cynical about the richest company in the world beginning its annual unveiling of new products with what effectively amounted to a promotional video for a building custom-built at enormous expense for said unveiling, set to the soundtrack of John Lennon singing “All You Need is Love”.1

There’s nothing you can do that can’t be done
Nothing you can sing that can’t be sung
Nothing you can say but you can learn how to play the game
It’s easy

Nothing you can make that can’t be made
No one you can save that can’t be saved
Nothing you can do but you can learn how to be you in time
It’s easy

In fact, the song was perfect; the temptation to be cynical is right there in the first verse, with the observation that by virtue of doing or singing or making you are operating in the bounds of what is merely possible, no more. And yet, the second verse holds forth salvation: find yourself, and find fulfillment. After all, you are the only one that can accomplish that precise task.

After the song finished, with the stage saying nothing more than “Welcome to the Steve Jobs Theater,” a recording of the late Apple founder and two-time CEO made the same point:

There’s lots of ways to be as a person. And some people express their deep appreciation in different ways. But one of the ways that I believe people express their appreciation to the rest of humanity is to make something wonderful and put it out there. And you never meet the people, you never shake their hands, you never hear their story or tell yours, but somehow, in the act of making something with a great deal of care and love, something is transmitted there. And it’s a way of expressing to the rest of our species our deep appreciation. So we need to be true to who we are, and remember what’s really important to us. That’s what is going to keep Apple Apple, if we keep us us.

I don’t know when Jobs said those words, but one of the most compelling examples of what he meant was, by definition, yet to come. My mind immediately went to the days after Jobs passed away in October 2011:

Spontaneously, all over the world, makeshift memorials, usually around Apple Stores, sprang up to honor someone whom, to paraphrase Jobs, they never met, whose hand they never shook, who never heard their story — and frankly, had they met Jobs, they very well might have regretted the experience!

That, though, was Jobs’ point: the stories of his mistreatment of those closest to him, both professional and deeply personal, reveal the man’s weaknesses; I see no need and have no desire to whitewash them. The company he built and the products that engendered such a deep emotional attachment in their owners, though, captured his strengths — and Apple’s customers felt his appreciation. You might call it love.

To return to Lennon’s words, Jobs, particularly in his second stint at Apple, had learned how to be himself: less designer than editor-in-chief, Jobs not only drove those he worked with to create “with great deal of care”, he also set Apple on a path towards being its best self. That, famously, means the integration of hardware and software, but at least in the case of the iPhone, the pertinent integration goes down to the silicon.

To that end, the products Apple unveiled at the new Steve Jobs Theater could not have been more appropriate: a cellular watch significantly smaller than competitors with comparable battery life, a new iPhone 8 improved in virtually every dimension, and, of course, the iPhone X, with nearly every new feature dependent on that integration.2

About That Notch

Apple clearly decided to not minimize the notch, the black cut-out at the top of the iPhone X that houses an array of sensors and cameras. If anything, the company went out of its way to emphasize it, including playing video such that the notch obscured what was being shown (that is actually an optional view; by default video is letter-boxed such that it avoids the notch).

I think the emphasis on the notch served another purpose, though: it is, in its own way, something that only Apple can do.3 First, the operating system needed to be modified to work around the notch. Only Apple has sufficient control of the entire stack that they can pull off such a radical overhaul in software to accommodate the change in hardware. Second, applications will need to be reworked to look their best; thousands of developers are hard at work today doing just that, because the iOS ecosystem is so valuable.

Moving beyond the notch, Apple is also demonstrating its power over users; using an iPhone X is going to be significantly different than any other previous iPhone. Everything has changed, from unlocking the phone to invoking Siri to exiting apps to multi-tasking to Apple Pay. And yet there is little doubt that millions will do just that (and, naturally, insist that the new way is obviously better).

What is and remains so brilliant about the iPhone specifically and Apple’s business broadly is how everything is aligned around Apple being the Apple Jobs envisioned: a company that shows its “appreciation to the rest of humanity [by making] something wonderful and put[ting] it out there.” By making the best products Apple earns loyal customers willing to pay a premium; loyal customers give Apple both freedom to make large scale changes and also a point of leverage against partners like carriers and developers. And then, the resultant profits lets Apple buy the small companies and do the R&D to create the next set of products.

This has been the story of the iPhone: for ten years every single model has been a meaningful jump over the previous one, giving Apple a stranglehold on the top of the market. There was no further segmentation needed: the smartphone market was growing around the world, and Apple was taking the premium part. Indeed, the company’s one misstep — 2013’s iPhone 5C — came from a misguided attempt to go downmarket.

The iPhone 5C

“Misstep” is perhaps a bit harsh. What we know about the iPhone 5C is this: in 2013 Apple was under tremendous external pressure, not just in the press but especially on Wall Street4, to produce a lower-cost iPhone. Most analysts were convinced the company had not just saturated the high end but was in imminent danger of being disrupted by cheaper good-enough Android phones5, and speculation was rampant that Apple would release a new iPhone at a significantly lower price point.

Apple went the other way; in one of my favorite Apple keynotes, the company stuck to the high end. The iPhone 5C was cheaper than the 5S, announced on the same day, but only by $100; it was effectively a replacement for the iPhone 5 in terms of Apple’s previous practice of selling previous iPhones at a lower price.

