Manifestos and Monopolies

It is certainly possible that, as per recent speculation, Facebook CEO Mark Zuckerberg is preparing to run for President. It is also possible that Facebook is on the verge of failing “just like MySpace”. And while I’m here, it’s possible that UFOs exist. I doubt it, though.

The reality is that Facebook is one of the most powerful companies the tech industry — and arguably, the world — has ever seen. True, everything posted on Facebook is put there for free, either by individuals or professional content creators;1 and true, Facebook isn’t really irreplaceable when it comes to the generation of economic value;2 and it is also true that there are all kinds of alternatives when it comes to communication. However, to take these truths as evidence that Facebook is fragile requires a view of the world that is increasingly archaic.

Start with production: there certainly was a point in human history when economic power was derived through the control of resources and the production of scarce goods:

fullsizerender

However, for most products this has not been the case for well over a century; first the industrial revolution and then the advent of the assembly-line method of manufacturing resulted in an abundance of products. The new source of economic power became distribution: the ability to get those mass-produced products in front of customers who were inclined to buy them:

fullsizerender-2

Today the fundamental impact of the Internet is to make distribution itself a cheap commodity — or in the case of digital content, completely free. And that, by extension, is why I have long argued that the Internet Revolution is as momentous as the Industrial Revolution: it is transforming how and where economic value is generated, and thus where power resides:

img_0138

In this brave new world, power comes not from production, not from distribution, but from controlling consumption: all markets will be demand-driven; the extent to which they already are is a function of how digitized they have become.

This is why most Facebook-fail-fundamentalists so badly miss the point: that the company pays nothing for its content is not a weakness, it is a reflection of the fundamental reality that the supply of content (and increasingly goods) is infinite, and thus worthless; that the company is not essential to the distribution of products is not a measure of its economic importance, or lack thereof, but a reflection that distribution is no longer a differentiator. And last of all, the fact that communication is possible on other platforms is to ignore the fact that communication will always be easiest on Facebook, because they own the social graph. Combine that with the fact that controlling consumption is about controlling billions of individual consumers, all of whom will, all things being equal, choose the easy option, and you start to appreciate just how dominant Facebook is.

Given this reality, why would Zuckerberg want to be President? He is not only the CEO of Facebook, he is the dominant shareholder as well, answerable to no one. His power and ability to influence is greater than any President subject to political reality and check-and-balances, and besides, as Zuckerberg made clear last week, his concern is not a mere country but rather the entire world.

Facebook Unease

The argument that Facebook is more powerful than most realize is not a new one on Stratechery; in 2015 I wrote The Facebook Epoch that made similar points about just how underrated Facebook was, particularly in Silicon Valley. In my role as an analyst I can’t help but be impressed: I have probably written more positive pieces about Facebook than just about any other company, and frankly, still will.

And yet, if you were to take a military-type approach to analysis — evaluating Facebook based on capabilities, not intent — the company is, for the exact same reasons, rather terrifying. Last year in The Voters Decide I wrote:

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.

The furor last May over Facebook’s alleged tampering with the Trending Topics box — and Facebook’s overwrought reaction to even the suggestion of explicit bias — seemed to confirm that Facebook’s incentives were such that the company would never become overtly political. To be sure, algorithms are written by humans, which means they will always have implicit bias, and the focus on engagement has its own harms, particularly the creation of filter bubbles and fake news, but I have long viewed Facebook’s use for explicit political ends to be the greatest danger of all.

This is why I read Zuckerberg’s manifesto, Building a Global Community, with such alarm. Zuckerberg not only gives his perspective on how the world is changing — and, at least in passing, some small admission that Facebook’s focus on engagement may have driven things like filter bubbles and fake news — but for the first time explicitly commits Facebook to playing a central role in effecting that change in a manner that aligns with Zuckerberg’s personal views on the world. Zuckerberg writes:

This is a time when many of us around the world are reflecting on how we can have the most positive impact. I am reminded of my favorite saying about technology: “We always overestimate what we can do in two years, and we underestimate what we can do in ten years.” We may not have the power to create the world we want immediately, but we can all start working on the long term today. In times like these, the most important thing we at Facebook can do is develop the social infrastructure to give people the power to build a global community that works for all of us.

For the past decade, Facebook has focused on connecting friends and families. With that foundation, our next focus will be developing the social infrastructure for community — for supporting us, for keeping us safe, for informing us, for civic engagement, and for inclusion of all.

It all sounds so benign, and given Zuckerberg’s framing of the disintegration of institutions that held society together, helpful, even. And one can even argue that just as the industrial revolution shifted political power from localized fiefdoms and cities to centralized nation-states, the Internet revolution will, perhaps, require a shift in political power to global entities. That seems to be Zuckerberg’s position:

Our greatest opportunities are now global — like spreading prosperity and freedom, promoting peace and understanding, lifting people out of poverty, and accelerating science. Our greatest challenges also need global responses — like ending terrorism, fighting climate change, and preventing pandemics. Progress now requires humanity coming together not just as cities or nations, but also as a global community.

There’s just one problem: first, Zuckerberg may be wrong; it’s just as plausible to argue that the ultimate end-state of the Internet Revolution is a devolution of power to smaller more responsive self-selected entities. And, even if Zuckerberg is right, is there anyone who believes that a private company run by an unaccountable all-powerful person that tracks your every move for the purpose of selling advertising is the best possible form said global governance should take?

The Cost of Monopoly

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.

Facebook is already problematic for society when it comes to opportunity costs. While the Internet — specifically, the removal of distribution as a bottleneck — is the cause of journalism’s woes, it is Facebook that has gobbled up all of the profits in publishing. Twitter, a service I believe is both unique and essential, was squashed by Facebook; I suspect the company’s struggles for viability are at the root of the service’s inability to evolve or deal with abuse. Even Snapchat, led by the most visionary product person tech has seen in years, has serious questions about its long-term viability. Facebook is too dominant: its network effects are too strong, and its data on every user on the Internet too compelling to the advertisers other consumer-serving businesses need to be viable entities.3

I don’t necessarily begrudge Facebook this dominance; as I alluded to above I myself have benefited from chronicling it. Zuckerberg identified a market opportunity, ruthlessly exploited it with superior execution, had the humility to buy when necessary and the audacity to copy well, and has deservedly profited in the face of continual skepticism. And further, as I noted, as long as Facebook was governed by the profit-maximization incentive, I was willing to tolerate the company’s unintended consequences: whatever steps would be necessary to undo the company’s dominance, particularly if initiated by governments, would have their own unintended consequences. And besides, as we saw with IBM and Windows, markets are far more effective than governments at tearing down the ecosystem-based monopolies they enable — in part because the pursuit of profit-maximizing strategies is a key ingredient of disruption.

That, though, is why for me this manifesto crosses the line: contra Spider-Man, Facebook’s great power does not entail great responsibility; said power ought to entail the refusal to apply it, no matter how altruistic the aims, and barring that, it is on the rest of us to act in opposition.

Limiting Facebook

Of course it is one thing to point out the problems with Facebook’s dominance, but it’s quite another to come up with a strategy for dealing with it; too many of the solutions — including demands that Zuckerberg use Facebook for political ends — are less concerned with the abuse of power and more with securing said power for the “right” causes. And, from the opposite side, it’s not clear that a traditional antitrust is even possible for companies governed by Aggregation Theory, as I explained last year in Antitrust and Aggregation:

To briefly recap, Aggregation Theory is about how business works in a world with zero distribution costs and zero transaction costs; consumers are attracted to an aggregator through the delivery of a superior experience, which attracts modular suppliers, which improves the experience and thus attracts more consumers, and thus more suppliers in the aforementioned virtuous cycle…

The first key antitrust implication of Aggregation Theory is that, thanks to these virtuous cycles, the big get bigger; indeed, all things being equal the equilibrium state in a market covered by Aggregation Theory is monopoly: one aggregator that has captured all of the consumers and all of the suppliers.

This monopoly, though, is a lot different than the monopolies of yesteryear: aggregators aren’t limiting consumer choice by controlling supply (like oil) or distribution (like railroads) or infrastructure (like telephone wires); rather, consumers are self-selecting onto the Aggregator’s platform because it’s a better experience.

Facebook is a particularly thorny case, because the company has multiple lock-ins: on one hand, as per Aggregation Theory, Facebook has completely modularized and commoditized content suppliers desperate to reach Facebook’s massive user base; it’s a two-sided market in which suppliers are completely powerless. But so are users, thanks to Facebook’s network effects: the number one feature of any social network is whether or not your friends or family are using it, and everyone uses Facebook (even if they also use another social network as well).

To that end, Facebook should not be allowed to buy another network-based app; I would go further and make it prima facie anticompetitive for one social network to buy another. Network effects are just too powerful to allow them to be combined. For example, the current environment would look a lot different if Facebook didn’t own Instagram or WhatsApp (and, should Facebook ever lose an antitrust lawsuit, the remedy would almost certainly be spinning off Instagram and WhatsApp).

Secondly, all social networks should be required to enable social graph portability — the ability to export your lists of friends from one network to another. Again Instagram is the perfect example: the one-time photo-filtering app launched its network off the back of Twitter by enabling the wholesale import of your Twitter social graph. And, after it was acquired by Facebook, Instagram has only accelerated its growth by continually importing your Facebook network. Today all social networks have long since made this impossible, making it that much more difficult for competitors to arise.

Third, serious attention should be given to Facebook’s data collection on individuals. As a rule I don’t have any problem with advertising, or even data collection, but Facebook is so pervasive that it is all but impossible for individuals to opt-out in any meaningful way, which further solidifies Facebook’s growing dominance of digital advertising.4


Anyone who has read Stratechery for any length of time knows I have great reservations about regulation; the benefits are easy to measure, but the opportunity costs are both invisible and often far greater. That, though, is why I am also concerned about Facebook’s dominance: there are significant opportunity costs to the social network’s dominance. Even then, my trepidation about any sort of intervention is vast, and that leads me back to Zuckerberg’s manifesto: it’s bad enough for Facebook to have so much power, but the very suggestion that Zuckerberg might utilize it for political ends raises the costs of inaction from not just opportunity costs to overt ones.

Moreover, my proposals are in line with Zuckerberg’s proclaimed goals: if the Facebook CEO truly wants to foster new kinds of communities, then he ought to unleash the force that can best build the tools those disparate communities might need. That, of course, is the market, and Facebook’s social graph is the key. That Zuckerberg believes Facebook can do it alone is evidence enough that for Zuckerberg, saving the world is at best a close second to saving Facebook; the last thing we need are unaccountable leaders who put their personal interests above those they purport to govern.

  1. Plus, of course, the content Facebook pays for to seed initiatives like live video and dedicated content for the new video tab []
  2. To be clear, economic value is generated on Facebook, but the role Facebook plays, whether that be advertising, small business sites, buy-and-sell groups, etc., could be done by alternatives []
  3. Social networks must be free []
  4. Google is a separate topic []

Snap’s Apple Strategy

At first — or even second — glance at Snap’s S-1 it’s easy to see why many are drawing a comparison to Twitter. Like Twitter, Snap is losing a lot of money; like Twitter, Snap’s growth rate is slowing; and, like Twitter, Snap is actually losing leverage.

To see what I mean by the last point, consider this chart of Facebook at the time of its IPO:

  • Daily Active Users (in millions)
  • Revenue per User (in dollars, as are all the rest)
  • Cost of Revenue per User (i.e. the actual cost of running the service, like running servers, paying partners, etc.)
  • Total Costs per User (i.e. cost of revenue plus the cost of running the company, including engineering, marketing, etc.)
  • Profit per User

facebook

This is a pretty good chart on the verge of an IPO: Facebook’s cost of revenue per user was holding steady, which meant every additional user cost about the same to serve as the previous user; the company wasn’t gaining leverage, but it wasn’t losing it either. Total costs, meanwhile, were escalating just a bit, which meant Facebook was spending slightly more per user than before (likely because of a mid-2011 acquisition spree), but the situation was largely under control. That meant that Facebook’s profits would grow as long as it grew either average revenue per user or the total number of users; the company is such a juggernaut because it has continually done both.

Twitter, meanwhile, wasn’t as bad as people (now) remember:

twitter

Like Facebook, Twitter’s cost of revenue per user was basically flat; total costs were higher than Facebook’s, and had taken a recent upturn thanks to the acquisition of MoPub, but that was assumed to be temporary. As long as Twitter could grow revenue per user or the total number of users the company would be profitable; if it could do both it too could be a juggernaut. Obviously things didn’t turn out that way, in part because user growth was already slowing, but also because Twitter’s costs never flattened out; since the MoPub acquisition the company has spent around $1.24 for every $1 in revenue brought in. Had the company simply kept its pre-IPO cost structure it would be in far better shape today.

Snap is actually in worse shape than either:

snap

The biggest problem here is Snap’s cost of revenue per user: it’s going up, and it has been for a while. This isn’t quite as bad as it seems, because Snap’s cost of revenue includes revenue sharing payments to publishers; once you back that out, though, the company has gone from paying ~$0.47/user in 2015 to ~$0.66/user in 2016, a 40% increase, and an amount (per user) that well exceeds that of Facebook or Twitter at the time of their IPOs. That means that to become profitable Snap has to not only grow users, it has to grow them faster than its costs are increasing, or grow revenue per users by that much more.

What is the most fascinating, though, is Snap’s insistence that it has no choice.

Snap’s Gingerbread Man Strategy

Snap’s S-1 is a remarkable document, because its strategy is remarkable. To quote:

Our strategy is to invest in product innovation and take risks to improve our camera platform. We do this in an effort to drive user engagement, which we can then monetize through advertising. We use the revenue we generate to fund future product innovation to grow our business.