Still, I for one thought it would sell very well; all indications are that Apple agreed, but it quickly became apparent that customers overwhelmingly preferred the iPhone 5S. Apple struggled to keep the latter in stock, having produced far too many 5Cs, and the model was quietly discontinued two years later. I wrote at the time:

The problem with the 5C, though, is that it wasn’t an iPhone. Well, technically it was — it was made by Apple, after all — but particularly in Asia, and especially in China, an iPhone is about more than even the hardware and software that Apple is so proud of integrating. It is the device to own for emerging upper middle class consumers, and what is brilliant about the sell-old-flagship-iPhones strategy is that it allows the cheaper iPhones to punch above their weight: after all, that iPhone 5S you pull out of your pocket and casually place on the table may be brand new today (because you can only afford $450), or you may simply have not yet replaced the iPhone you bought at full price when it came out. Regardless, you have a flagship; the 5C, on the other hand, was from day one not the flagship, and quite obvious about it (one is reminded of Jony Ive calling it “unapologetically plastic”). To buy a 5C was to show you couldn’t afford a better one.

The 5C’s failure, such that it was, showed that the iPhone had three distinct markets:

  • Customers who wanted the best possible phone. They bought the 5S.
  • Customers who wanted the prestige of owning the highest-status phone on the market. Heavily concentrated in China, they bought the gold 5S.
  • Customers who aspire to owning a top-of-the-line iPhone, but couldn’t afford one. They bought the 4S instead of the 5C.

What was missing was the cost-conscious customer; the truth is that if price is the priority an Android phone will always win. By 2013 even the cheapest phones were “good enough”; only people who cared about owning an iPhone would pay more,6 and if they were going to pay more of course they wanted the best, or at least a phone that gave off the prestige of having been the best at some point in time.

More Lessons Learned

A year later Apple (finally) released two iPhones with significantly larger screens: the iPhones 6 and 6 Plus. The response was incredible: iPhone sales jumped a staggering 45% year-over-year. That, though, made the iPhone 6S a much tougher sale. It became clear that Apple had pulled forward some number of upgraders to the iPhone 6, even as other customers held onto their good-enough phones for longer.

The iPhone 7 cemented this view: growth returned inline with models that presumed that the iPhone 6 pulled forward upgrades in an increasingly saturated market; Apple was no longer benefiting from overall smartphone growth, but the company also wasn’t losing customers to Android — if anything, it was gaining them.

The one exception was China. As I noted in Apple’s China Problem, the iPhone was growing all over the world but shrinking in China, and I blamed WeChat:

WeChat works the same on iOS as it does on Android. That, by extension, means that for the day-to-day lives of Chinese there is no penalty to switching away from an iPhone. Unsurprisingly, in stark contrast to the rest of the world, according to a report earlier this year only 50% of iPhone users who bought another phone in 2016 stayed with Apple:

This is still better than the competition, but compared to the 80%+ retention rate Apple enjoys in the rest of the world, it is shockingly low, and the result is that the iPhone has slid down China’s sales rankings: iPhone sales were only 9.6% of the market last year, behind local Chinese brands like Oppo, Huawei and Vivo. All of those companies sold high-end phones of their own; the issue isn’t that Apple was too expensive, it’s that the iPhone 6S and 7 were simply too boring.

There was one more lesson learned from the iPhone 7: for the first time Apple raised prices. Specifically, the iPhone 7 Plus was $769, $20 more than the iPhone 6S Plus at launch; the iPhone 7 pricing was identical to the iPhone 6S ($650). Theoretically this should have curbed demand for the 7 Plus, but the opposite happened: Apple sold more 7 Pluses relative to the 7 than they did 6S Pluses relative to the 6S. To be clear, I don’t think they sold more because of the price change; rather, consumer preferences continued to move towards bigger phones and, at least for an iPhone buyer, price simply isn’t the top priority.

Apple’s New iPhone Strategy

Forgive the long-winded history of the iPhone, but I think it is critical to understand Apple’s thinking when it comes to this year’s announcements; I think all of the lessons I referenced above influenced this lineup:

Start at the top. The iPhone X sells to two of the markets I identified above:

  • Customers who want the best possible phone
  • Customers who want the prestige of owning the highest-status phone on the market

Note that both of these markets are relatively price-insensitive; to that end, $999 (or, more realistically, $1149 for the 256 GB model), isn’t really an obstacle. For the latter market, it’s arguably a positive.

The iPhone 8 (and 8 Plus), meanwhile, serves the slow and steady markets that bought the iPhone 7: previous iPhone owners upgrading and Android switchers. Critically, the iPhone 8 also serves those folks who aspire to an iPhone. No, they can’t afford an iPhone 8, but the iPhone 6S they can afford looks almost exactly the same, and in a few years the iPhone 8 will still be viewed as a once-flagship (the SE, meanwhile, deliberately apes the shape of the once-flagship 5S). Oh, and by the way, Apple is raising the price on the 8 as well: if price isn’t the chief factor, how far can you go?