In a world where anyone can distribute products instantly and provide them for free, the best way to compete is by innovating to create the most engaging products. That’s because it’s difficult to use distribution or cost as a competitive advantage—new software is available to users immediately, and for free. We believe this means that our industry favors companies that innovate, because people will use their products.

We invest heavily in future product innovation and take risks to try to improve our camera platform and drive long-term user engagement. Sometimes this means sacrificing short-term engagement to introduce products, like Stories, that might change the way people use Snapchat. Additionally, our products often use new technologies and require people to change their behavior, such as using a camera to talk with their friends. This means that our products take a lot of time and money to develop, and might have slow adoption rates. While not all of our investments will pay off in the long run, we are willing to take these risks in an attempt to create the best and most differentiated products in the market.

Most companies use their S-1 to explain how they are building a sustainable competitive advantage — a moat, if you will. Snap is declaring that moats no longer exist; all it has is the Gingerbread Man strategy:

Run, run, run as fast as you can.
You’ll never catch me, I’m the gingerbread man.

That’s why the cost of revenue must rise; Snap explains:

Providing our products to our users is costly, and we expect our expenses, including those related to people and hosting, to grow in the future. This expense growth will continue as we broaden our user base, as users increase the number of connections and amount of content they consume and share, as we develop and implement new product features that require more computing infrastructure, and as we hire additional employees at a rapid pace to support potential future growth. Historically, our costs have increased each year due to these factors, and we expect to continue to incur increasing costs.

The payoff, though, at least in Snap’s telling, is a big opportunity to dramatically increase the average revenue per user by capturing technology’s white whale — television advertising money:1

Worldwide advertising spend is expected to grow from $652 billion in 2016 to $767 billion in 2020. The fastest growing segment is mobile advertising, which is expected to grow nearly 3x from $66 billion in 2016 to $196 billion in 2020. We believe that one of the major factors driving this growth is the shift of people’s attention from their televisions to their mobile phones. This trend is particularly pronounced among the younger demographic, where our Daily Active Users tend to be concentrated. According to Nielsen, people between the ages of 18 and 24 spent 35% less time watching traditional (live and time-shifted) television in an average month during the second quarter of 2016 compared to the second quarter of 2010.

Snap goes on to explain how its concentration in western markets, particularly the United States; the quality of its ad units (especially relative to Facebook); and the depth of engagement it drives with the most desirable demographic for advertisers, set the company up well to capture enough advertising that not only justifies the company’s increasing costs but actually provide a profit — as long as the company keeps innovating.

To summarize, Snap’s strategy is to:

  • Deliver innovative and differentiated products that…
  • Cost a lot to deliver but…
  • Capture the best customers…and PROFIT!

That’s definitely not Twitter; indeed, the real analogy for Snap is from another part of technology entirely: it’s Apple.

Snap, Apple, and Humanity

Seven years ago, well before I started Stratechery, I wrote a paper in business school called Apple and the Innovator’s Dilemma;2 it concluded like this:

The secret of Appleʼs success is about design and a different way of thinking. Design at its essence, is not just about form, and not just about function. Instead, itʼs both, and more. It is ultimately about the user and delivering exactly what they need, not just what they say they want. Apple takes it as their responsibility — what customers pay them for — to both know technology and customers better than customers know themselves and deliver products that truly surprise and delight…

Moreover, it is a way of thinking that Apple does not have a monopoly over. It requires acknowledging that there are product attributes that cannot be measured, and that value means much more than money. It also requires thoughtfulness and patience, and a broad appreciation of people and culture. Escaping the Innovatorʼs Dilemma is about escaping the operational mindset that is the current ideal in much of business. In short, there are few other companies like Apple because no one dares or is allowed to think different, not because it is impossible.

Compare that to this paragraph from Snap’s S-1:

Our drive to create new things comes from the belief that we can create products that will improve the lives of the people who use them. We believe it’s always worth trying to build something that will empower people to express themselves, live in the moment, learn about the world, and have fun together — even when it’s not clear that what we build will be successful or make money.

While we get many of our ideas by listening to our community, sometimes it takes a long time to get the product solution just right. Even when we have the right solution, it’s often in the form of a new product that might take a while for our community to learn how to use. Just because products are sometimes confusing when they’re new doesn’t mean we are going to stop building innovative products for our community. Part of the joy of using Snapchat is discovering new features and learning how to use all of the products that we create.

Snap gives the example of Stories:

Our community started asking for an easier way to send a Snap to all of their friends, not just one or two at a time…Some people in our community asked for a “Send to All” button, but we thought this might encourage users to spam each other by making it too easy to send a Snap to everyone very quickly, ruining what made Snapchat personal and fun.

We learned that our community often shared things with all of their friends using social media, but we also heard that traditional social media was confusing because the typical feed placed every update in reverse chronological order. If you posted photos from a birthday party and then viewed them in the feed, the first photo in the feed would be from the end of the party, and the last photo in the feed would be from the beginning of the party. Our community wanted to view updates in chronological order, the way that they were experienced. That made sense to us because humans have been telling stories with a beginning, a middle, and an end for a long time.

While we understood why people used social media, we didn’t want to make a traditional profile on Snapchat because we knew from our experience with delete by default that people didn’t like the burden of accumulating perfect moments for their friends. Our community wanted to express themselves and tell stories in a way that embraced change and growth.

In October 2013, slightly more than two years after we first launched Snapchat, we introduced My Story. Stories are collections of Snaps viewed in chronological order that expire within 24 hours. Every user on Snapchat has their own personal and ephemeral Story that can be viewed by all of their friends. With Stories, every day begins anew.

This too is remarkable: not only is Snap not promising a traditional moat, it is in fact selling its humanity as a company. That the company and its Steve Jobs-admiring CEO in fact do understand users better than everyone else, that that will result in a sustainable differentiation, and that the prize will be the top end of the advertising market.

Without question Apple’s ongoing success lends credence to the idea of humanity as a differentiator; the challenge for Snap, though, is that that approach didn’t work too well for Apple the first time around.

Facebook = Microsoft

Perhaps the single most misunderstood fact about the most misunderstood episode in tech history is that the Macintosh computer never had a chance against Windows. Sure, “Windows” launched after the Mac, and certainly leaned on Apple’s creation for product inspiration, but the fact that mattered was that it was built on DOS — and it was fully backwards compatible. That meant that all of the businesses that had already bought PCs — the DOS-running IBM PC had launched three years before the Macintosh, and was a massive success — along with all of the software that had already been created for DOS, were going to buy/run-on Windows. The competition was over before it began, no matter how much humanity may have been in the Macintosh’s design.3

Today, if Snap is Apple, then Facebook is Microsoft. Just as Microsoft succeeded not because of product superiority but by leveraging the opportunity presented by the IBM PC, riding Big Blue’s coattails to ecosystem dominance, Facebook has succeeded not just on product features but by digitizing offline relationships, leveraging the desire of people everywhere to connect with friends and family. And, much like Microsoft vis-à-vis Apple, Facebook has had The Audacity of Copying Well.