Apple’s Risk

That said, I think Apple is taking a pretty significant risk with the iPhone 8 in particular: we know the company can succeed by selling the “best” phone, but the one example we have of building a less-than-best phone was underwhelming; to that end, how many iPhone buyers will forgo the 8 to wait for the X?

In some respects this is a good problem to have — customers wanting to give you more money for a more expensive phone — but the fact the iPhone X is not launching until November suggests it is well behind in production, which further suggests supply will be limited for some time to come. It is quite possible that Apple’s fiscal Q12018 results will be depressed by limited supply.

Of course this is a short-term problem; I do expect the iPhone X to be a massive hit in China in particular. Indeed, I wouldn’t be surprised if most of the early iPhone X supply were earmarked for the country. My argument about WeChat’s effect on Apple is that it elevates the importance of fresh hardware designs over iOS when it comes to iPhone sales; iPhone X is as fresh as it gets.

There’s one more verse in Lennon’s song:

Nothing you can know that isn’t known
Nothing you can see that isn’t shown
Nowhere you can be that isn’t where you’re meant to be
It’s easy

I have to disagree: I don’t know if Apple can segment the iPhone market; what has been shown is that they can’t, that the iPhone can only be the best, nothing less.

That is why I find this launch so fascinating, and will be watching the upcoming quarter’s results so closely: Jobs built Apple to be the best, and the company has succeeded by being exactly that. Does that foreclose the possibility of also being really good, and the gains from market segmentation that follow?

  1. Unfortunately, the video of the event no longer includes the opening with The Beatles song; you’ll have to take my word for it []
  2. I will cover all aspects of Apple’s keynote in tomorrow’s Daily Update []
  3. Other phones, like the Essential Phone, do have a much smaller cutout; the operating system isn’t re-worked to the degree the iOS is for the iPhone X, though, nor will developers put in special work []
  4. The stock had fallen to $55.79 in April 2013, nearly half the price of a year earlier []
  5. In a fortuitous coincidence, I started Stratechery in 2013, and I got a lot of early traction by arguing that Apple was fine []
  6. I’m generalizing here; some customers genuinely prefer Android and primarily bought Samsung; Apple dominated the high end though []

Everything is Changing; So Should Antitrust

Late last month WPP, the largest advertising group in the world, announced results and forecasts that were sharply down. Those results, though, were not what I found striking about CEO Martin Sorrell’s remarks on the group’s earnings call; after all, I argued last summer that such a decline was inevitable.

Rather, it was striking just how feeble Sorrell’s proposed response was:

So what’s our response to all this? Well, further focus on our 4 strategic priorities. Horizontality, which we moved up from, I think it was #4 a year or so ago to #1, is our first critical priority. And it really means ensuring that our people work seamlessly. They’re accustomed to working vertically and by agency brand, but they work seamlessly horizontally across the group together through client teams, I’ll come on to those, and country managers and subregional managers to provide an integrated benefit for clients. And clients are pressurizing us for more effectiveness and more efficiency, this is the way, probably the most significant way that we can respond.

Make no mistake, I’m a student of organizational structure and the importance of aligning an organization to the challenge at hand. Moreover, WPP’s conglomerate nature make any sort of cross-agency collaboration challenging; that, though gets at the real problem. If WPP must change the way it works internally, that by definition means the environment in which it is operating is fundamentally different than the one that existed while WPP grew into the organization it is today.

Ad Agencies and the Internet

I wrote about ad agencies earlier this year in the context of complaints about ads appearing next to objectionable content:

Way back in 1841, Volney B. Palmer, the first ad agency, was opened in Philadelphia. In place of having to take out ads with multiple newspapers, an advertiser could deal directly with the ad agency, vastly simplifying the process of taking out ads. The ad agency, meanwhile, could leverage its relationships with all of those newspapers by serving multiple clients:

It’s a classic example of how being in the middle can be a really great business opportunity, and the utility of ad agencies only increased as more advertising formats like radio and TV became available. Particularly in the case of TV, advertisers not only needed to place ads, but also needed a lot more help in making ads; ad agencies invested in ad-making expertise because they could scale said expertise across multiple clients.

Over the past few weeks (here and here) I have been revisiting Clayton Christensen’s Law of Conservation of Attractive Profits, a theory I first explored in this 2015 article about Netflix:

Breaking up a formerly integrated system — commoditizing and modularizing it — destroys incumbent value while simultaneously allowing a new entrant to integrate a different part of the value chain and thus capture new value.

Commoditizing an incumbent’s integration allows a new entrant to create new integrations — and profit — elsewhere in the value chain.

This starts to get at what is happening to WPP: the very idea of an ad agency arose from the opportunity to integrate the creation and placement of ads across disparate outlets, creating a one-stop shop for advertisers.

Those outlets, though, were only ever a proxy; advertisers don’t run ads for the sake of running ads, but rather to reach consumers. And on the Internet, where distribution is free and content abundant, more and more consumers found themselves relying on two services that focused on discovery and personalization: Google and Facebook. From that piece on ad agencies:

There are really only two options for the sort of digital advertising that reaches every person an advertiser might want to reach:

That’s a problem for the ad agencies: when there are only two places an advertiser might want to buy ads, the fees paid to agencies to abstract complexity becomes a lot harder to justify.

In fact, the issue is not even really about the money, but theory. Google and Facebook are the new integration points in the advertising value chain; it follows, then, that the rest of the value chain will modularize itself and re-organize around the integrated players. Or, as Sorrell put it, “horizontality.”

The problem for Sorrell is two fold: first, fundamentally re-orienting a business away from a vertical integrative approach to a horizontal modular approach is extremely difficult, both in terms of company culture and the effect on the bottom line. In truth I expect WPP to continue to lose business to digital agencies structured from day one with the assumption that Google and Facebook are the integrators in the advertising value chain.

The second point, though, is worse: what is happening to WPP is happening to the rest of WPP’s ecosystem — media on one side, and advertisers on the other.

The Reorganization of Everything

There used to be a limited number of media outlets — newspapers, radio, and television, primarily — all of which had substantial barriers to entry. That meant these outlets had a monopoly on reaching customers, leaving advertisers no choice but to pay up.

Now, though, there is an effectively unlimited amount of media: countless web pages, streaming music and podcasts, and services like Netflix and YouTube that, unbounded from the constraints of linearity, offer far more content than was ever accessible before. That, as noted above, meant that discovery mattered most, which meant Google and Facebook.

The parallel should be obvious: the clearest manifestation of how the media value chain has been fundamentally reconfigured is the fact that advertising has fled newspapers in particular; in other words, the media story is an advertising story, which is to say that given the upheaval in the media industry, the most surprising part of WPP’s struggles is that it took this long to manifest (thanks, primarily, to television’s resilience).

The exact same value chain reorganization is happening to WPP’s clients: major advertisers like consumer packaged goods companies which built their businesses on integrating the creation and distribution of consumer staples. From Dollar Shave Club and the Disruption of Everything:

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

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

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

The most obvious change has been the rise of Amazon: instead of limited shelf space, the selection is orders of magnitude greater than any bricks-and-mortar store, and integrated with a scaled fulfillment operation. That new integration means that suppliers and merchants have no choice but to modularize and build their businesses around Amazon.

Of course that isn’t the only option: new, smaller companies, like the aforementioned Dollar Shaving Club, can leverage the big platform providers — YouTube, Facebook, AWS, etc. — to compete with massive companies like P&G on far more equal terms than before.

A New Reality

For long time Stratechery readers this analysis isn’t that novel; the shift in value chains that result from the Internet enabling zero distribution and zero transactional costs are the foundation of Aggregation Theory. It certainly is gratifying, in a way, to see the theory play out in what has long been the part of the value chain most resistant to upheaval (TV advertising and TV advertisers).

There is another context, though: the increasing appreciation outside of technology of just how dominant companies like Google, Facebook, Amazon, and even Netflix have become, and more and more discussion about whether antitrust is the answer. The problem is that much of this discussion is rooted in the old value chain, where power came from controlling distribution.

What is critical to understand is that that world is fading away; the fundamental nature of the Internet is abundance, and the critical competency is discovery. Moreover, the platform that harnesses discovery also harnesses a virtuous cycle between users and suppliers that leads to a winner-take-all situation inherent in two-sided networks. In other words, to the extent these platforms are monopolies, said monopoly is much more akin to AT&T than it is to Standard Oil.

This matters for three reasons:

  • First, the fact that newspapers, for example, or perhaps one day WPP, are being driven out of business is not a reason for antitrust action; their problem is their business model is obsolete. The world has changed, and invoking regulation to try to change that reality is a terrible idea.
  • Second, the consumer-friendly approach of these platform companies is no accident: when market power comes from owning demand, then the way to gain power is to create a great experience for consumers. The casual way in which many antitrust crusaders ignore the fact that, for example, Amazon is genuinely beloved by consumers — and for good reason! — is frustrating intellectually and eye-rolling politically.
  • Third, the presence of these platforms creates incredible new opportunities for businesses that were never before possible. I already described how Dollar Shaving Club was enabled by platform companies; Amazon has also enabled a multitude of merchants, Facebook an entire ecosystem of apps and personalized startups, and Google every possible service under the sun.

In a 30-second commercial, of the sort that WPP might have made, drawing clear villains and easy narratives is valuable; the reality of aggregators is far more complicated. That Google, Facebook, Amazon, and other platforms are as powerful as they are is not due to their having acted illegally but rather to the fundamental nature of the Internet and the way it has reorganized value chains in industry after industry.

Moreover, these platforms have far more positive outcomes than distribution-based monopolies ever did: the consumer experience is better, and there are huge new opportunities to build new businesses (especially serving niches completely ignored in a distribution-based world) on top of them. That is a good thing, worth preserving.

To that end any antitrust regulation, if it comes, needs a fresh approach rooted in the reality of the Internet. I agree that too much concentrated power has inherent problems; I also believe a structural incentive to provide a great customer experience, along with the potential to create completely new kinds of businesses, is worth preserving. Antitrust crusaders, to whom I am clearly sympathetic, ignore these realities at their political peril.