The trouble for Snap is that if this comparison holds, the company may indeed be in danger of being like Apple — the 80s version, that is. Facebook is already threatening to saturate the direct response market for mobile — the analogy would be to Microsoft’s hold on the enterprise — and just as the consumer market Apple built the Macintosh for never really materialized, the same may be the case for the long-awaited shift of TV brand advertising to mobile.

That, though, is the key to Snap’s insistence it is a camera company. What changed for Apple the second time around was that there was a paradigm shift — and in paradigm shifts, the incumbents’ lock-in evaporates. Again from the S-1:

In the way that the flashing cursor became the starting point for most products on desktop computers, we believe that the camera screen will be the starting point for most products on smartphones. This is because images created by smartphone cameras contain more context and richer information than other forms of input like text entered on a keyboard. This means that we are willing to take risks in an attempt to create innovative and different camera products that are better able to reflect and improve our life experiences.

Snap’s bet is that Facebook, with all of the baggage of putting your best self forward, will never be truly able to step into this brave new future. No, capturing that future won’t be as simple as re-making the connections you already have — new users will need to be won, feature by feature and innovation by innovation — but that is exactly what Snap insists it does better than anyone else.


So will Snap succeed?

The trouble for the company is that some of the conditions necessary for its success are out of its hands: on a macro level, the timing of The Great Unbundling, an important aspect of advertising moving away from TV, is as uncertain as ever. On a competitive level I suspect Snap is more surprised than anyone at how effectively Facebook has leveraged Instagram to foreclose Snapchat’s growth.

I do, though, have faith in Snap itself: Spiegel and team are the most innovative in tech, brilliantly laddering up to new opportunities, and creating new markets. The products will be great; we’ve known for 30 years, though, that that is not always enough.

  1. As noted on this site two years ago []
  2. I used this same conclusion in one of my first ever pieces on Stratechery called Apple the Black Swan []
  3. By extension, it didn’t really matter that the Macintosh was integrated and Windows wasn’t; what mattered was the ecosystem []

Inspired Media

There was a sort of symbolism in the way President Donald Trump and his inner circle formulated and rolled out last Friday’s executive order blocking entry to the United States from seven Muslim-majority nations; according to Politico:

Senior staffers on the House Judiciary Committee helped Donald Trump’s top aides draft the executive order curbing immigration from seven Muslim-majority nations, but the Republican committee chairman and party leadership were not informed, according to multiple sources involved in the process…

It’s extremely rare for administration officials to circumvent Republican leadership and work directly with congressional committee aides…GOP leaders received no advance warning or briefings from the White House or Judiciary staff on what the executive order would do or how it would be implemented…Republicans on the Hill spent the entire weekend scrambling to find out what was going on, who was involved and how it was that they were caught so flat-footed.

“Caught so flat-footed” is basically the entire story of Trump and the Republican establishment (and later, Hillary Clinton and the Democrats), and what makes this a story for Stratechery is that, as with so many other things in our world, technology is directly implicated.

Political Parties and the Media

There is little question that social media is the most important factor in Trump ascending to the presidency. No, not because of fake newsnew research confirms the common sense conclusion that made-up stories almost exclusively appeal to people who have already made up their minds — but rather the dilution of “real” news, or more broadly, the media as a whole.

As I explained last year, in a world where most voters only had access to one or two newspapers, or three or four TV stations, the sheer logistics of gaining the sort of nationwide awareness necessary for a viable presidential campaign required institutional support — political parties, specifically. This was the core thesis of The Party Decides, a conventional wisdom-defining book which held that, even though the presidential candidate selection process had shifted from smoke-filled rooms to democratic primaries (and somewhat less democratic caucuses), in practice political parties (specifically, the activists who actually cared about outcomes and thus did the work and raised the money) still had veto power on their candidates.

What so many missed, though, was that this definition of political parties and the roles they play was inextricably tied up with the media — specifically, the pre-Internet media. As long as there were only two ways to reach voters — “paid” media (i.e. advertisements) and “earned” media (i.e. news coverage) — then those who raised the money and made the news had the power to end most campaigns before they could even begin.

However, as has been well-documented on this site and many others, the media industry has, thanks to the Internet, been completely stripped of its gatekeeper role when it comes to the spread of information. Instead of scarce newspapers or TV stations there is an abundance of information providers, which means the real power has shifted from distribution to discovery.

Thus, by extension, the real power in politics has shifted from parties to the people.

Facebook Candidates

The first company to benefit from the shift to abundance was Google, which reduced newspapers to articles and proceeded to give you exactly what you were looking for; in 2008 the search engine’s increasing importance paid off in a big way for a then relatively-unknown Senator from Illinois named Barack Obama, who both dominated Google Trends and invested disproportionately in Internet advertising generally and search advertising in particular.

Eight years later the dominant force in discovery is Facebook; whereas Google gave answers, Facebook doesn’t even require you to ask a question. And, once again, the winning candidate was the one who dominated the new metrics: Hillary Clinton may have had 500 newspapers and magazine endorsements to Trump’s 27, and may have spent more than twice as much as the Republican nominee on television ads, but the ratio was reversed when it came to digital advertising, and perhaps most tellingly Trump crushed Clinton when it came to Facebook activity, with over 960 million likes, comments, shares & posts, as compared to Clinton’s 410 million.

Interestingly, there was one candidate who rivaled Trump on Facebook; according to FiveThirtyEight, as of April 18 Bernie Sanders had 25% of all Presidential ‘likes’, exceeding Trump’s 24%:

screen-shot-2017-01-31-at-9-39-55-pm

There are obviously caveats to this data, as FiveThirtyEight notes:

Be careful how you interpret these numbers: Facebook likes are not votes. According to the Pew Research Center, 58 percent of American adults use Facebook. But this share is not a representative sample of the country — Facebook users are disproportionately young (although not as young as users of other social media networks), low-income and female. And the sample may be even more skewed because only some people on Facebook have liked a presidential candidate’s page and because those pages haven’t existed for the same amount of time. As “The Literary Digest” taught us in 1936, large but biased samples aren’t so effective.

I’ll add my own caveat: this isn’t a political blog, and I’m making no judgment on how Sanders may have fared in a hypothetical face-off with Trump. Rather, there is a broader takeaway about the Internet’s impact.