Uber’s New CEO

In the last seven months, Uber has endured:

  • The #DeleteUber campaign
  • The fallout from Susan Fowler Rigetti’s blog post, including the Holder investigation and report
  • A lawsuit from Waymo alleging the theft of intellectual property
  • Multiple revelations of past misconduct, including Greyball, which has prompted an investigation from the Department of Justice
  • The forced resignation of founder and CEO Travis Kalanick, and then, earlier this month, an explosive lawsuit against Kalanick from the company’s biggest investor

And, at the end of all that drama — and this is only a partial list (as of the time of this writing Techmeme has had 280 posts about Uber in 2017) — Dara Khosrowshahi, the very successful, very stable, and very well-compensated CEO of Expedia, jumped at the opportunity to take the helm, beating out GE CEO Jeffrey Immelt and and Hewlett Packard Enterprise CEO Meg Whitman for the honor…it’s an honor, right?

In fact, I think Khosrowshahi is a great choice for CEO, and understanding why goes a long ways towards explaining why the Uber job remains an attractive one, even after the worst seven-month stretch in startup history.


Most news stories are making the obvious point that Khosrowshahi is qualified because he is a CEO for a tech company in the travel industry. What is even more relevant, though, is that Khosrowshahi is the CEO of an aggregator. Expedia and other online travel agents (and their associated stables of sites) have built businesses by focusing on discovery: instead of having to find hotels directly, a customer can go to Expedia and simply search for a location.

This, by extension, draws supply; while hotels may complain about having to pay OTA fees, the truth is the volume driven by the OTAs is well worth the cost — and Khosrowshahi has been willing to remind hotels of that fact. Indeed, Khosrowshahi had to learn just how powerful the effect of aggregation on suppliers can be. In an oral history on Skift about online travel, Khosrowshahi (who was then CFO of Expedia controlling-shareholder IAC/Interactive) recounted how it was that the company passed on

I think the Expedia team had taken a look at and Active [Hotels, acquired by Priceline in 2005 and 2004, respectively] and again had passed. And, I think it was because we were attached to the merchant model and we were attached to high margins at the time.

The merchant model Khosrowshahi is referring to is where an OTA buys rooms at a wholesale rate and then sells them to end users; the advantage is a bigger margin on the sale of a room plus a positive cash cycle: the customer pays immediately but the OTA doesn’t pay the hotel until the stay occurs. The disadvantage, though, is that it requires making deals with hotels to buy rooms. Former Priceline CEO Jeffery Boyd, in the same oral history, explained what made unique:

What the guys at did the best really was that they understood how to basically address the entire market and not just the big chain hotels, the Accors and Marriotts and Hiltons in London, but ultimately leads to find demand for and service hotels in all countries, small towns, small hotels. used the agency model: instead of selling rooms at a markup Booking collected a commission on the rooms booked through its service. This meant significantly lower margins, no money until the stay occurred, and even then collection required some sort of enforcement mechanism.

The payoff, though, was tremendous:, unlike Expedia, had minimal transactions costs for customers and suppliers. Hotels could sign up for on their own instead of having to negotiate a deal, which meant it was that led the industry in growth for many years; the full payoff of owning discovery in a world of drastically reduced distribution and transaction costs comes not from extracting margin from a limited set of suppliers, but rather from expanding the market to the greatest extent possible, creating the conditions for a virtuous cycle of more customers -> more suppliers -> more customers.

To Khosrowshahi’s credit he learned this lesson: Expedia was in big trouble in the years after he took over, and one of the changes Khosrowshahi made was to add the agency model to Expedia’s properties (Expedia now has a hybrid approach). It is a lesson that will serve him well as Uber’s CEO; the fundamental mistake made in so much Uber analysis comes from believing that drivers are the key to the model. For example, there was a very popular piece of analysis some months ago premised on evaluating the cost of driving for Uber relative to driving for a traditional cab company. It was a classic example of getting the facts right and missing the point.

In fact, what makes Uber so valuable — and still so attractive, despite all of the recent troubles — is its position with riders. The more riders Uber has, the more drivers it will attract, even if the economics are worse relative to other services: driving at a worse rate is better than not driving at a better one.

To that end, Uber’s strength — and its sky-high valuation — comes from the company’s ability to acquire customers cheaply thanks to a combination of the service’s usefulness and the effects of aggregation theory: as the company acquires users (and as users increases their usage) Uber attracts more drivers, which makes the service better, which makes it easier to acquire marginal users (not by lowering the price but rather by offering a better service for the same price). The single biggest factor that differentiates multi-billion dollar companies is a scalable advantage in customer acquisition costs; Uber has that.

Indeed, Uber’s position is in this respect stronger than Expedia’s: Expedia is an aggregator of sorts, but a huge portion of its audience in fact starts with a Google search, which means Expedia must pay Google a huge “tax”, in the form of search ads, to acquire users. Moreover, Expedia lives in constant fear that Google is simply going to fill the OTA role directly; that is why Expedia was a complainant in the EU’s antitrust case against Google. An even more pressing concern is Airbnb, which is forging its own customer relationship and own supply, and could (should?) move into hotel booking as well.


Expedia’s experience with Google as intermediary has its advantages: OTAs like Expedia and Priceline are, by necessity, the absolute best at testing and measuring the return on investment of outbound marketing, particular search advertising. That specific skill may not be particularly useful to Uber, but what the company certainly needs is a far more disciplined and exact approach to its accounting.