Breaking Through on the Internet

Consider the mechanics of reaching voters/customers/users:

  • Before the Internet, when distribution was the bottleneck, the optimal strategy was to maximize the available throughput. The best example is consumer packaged goods: companies like Proctor & Gamble built massive brands that were designed to appeal to the broadest swaths of population possible, maximizing the return on the effort and expense necessary to advertise and secure retail space. In the case of politics, this manifested as a push by the parties for broadly acceptable candidates who could appeal to the middle.
  • Internet companies, on the other hand, have effectively infinite throughput. Amazon, for example, unbound by the need for shelf space and capitalizing on its transformation into an e-commerce platform, can plausibly bill itself as “The Everything Store”; products are found not through browsing but by search. This, by extension, means that products need to be wanted, not simply recognized — and the same goes for Google’s impact on politics.
  • Facebook, as is its wont, supercharges these effects: instead of users “pulling” out content they are interested in, the algorithm “pushes” content based on its capability of driving engagement. And what drives engagement? Emotion and passion. That may mean a funny product video, or, in the case of politics, politicians who eschew the middle and run to the extremes.

Given the fundamentally different mechanics of Internet distribution, those Facebook numbers make a lot more sense: the extremes inspire passion which drives engagement; “broadly acceptable” doesn’t go anywhere.

This has profound implications for products and politics. First and foremost, it is fundamentally misguided to simply view “digital” as another channel that you layer on top of traditional marketing/campaign tactics like TV advertisements. In fact, products and politicians designed for the TV age — that is, meant to be palatable to the greatest number of people — are at a fundamental disadvantage on platforms like Facebook. The products and politicians that win inspire passion, stirring up a level of engagement that breaks through on a scale that far exceeds an ad buy. To put it another way, above I mentioned “paid” media and “earned” media; what matters on the Internet is “inspired” media.

The second implication is just as profound: campaigns — both for products and presidential candidates — used to be discrete events. This too sprang from the constraints of media: it takes a significant logistical effort to get a campaign off the ground. That, however, is not the case for “inspired” media: customers/voters are not passive recipients, they are active participants, and the speed with which a campaign can be created is breathtaking.

Consider the protests that erupted in response to that executive order: in a matter of hours tens of thousands of people were marching at airports around the country, driven not by professional politicians running a campaign but in response to exhortations on social media — and, as with any campaign, there was a lot of money raised as well.

The broader takeaway is that the Internet is the Rubicon: products, politicians, and strategies that were optimal on one side are suboptimal on the other. There is little to be gained from “layering on” a digital strategy to a broadly acceptable mass market offering; to succeed on the Internet the pursuit of passion must be the goal from the beginning.

The Great Unbundling

To say that the Internet has changed the media business is so obvious it barely bears writing; the media business, though, is massive in scope, ranging from this site to The Walt Disney Company, with a multitude of formats, categories, and business models in between. And, it turns out that the impact of the Internet — and the outlook for the future — differs considerably depending on what part of the media industry you look at.

The Old Media Model

Nearly all media in the pre-Internet era functioned under the same general model:

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Note that there are two parts in this model when it comes to making money — distribution and then integration — and the order matters. Distribution required massive up-front investment, whether that be printing presses, radio airplay and physical media, or broadcast licenses and cable wires; the payoff was that those that owned distribution could create money-making integrations:

Print: Newspapers and magazines primarily made money by integrating editorial and advertisements into a single publication:

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Music: Record labels primarily made money by integrating back catalogs with new acts (which over time became part of the back catalog in their own right):

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TV: Broadcast TV functioned similarly to print; control of distribution (via broadcast licenses) made it possible to integrate programming and advertising:

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Cable TV combined the broadcast TV model with bundling, a particular form of integration:

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The Economics of Bundling

It is important to understand the economics of bundling; Chris Dixon has written the definitive piece on the topic:

Under assumptions that apply to most information-based businesses, bundling benefits buyers and sellers. Consider the following simple model for the willingness-to-pay of two cable buyers, the “sports lover” and the “history lover”:

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What price should the cable companies charge to maximize revenues? Note that optimal prices are always somewhere below the buyers’ willingness-to-pay. Otherwise the buyer wouldn’t benefit from the purchase. For simplicity, assume prices are set 10% lower than willingness-to-pay. If ESPN and the History Channel were sold individually, the revenue maximizing price would be $9 ($10 with a 10% discount). Sports lovers would buy ESPN and history lovers would buy the History Channel. The cable company would get $18 in revenue.

By bundling channels, the cable company can charge each customer $11.70 ($13 discounted 10%) for the bundle, yielding combined revenue of $23.40. The consumer surplus would be $2 in the non-bundle and $2.60 in the bundle. Thus both buyers and sellers benefit from bundling.

Dixon’s article is worth reading in full; what is critical to understand, though, is that while control of distribution created the conditions for the creation of the cable bundle, there is an underlying economic logic that is independent of distribution: if customers like more than one thing, then both distributors and customers gain from a bundle.

When Distribution Goes to Zero

A consistent theme on Stratechery is that perhaps the most important consequence of the Internet, at least from a business perspective, was the reduction of the cost of distribution to effectively zero.

The most obvious casualty has been text-based publications, and the reason should be clear: once newspapers and magazines lost their distribution-based monopoly on customer attention the integration of editorial and advertising fell apart. Advertisers could go directly to end users, first via ad networks and increasingly via Google and Facebook exclusively, while end users could avail themselves of any publication on the planet.

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For Google and Facebook, the new integration is users and advertisers, and the new lock-in is attention; it is editorial that has nowhere else to go.

The music industry, meanwhile, has, at least relative to newspapers, come out of the shift to the Internet in relatively good shape; while piracy drove the music labels into the arms of Apple, which unbundled the album into the song, streaming has rewarded the integration of back catalogs and new music with bundle economics: more and more users are willing to pay $10/month for access to everything, significantly increasing the average revenue per customer. The result is an industry that looks remarkably similar to the pre-Internet era:

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Notice how little power Spotify and Apple Music have; neither has a sufficient user base to attract suppliers (artists) based on pure economics, in part because they don’t have access to back catalogs. Unlike newspapers, music labels built an integration that transcends distribution.

That leaves the ever-fascinating TV industry, which has resisted the effects of the Internet for a few different reasons:

  • First, and most obviously, until the past few years the Internet did not mean zero cost distribution: streaming video takes considerable bandwidth that most people lacked. And, on the flipside, producing compelling content is difficult and expensive, in stark contrast to text in particular but also music. This meant less competition.
  • Second, advertisers — and brand advertisers, in particular — choose TV not because it is the only option (like newspapers were), but because it delivers a superior return-on-investment. A television commercial is not only more compelling than a print advertisement, but it can reach a massive number of potential customers for a relatively low price and relatively low investment of resources (more on this in a moment).
  • Third, as noted above, the cable bundle, like streaming, has its own economic rationale for not just programmers and cable providers but also customers.

This first factor, particularly the lack of sufficient bandwidth, has certainly decreased in importance the last few years; what is interesting about TV, though, is that it is no more a unitary industry than is media: figuring out what will happen next requires unpacking TV into its different components.