A few months ago, when Uber lost its head of finance Gautam Gupta, The Information reported that:

Financial-performance data tools that Uber executives use for internal purposes have a long way to go, according to two people who have been briefed about the issue. For instance, Uber until recently didn’t have a way to accurately calculate the amount in bonuses that Uber paid to drivers in, say, the past week.

As I noted in a Daily Update at the time, this is staggering: Uber cannot measure the “single most important factor in [its] profitability” on something approaching a real-time basis. Moreover, as I wrote then:

The implication of this lack of tracking is that Uber may not have a clear picture as to what its unit costs are; as I noted in a Daily Update last year about Uber’s unit economics, driver bonuses based on meeting a quota of rides in a specific time period are absolutely variable costs that should be allocated to a unit cost calculation. But, if Uber doesn’t even know what those costs are in anything approaching real time, how can it really know what its unit costs are?

No wonder Benchmark, the investor that is suing Kalanick, listed the lack of a CFO as a reason for its lawsuit. And in that light, Khosrowshahi’s finance background is an asset, not a liability. Nothing is more important for Uber than getting its books straight, because I suspect the company’s tactics might change as well. From that Daily Update:

It is worrisome that these bonuses are the key to profitability; I have long argued that Uber wins not by monopolizing drivers (i.e. supply) but by monopolizing riders (i.e. demand). And, optimizing for demand would suggest giving drivers a bigger cut of each ride such that marginal drivers (i.e. those that aren’t in a position to earn those volume bonuses) are encouraged to come on to the network and improve liquidity. Of course, higher driver payouts quite obviously impact unit economics; if bonuses, at least in Uber’s accounting, do not, then its easy to see how a suboptimal decision that favors bonuses over higher payouts could result. Accounting matters!

In other words, I think that Uber’s use of the bonus model with drivers has the whiffs of Expedia using a merchant model: it makes sense in the short term (in this case, monopolizing the time of professional drivers such that they can’t drive for the competition) but it ignores the long term value of having less friction for suppliers to come on board (that is, the part time drivers that overwhelmingly favor Lyft). Khosrowshahi’s painful lesson with may be an advantage here as well.


I noted that Expedia was in trouble at the beginning of Khosrowshahi’s tenure; in fact, the company’s situation deteriorated over Khosrowshahi’s first few years, culminating in a $2.52 billion loss for 2008. To be fair the biggest part of that loss was the write-down of intangible assets layered on top of the Great Recession, but the truth was that Expedia had been slumping for a long time.

In response Khosrowshahi did something that may have seemed quite risky: instead of trying to apply a quick fix to the business, he led a complete rebuild of the underlying platform that powered Expedia and its various house brands. This new platform not only enabled the shift to the agency model noted above, but dramatically improved the company’s ability to test and iterate its offering. Moreover, because the platform was designed to work with multiple brands, it set Expedia up for its recent acquisition binge, including Orbitz and HomeAway; critics say the company has bought growth, I say that owning more customer touchpoints, provided you can execute against them, is exactly what an aggregator should be doing.

The deeper takeaway, though, is that Khosrowshahi has demonstrated the patience and resolve to fix problems at their root. In the case of Uber, the business may be in better shape than Expedia’s was (pending the fixing of finance, of course), but as this year has made clear the culture needs a fundamental reworking, not simply a fresh coat of paint. Khosrowshahi seems like an ideal candidate to take on the problem at a fundamental level, and has already shown at Expedia that he is willing to walk the walk on issues of sexism in particular.

It is easy to mock Uber and the ridiculous CEO selection process that resulted in Khosrowshahi getting the job. Even the final selection process itself was a joke: in the span of 24 hours the presumed favorite shifted from Immelt to Whitman to the surprise selection of Khosrowshahi, with Uber reporters literally changing their stories by the minute as board members leaked like sieves in an attempt to rally public opinion to their sides.1 Without question Uber has been horrifically served by its board of directors — all of them.

And yet, the company has landed on a candidate that I am quite enthused about, and that, I think, is a reminder of just why Uber is so compelling. So many tech startups blather on about changing the world; Uber actually is, for the better. To that end, I would argue that one of Kalanick’s greatest failings was in his inability to sell Uber: the company offers a compelling service for riders, an economically attractive one for drivers (who drive by choice), and makes the cities within which it operates better. That the company has managed to become a pariah is the most powerful testament there is to Kalanick’s failure as CEO.

To that end I hope Kalanick and the other members of the board truly give Khosrowshahi the space he needs to rework Uber’s culture, finances, strategy, and image. The fact of the matter is that Uber’s missteps have already cost it much of its global ambitions; Kalanick in particular needs to give the space for Khosrowshahi to aggregate the opportunity that remains.

  1. As an aside, Immelt would have been a terrible choice: he has no relevant experience, particularly given his job at an old-line company with zero experience in aggregation effects. Whitman, on the other hand, pioneered the aggregation model at Ebay; however, because of Ebay it seems clear that Whitman was closely aligned with Benchmark, which may have made board dynamics with Kalanick untenable. Moreover, Whitman’s experience at HP-E isn’t really relevant at all []

Disney’s Choice

While the “look-at-the-silly-millenials” genre tends to be a bit tiresome, the Wall Street Journal came up with a novel angle earlier this month: the TV antenna.

The antenna is mounting a quiet comeback, propelled by a generation that never knew life before cable television, and who primarily watch Netflix, Hulu and HBO via the Internet. Antenna sales in the U.S. are projected to rise 7% in 2017 to nearly 8 million units, according to the Consumer Technology Association, a trade group…

Since the dawn of television, the major networks have broadcast signals over the airwaves. It is free after buying an antenna, indoor or outdoor, and plugging it into your TV set. It still exists, though now most consumers have switched to cable television, which includes many more channels and costs upward of $100 a month.

The story is even more ironic when you consider the origins of cable TV. In the late 1940s, households that, due to geography, could not receive over-the-air television signals in their homes, banded together to erect “community antennas” on mountain tops or tall buildings, and then ran cables from said antennas to individual houses. In other words, cable TV originated as a means to get the free TV that was broadcast to everyone.

It turned out, though, that these “super antennas” could pick up not only local broadcast signals but also signals from stations hundreds of miles away; that meant that having cable access didn’t simply bring households to parity with customers using in-house antennas: cable TV was actually better. And while the FCC soon killed the ability of cable operators to offer those far-off channels, the idea of using cable access to offer additional differentiated content inspired Charles Dolan and Gerald Levin to launch the United States’ first pay-TV network in 1972; they called it the Home Box Office, now more commonly known by its acronym, HBO.

HBO pioneered the use of satellites to spread its content to all those community access cable networks; TBS, an Atlanta local television station owned by Ted Turner soon joined them, at first offering content for free, funded by advertising. Eventually, though, TBS and other channels, including the USA Network and an all-sports venture called ESPN, realized that the entrepreneurs investing in building out cable systems needed content to entice new subscribers in order to pay off their fixed costs: that meant the ability to charge fees on a per-subscriber basis — provided, of course, that the cable channel charging such fees actually had content that was worth paying for.

What made this transition easier is that cable operators were already charging customers for access; cable channels didn’t have to charge customers directly, and if their subscriber fees resulted in higher cable rates, well, that wasn’t their problem! Indeed, it wasn’t a problem for anyone: thanks to bundle economics everyone was happy. Cable operators charged more but justified increases with more and more cable channels; customers may have grumbled but increasingly found cable indispensable, thanks to cable networks doing exactly what they were incentivized to do: create or acquire content that was worth paying for.

Vertical Versus Horizontal

Perhaps the oldest theme on Stratechery is the importance of understanding the difference between vertical and horizontal companies; in May 2013 I wrote of Apple and Google:

Apple invests in software, apps, and services to the extent necessary to preserve the profit they gain from hardware. To serve another platform would be actively detrimental to their bottom line. Google, on the other hand, spreads their services to as many places as possible – every platform they serve increases their addressable market.

Vertical companies like Apple achieve profits by selling differentiated goods at high margins. Horizontal companies like Google, on the other hand, achieve profits through scale, which by extension means being free (or as low cost as possible) is more important than being the “best”; the brilliance of Google’s model, of course, is that having more users, and thus more data, means it is the best as well.

Indeed, that is the foundation of another major Stratechery theme: Aggregation Theory. Some companies, in markets with zero distribution costs and zero transactions costs (like search, for example), can leverage an initial user experience advantage into a virtuous cycle: new users attract new suppliers, which in turn increases the user experience, thus attracting even more users, in turn attracting more suppliers, until the aggregator has all the users and all the suppliers. Naturally, given that the payoff is, as I said, all the users, aggregators are horizontal companies.

Netflix: The Disruptive Aggregator

Netflix is an aggregator, perhaps my favorite example of all, in part because their industry — television — was in a far stronger position than the text-based industries aggregated by Google and Facebook. Making good content is hard, and expensive, and cable has always been a good deal; that Netflix has been as successful as it has is perhaps the most powerful example there is of how an initial user experience advantage can lead to a dominant position in an industry.

Netflix is also disruptive; while the term is overused, the formulation is actually quite simple: a new entrant leverages a technical innovation to serve customers with a business model incumbents cannot compete with, and over time moves up the value chain until those incumbents end up with a worse product that is more expensive to boot.

In the case of Netflix the innovation was streaming over the Internet: it was both a user experience breakthrough that gained the company customers, providing revenue with which the company could start to produce its own content, and also an enabler of a new business model — content everywhere. From a recent feature in Variety:

No media company today is expanding faster and is more talked about, admired, feared and debated than Netflix — which has upended the traditional models for television and inspired binge culture. “They totally made television global, and that was an unheard-of concept,” says Harvey Weinstein. “Whoever thought of buying universal rights to anything?” Depending on where you stand, Netflix is either saving Hollywood or wreaking havoc on an already unstable industry.

Netflix’s recent deal with longtime ABC Studios showrunner Shonda Rhimes draws that line quite nicely: for content creators Netflix’s rise has been a boon, not only financially but also creatively; for networks the streaming service is nothing but a threat, not just for talent but also viewer attention, and, inconveniently, a source of income at the same time.