The Jobs That TV Does

In 2013 I wrote a piece called The Jobs TV Does where I posited that TV has traditionally filled multiple roles in people’s lives:

  • TV kept us informed
  • TV provided educational content
  • TV provided a live view of sporting events
  • TV told stories
  • TV offered escapism, i.e. an antidote to boredom

It was already obvious then that the first two jobs had been taken over by the Internet: only old people got their news from TV, and there was better and broader educational content on YouTube or any number of websites than TV could ever deliver, even with 200 channels. The question I asked then was how long TV could maintain its advantage when it came to the last three jobs:

The disruption of TV will follow a similar path: a different category will provide better live sports, better story-telling, or better escapism. Said category will steal attention, and when TV no longer commands enough attention of enough people, the entire edifice will collapse. Suddenly.

I’d bet on escapism being the next job we give to something else, for a few reasons:

  • The economics of live sports are completely intertwined with the pay-TV model; this will be the last pillar to crumble
  • Networks still play a crucial role in providing “venture-funding” for great story-telling. Netflix is the great hope here
  • Escapism is in some sense indiscriminate; it doesn’t matter how our mind escapes, as long as it does. Yet it’s also highly personal; the more tailored the escape, the more fulfilling. This is why there are hundreds of TV channels. However, there will never be as many TV channels as there are apps.

I was right about escapism being on the verge of collapse, but the mechanism wasn’t so much apps as it was one app: Facebook.

Facebook, Snapchat, and Escapism

I wrote in The Facebook Epoch:

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. Into this void — this massive market, both in terms of numbers and available time — came the perfect product: a means of following, communicating, and interacting with our friends and family. And, while we use a PC with intent, what we humans most want to do with our free time is connect with other humans: as Aristotle long ago observed, “Man is by nature a social animal.” It turned out Facebook was most people’s natural habitat, and by most people I mean those billions using mobile.

Snapchat is certainly challenging Facebook in this regard, and one of the most interesting questions to watch in 2017 is if this is the year both companies finally start to steal away not just TV’s attention but also TV’s advertising.

Facebook is laying the groundwork to do just that; the company has been pushing video for a long time now, and recently added a dedicated video tab to its app. What has been missing, though, is an advertising unit that can actually compete with TV for brand advertising dollars; Facebook’s current advertising options are, both in terms of format but also in their focus on fine-toothed targeting, predominantly designed for direct marketing. Direct marketing has always been well-suited for digital advertising; the point of the ad is to drive conversion, and digital is very good, not only at measuring if said conversion occurred, but also at targeting customers most likely to convert in the first place.

Brand advertising is different; whereas direct marketing is focused at the bottom of the marketing funnel, brand advertising is about making end users aware of your product in the first place, or just building affinity for your brand as an investment in some future payoff. The mistake Facebook made for a long time was in trying to win brand marketing dollars by delivering direct marketing results: the company invested tons of time and money in trying to detect and track the connection between a brand-focused advertisement and eventual purchase, which is not only technically difficult — what if the purchase takes place months in the future, or offline? — but also completely misunderstood what mattered to brand advertisers.

I noted above that brand advertisers find TV to deliver a superior return-on-investment; with its focus on tracking Facebook was too concerned with the “return” at the expense of the “investment”. Specifically, taking advantage of Facebook’s targeting and tracking capabilities requires the continual time and attention of marketers; it was far more efficient to simply create a television commercial that reached a bunch of people at once and then track lift after the fact. This is why Procter & Gamble, the biggest TV advertiser in the world, scaled back its targeting efforts on Facebook.

Facebook is doing two things to change its value proposition for brand advertisers:

  • First, the company is reportedly on the verge of rolling out a new video advertising unit that will play in the middle of videos — kind of like a TV commercial.
  • Second, Facebook is focusing much more on being an advertising platform with massive scale than can also target — kind of like cable TV, but better — as opposed to a measurement machine that targets individuals and tracks them to the grocery store register.

That last point may not seem like much but it’s a noticeable shift: on last quarter’s earnings call COO Sheryl Sandberg focused on the fact Facebook made it possible for brand advertisers to do “big brand buys on our platform like they would do on TV, but make them much more targeted.”; exactly one year earlier the pitch was “personalized marketing at scale” and “measuring ROI”.

I think this is the right shift for Facebook, but it also highlights why Snapchat is very much its rival: thanks to Facebook’s ownership of identity the latter is unlikely to mount a serious challenge for direct marketing dollars (although it is — mistakenly in my opinion — building an app-install product); however, if identity is less important for brand advertising than simply scale, then Snapchat’s push for attention, particularly amongst young people, is very much a threat to Facebook.

Not that that is much comfort to TV: Facebook and Snapchat have peeled off the “escapism” job in terms of attention; doing the same in terms of advertising is a question of when, not if.

Netflix and Story-Telling

Meanwhile, Netflix is proving to be far more than a “hope”; as I described last year in Netflix and the Conservation of Attractive Profits, the company leveraged the commoditization of time enabled by streaming to own end users, creating the conditions to modularize suppliers — and that’s exactly what is happening.

What is interesting is that scripted TV is turning out very differently than music: instead of leveraging their back catalogs to maintain exclusivity on new releases, most networks sold the former to Netflix, giving the upstart the runway to compete and increasingly dominate the market for new shows. The motivation is obvious: networks have been far more concerned with protecting their lucrative paid-TV revenue than with propping up their streaming initiatives; the big difference in music is that the labels’ old album-based business model had already been ruined. It’s a lot easier to move into the future when there is nothing to lose.

The Great Unbundling

The shift of both escapism and story-telling away from traditional TV are noteworthy in their own rights; equally important, though, is that they are happening at the same time. Here is what the landscape looks like once TV is broken up into the different “jobs” it has traditionally done for viewers:

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First, the new winners have models that look a lot like the one that destroyed the publishing industry: by owning end users these companies either capture revenue directly (Netflix) or have compelling platforms for advertisers; content producers, meanwhile, are commoditized.

Secondly, all four jobs were unbundled by different services, which is another way of saying there is no more bundle. That, by extension, means that one of the most important forces holding the TV ecosystem together is being sapped of its power. Bundling only makes sense if end users can get their second and third-order preferences for less; what happens, though, if there are no more second and third-order preferences to be had?

To put this concept in concrete terms, the vast majority of discussion about paid TV has centered around ESPN specifically and sports generally; the Disney money-maker traded away its traditional 90% penetration guarantee for a higher carriage fee, and has subsequently seen its subscriber base dwindle faster than that of paid-TV as a whole, leading many to question its long-term prospects.

The truth, though, is that in the long run ESPN remains the most stable part of the cable bundle: it is the only TV “job” that, thanks to its investment in long-term rights deals, is not going anywhere. Indeed, what may ultimately happen is not that ESPN leaves the bundle to go over-the-top, but that a cable subscription becomes a de facto sports subscription, with ESPN at the center garnering massive carriage fees from a significantly reduced cable base. And, frankly, that may not be too bad of an outcome.


To be sure, it will take time for a lot of this analysis to play out; indeed, I’ve long criticized cable-cutting apostles for making the same prediction for going on 20 years. It’s a lot easier to predict unbundling than to say when it will happen — or how.

To that end, this is my best guess at the latter; as for when, the amount of change that has happened in just the last three years (since I wrote The Jobs TV Does) is substantial — and most of that change was simply laying the groundwork for actual shifts in behavior. Once those shifts start to happen in earnest there will be feedback loops in everything from advertising to content production to consumption that will only accelerate the changes, resulting in a transformed media landscape that will impact all parts of society. I’m starting to agree that the end is nearer than many think.

The Ten Year Anniversary of the Apple TV

On January 9, 2007, ten years ago today, Steve Jobs took the Macworld stage and introduced the Apple TV.1

That the iPhone had to share the stage the same day it was unveiled to the world is a footnote in history, especially given the degree to which that history has been indelibly shaped by the most consequential device the tech industry has ever produced.

I get that that is a bold statement: what about the IBM System/360, which transformed the back-end systems of governments, financial institutions, and enterprise? What about the PC, that did the same on an even broader scale, first in the office and then at the home, achieving Microsoft’s seemingly impossible goal of “a computer on every desk and in every home”? Or what about the data center, without which much of the iPhone’s magic would simply not exist?

In fact, the truth about any historical breakthrough is that it is built on everything that came before; this is especially the case with technological products. Even looked at narrowly, the iPhone’s software was built on OS X, itself built on NeXTSTEP, which was built on Unix; Unix was a product of AT&T’s Bell Labs research center, which also pioneered the transistor. The latter’s evolution to a 412 MHz single-core ARM11 CPU that was just powerful enough to drive the iPhone was just as critical to making the iPhone a viable product as was the evolution of a command-line driven operating system to one driven by touch.

And yet, out of all the evolutionary steps of both software and hardware the iPhone truly is special for a very simple reason: it combined the two in a way that made the power of each not just accessible but desirable for every single person on earth, resulting in a device that was not just stuck on a desk but in every pocket. This is the potential payoff from Apple’s focus on the integration of hardware and software: it creates the conditions to bring in users motivated not by a sense of professional obligation but drawn by delight.


I have long been struck by Marc Andreessen’s comment in a 2014 New York Magazine interview that he arrived in Silicon Valley filled with disappointment:

There had been this PC boom in the ’80s, and it was gigantic — that was Apple and Intel and Microsoft up in Seattle. And then the American economic recession hit—in ’88, ’89 — and that was on the heels of the rapid ten-year rise of Japan…I came out here in ’94, and Silicon Valley was in hibernation. In high school, I actually thought I was going to have to learn Japanese to work in technology. My big feeling was I just missed it, I missed the whole thing. It had happened in the ’80s, and I got here too late.

Andreessen, of course, went on to create Netscape, the pioneering web browser that declared in its advertising that “the web is for everyone”; it is, in terms of historical impact, the software analog of the iPhone. The Internet had existed in some form since the 1970s, and the World Wide Web was first proposed by Tim Berners-Lee in 1989, but it was Netscape that made that transformational technology accessible to everyone. Indeed, this is the common trait of truly consequential breakthroughs: they are adopted by everyone. And, by extension, it is that adoption that drives everything that follows.

To that end, the reason I was struck by Andreessen’s quote is that I once felt the same: I went to university during the dot-com era, and while even then I was obsessed with technology, my background was such that I never even considered working in the tech industry; by the time I figured out that I might have something to contribute not only had the tech industry bounced back from the bubble bursting, but the iPhone and the competitors it inspired had long since launched. What was left?

In fact, nearly everything: the reason the iPhone is so important is that by combining the Internet with the portability of mobile it created the conditions for the transformation of every part of society, from business to government and everything in between. Today I see my role with Stratechery as not only providing analysis of the news of the day but in many respects as a chronicler of some of the most fundamental transformations in history.


So here we are, ten years on: over two billion people own smartphones, the entire post-World War II economic order is teetering, and populism is on the march; I don’t think these facts are independent of each other.

There is, though, one more lesson, and that comes from the Apple TV: none of us ultimately know anything, including the late Steve Jobs. There’s no question that Jobs knew that Apple was on to something — he said so in the keynote, when he analogized the iPhone to the Mac and iPod. And yet, had he truly known that the iPhone would be exponentially more consequential than either, the Apple TV would have not made an appearance.

The truth is that dents in the universe are only observable after they have occurred; this is why their continued creation is best induced by the establishment of conditions in which risk-taking and experimentation are rewarded. The temptation is to adopt the mistaken mindset that all there is to be invented — and, more pertinently, to be adopted — already exists.

Andreessen worried innovation was over, when in fact the browser unleashed more innovation than had ever come before; for me it turned out that the smartphone wars were simply a prerequisite for the upending of everything we thought we knew about business and society. And, ten years on, it’s worth remembering that even Steve Jobs hedged his bets; the truly transformational can scarcely be imagined, much less established by fiat. That it happens anyway is freedom’s greatest triumph.

  1. The product had been previewed as “iTV” a few months prior []

Alexa: Amazon’s Operating System

The concept of an operating system is pretty straightforward: it is a piece of software that manages a computer, making said computer’s hardware resources accessible to software through a consistent set of interfaces.

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Operating systems have a special allure to technology companies because of the unique properties that come from being at the center of this diagram:

  • First, by abstracting away the hardware an operating system reduces the plane of competition for hardware providers to pure performance (as opposed to, say, lock-in). In the short term this increases competition amongst hardware providers, which benefits the operating system, and in the long run, when performance becomes “good enough”, hardware is effectively commoditized allowing the operating system to capture the majority of profits in the value chain.
  • Second, by providing a consistent set of interfaces for software, operating systems create network effects: the more users there are of an operating system the more software applications that are developed for that operating system; this in turn drives more users which increases the addressable market for developers further still. In the long run this results in lock-in for both developers and users.
  • Third, operating systems by definition have a direct interface with end users, and owning the user relationship is massively valuable for the leverage it creates over entire ecosystems.

Much of the history of technology, particularly in the consumer space, is about owning the operating system.

Windows: The Perfect Business Model

The most famous operating system, of course, is Windows, which remains the best example of just how powerful owning an operating system can be:

  • Windows fostered and benefited from competition for nearly every piece of hardware in PCs, resulting in massive increases in performance and massive decreases in price.
  • Meanwhile, thanks to IBM, Windows (well, DOS to be precise, Windows’ command line interface-driven predecessor) was the default operating system for enterprise, which meant there was nearly immediately a huge and rapidly growing market for developers, which increased the desirability of Windows in the sort of virtuous cycle I described above.
  • Windows then leveraged its ownership of users to build out two other massive businesses: first its Office franchise, and then its Windows Server line of products.

The end result was one of the most perfect business models ever: commoditized hardware vendors competed to make Windows computers faster and cheaper, while software developers simultaneously made those same Windows computers more capable and harder to leave. And, all along, Microsoft collected a licensing fee that was basically pure profit.1

Mobile Operating Systems

On mobile Microsoft tried to repeat the trick, only to have its market stolen by Google’s Android, which was not only better than Windows Mobile but also free; unfortunately for Google, Android was so successful in its goal of ensuring Microsoft could never profit from the operating system chokepoint on mobile that Google itself was handicapped when it came to making money. Android provides valuable data and indirectly contributes to Google’s search-based profit-engine, but it is not nearly the business that Windows was.