Disney’s Netflix Problem

Rhimes former employer, Disney, is a perfect example. Back in 2012 the media company signed a deal with Netflix to stream many of the media conglomerate’s most popular titles; CEO Bob Iger had crowed on an earnings call earlier that year:

We feel very, very good about opportunities in SVOD and on digital platforms, as we’ve seen and other large media companies have seen the opportunities to monetize owned IP are only growing not just because of new technology but globally. And I think you’ll continue to see growth in both revenue and growth in bottom line, in income, from output deals to these third party or new platform owners. An exciting time for intellectual property owners.

Iger’s excitement was straight out of the cable playbook: as long as Disney produced differentiated content, it could depend on distributors to do the hard work of getting customers to pay for it. That there was a new distributor in town with a new delivery method only mattered to Disney insomuch as it was another opportunity to monetize its content.

The problem now is obvious: Netflix wasn’t simply a customer for Disney’s content, the company was also a competitor for Disney’s far more important and lucrative customer — cable TV. And, over the next five years, as more and more cable TV customers either cut the cord or, more critically, never got cable in the first place, happy to let Netflix fulfill their TV needs, Disney was facing declines in a business it assumed would grow forever.

The company finally responded earlier this month: not only did Disney terminate its deal with Netflix, CEO Bob Iger announced plans for Disney’s own streaming service, populated not only with the company’s family-friendly library but also original shows. Make no mistake, this is a big deal, and strategically sound; Disney, though, faces an under-appreciated challenge in making this streaming service a success: its own fundamental nature as a company.

Disney’s Choice

One of the luxuries of monopoly is that a company doesn’t need to make the vertical/horizontal distinction I referenced earlier; Microsoft, for example, profited for years with a vertical-type business model — making money on device sales, via licensing — without ever developing an internal culture suited towards creating differentiation that customers would pay for. The presumption was they would have no choice, leaving the company free to focus on horizontal empire expansion.

That is a big reason why the company floundered when the rise of mobile reduced PCs to a minority position in the market; in an effort to preserve the business model former CEO Steve Ballmer attempted to build a devices business that Microsoft was fundamentally unsuited for. And, on the flipside, CEO Satya Nadella’s greatest achievement has been shifting the company towards non-Windows-dependent services that serve everyone, the sort of approach that Microsoft as a company is far better at.

Disney has the opposite problem: the company is really good at creating differentiated content — the absolute best in the business. The business model, though, has been a horizontal one. Thanks to the cable bundle the company has long since grown accustomed to getting a little bit of money from everyone, not a lot from the smaller number of folks who are willing to pay a premium for Disney’s differentiation.

The challenge for Disney is that as that old business erodes, the freedom to not choose between a vertical and horizontal model will erode as well:

  • Disney could pursue a vertical business model that would suit its differentiated approach; this would mean a streaming service that looks a lot like HBO. A relatively high price for a relatively small amount of content, and, by extension, an outsized dependence on the company’s ability to continually generate must-see TV.
  • Disney could pursue a horizontal business model that better aligns with the economics of video; video has high fixed costs which means the more customers over which to spread those costs the better. This, interestingly enough, would look much more like Netflix: ever more content with the goal of reaching ever more customers, and becoming an aggregator.

The worst approach would be to try and have it both ways: a streaming service that has limited differentiated content with horizontal audience and revenue assumptions; unfortunately for Disney this is exactly what Iger hinted at in his announcement:

  • While Iger didn’t announce pricing, he did say that “What we’re going to go for here is significant distribution because we believe one way to be successful in the long run is for both of these services to reach a maximum number of people.” That sounds like a horizontal approach!
  • At the same time, Disney might not even include all of its own content in the service. Iger said of Marvel and Star Wars, “We’ve also thought about including Marvel and Star Wars as part of the Disney-branded service, but there where we want to be mindful of the Star Wars fan and the Marvel fan and to what extent those fans are either overlapped with Disney fans or they’re completely basically separate or incremental to Disney fans.”

To be clear, both of these decisions are up in the air, but Iger’s comments are fundamentally at odds with each other: you reach everyone by having more content, not less, and by building a new sort of bundle (which is exactly what Netflix is doing). That means not only including Marvel and Star Wars but also content from non-Disney studios as well. Yes, that may seem antithetical to Disney, the only company that can rival Apple when it comes to fanatical control of how it is perceived by customers, but the company is rapidly losing the luxury of having cable companies do its dirty work.

On the other hand, if Disney insists on doing its own thing, limiting its service to its own differentiated content, it needs to charge the premium that such a strategy entails, and accept the smaller customer base that will result.

The Challenge of Culture

From my perspective the best approach is the horizontal one: content production is economically suited to a model predicated on maximum reach, and the Disney brand is uniquely capable of giving Netflix a run for its money when it comes to acquiring customers and building the streaming bundle of the future.

I wonder, though, if Disney, particularly under leadership that was so successful under the old model, is desperate enough to do what it takes to build a truly successful horizontal business. In some respects the challenge is even more difficult than Microsoft’s: in that case the company had to give up its business model to pursue a new opportunity that fit the fundamental nature of the company. I am suggesting Disney do the opposite: keep its business model — making money from everyone — while letting go of the need to control everything that is so inextricably tied up with the ability to create differentiation. It might be too much to ask.