Apple, meanwhile, has always had a different business model: selling hardware. That hardware, though, is differentiated by its own operating system; thanks to the sheer size of the smartphone market this has led to far greater revenue and profits than even Microsoft in its heyday, but the model is ever so slightly more fragile than Windows’ was: Apple has to not only bear the risk inherent to building hardware, but also by definition can only ever own a minority of the market. First, no company could ever build enough phones for the world, and secondly, to serve every customer would ruin the profit margins that make the business model so successful. That, by extension, has meant a duopoly with Android, resulting in most developers serving both markets; Apple still has a moat, but it’s not nearly as deep as Microsoft’s used to be.

Google and the Internet Operating System

This brief history of consumer operating systems is less complete than it seems: Android and iOS have replaced Windows in importance, but in fact Windows lost its lock-in well before Steve Jobs launched the modern smartphone era in 2007. The Internet made the operating system of the computer used to access it irrelevant, and the most dominant company on the Internet was Google.

Of course Google is not an operating system according the strict definition of the term, but in effect Google was the operating system of the Internet. Consider the qualities of operating systems I noted above:

  • While websites could be accessed directly by typing a URL, in practice most websites in the desktop era were reached via search, akin to how computer hardware was accessed via a common operating system. And, just as hardware vendors had no choice but to commoditize themselves, websites had no choice but to make themselves as Google-friendly as possible.
  • The interplay between developers and users created a virtuous cycle that created Windows lock-in; in the case of Google the interplay was between users and the data they generated. Suppose you took two otherwise identical search engines and give one 51% of searches and the other 49%: the former would steadily become better than the latter simply by virtue of having more data on which to iterate. The reality in the case of Google was much more extreme: the company started out with a technological and engineering advantage over its rivals, which earned it market share, which then gave the company data with which to increase its quality lead even further, earning it even more market share; the end result was a monopoly built on user choice.
  • Over time Google has leveraged its relationship with users to build out its own suite of products — or, in many cases, acquired companies that gave it new opportunities to grow.

Google could afford the acquisitions thanks to a new business model for “operating systems”: advertising. Advertising doesn’t make much sense for traditional computer operating systems, which need to be platforms for applications — there is no room for the ads. Google, though, was a platform for attention, not applications, and attention is exactly what advertisers crave. To that end, the business model wasn’t so different after all: operating systems are the chokepoint of the value chain in which they operate, and money always flows to the chokepoints.

Facebook’s Lucky Break

On mobile the most important chokepoint is Facebook (and WeChat in China): the average user spends nearly an hour a day on Facebook, Messenger, and Instagram, and the results are predictable:

  • Facebook’s “suppliers”, in this case publishers, have fully commoditized themselves by not only putting their content on Facebook but even using Facebook’s preferred format; they have no choice.
  • Facebook’s network effect is perhaps the most straightforward of all: it is the people you know (which is one of many reasons why Snapchat is such a threat).
  • Facebook’s ownership of users pays off with its business model as well: not only does Facebook own attention for nearly two billion people, it also has better data about who we are and what we like than any company ever; after all, we told the company ourselves.

What is so fascinating about Facebook’s dominant position on mobile is that it was in many respects a lucky accident: Facebook on the desktop had designs on being something much more akin to a computer operating system, abstracting away the underlying operating system and building an application platform on top. And, when mobile rose to prominence, Facebook tried to build their own phone, convinced that was the only way to own users.

As I just noted, though, an application platform is fundamentally incompatible with an advertising-based business model; by extension, an advertising-based business is not necessarily in conflict with the operating system on which it runs. In the case of Google, the company made its fortune on top of Windows; the dominance of iOS and Android made Facebook just an app, which was the best possible thing that could have happened to the company.

Amazon’s Phone Failure

Amazon made the same mistake as Facebook: convinced it needed its own operating system and the direct access to users that entailed, the company made one of the worst phones in history. The product was misguided for all kinds of reasons, most of them predictable: iOS and Android may have been a duopoly, but their shared developer lock-in was arguably no less imposing than Windows’ had been (as Microsoft itself found out).

More fundamentally, Amazon sought to sell the phone through hardware and OS differentiation, much like Apple, but the company could not be more different organizationally and culturally from the iPhone maker; you don’t make good products because you really want to, you make good products by fostering the conditions in which great products can be made, and Amazon’s deeply rooted culture of modularity and services was completely ill-suited for building a highly differentiated physical product.

One of the things that makes Amazon such an impressive company, though, is that modularity and willingness to make multiple bets: on October 24, 2014 Amazon took a $170 million write-off on the Fire Phone business; two weeks later, the company launched the Amazon Echo.

Amazon’s Operating System

It was apparent on day one that the Echo was a much more compelling product than the Fire Phone:

  • The physical device (the Echo) was simply a conduit for Alexa, Amazon’s new personal assistant. And critically, Alexa was a cloud service, the development of which Amazon is uniquely suited to in terms of culture, organizational structure, and experience.
  • The Echo created its own market: a voice-based personal assistant in the home. Crucially, the home was the one place in the entire world where smartphones were not necessarily the most convenient device, or touch the easiest input method: more often than not your smartphone is charging, and talking to a device doesn’t carry the social baggage it might elsewhere.
  • There was an ecosystem to assemble: more and more “smart” products, from lightbulbs to switches, were coming on the market, but nearly every company trying to be the centerpiece of the connected home was relying on the smartphone.

Amazon seized the opportunity: first, Alexa was remarkably proficient from day one, particularly in terms of speed and accuracy (two factors that are far more important in encouraging regular use than the ability to answer trivia questions). Then, the company moved quickly to build out its ecosystem in two directions:

  • First, the company created a simple “Skills” framework that allowed smart devices to connect to Alexa and be controlled through a relatively strict verbal framework; in a vacuum it was less elegant than, say, Siri’s attempt to interpret natural language, but it was far simpler to implement. The payoff was already obvious at last year’s CES: Alexa support was everywhere.
  • Secondly, “Alexa” and “Echo” are different names because they are different products: Alexa is the voice assistant, and much like AWS and Amazon.com,2 Echo is Alexa’s first customer, but hardly its only one. This year CES announcements are dominated by products that run Alexa, including direct Echo competitors, lamps, set-top boxes, TVs, and more.

In short, Amazon is building the operating system of the home — its name is Alexa — and it has all of the qualities of an operating system you might expect:

  • All kinds of hardware manufacturers are lining up to build Alexa-enabled devices, and will inevitably compete with each other to improve quality and lower prices.
  • Even more devices and appliances are plugging into Alexa’s easy-to-use and flexible framework, creating the conditions for a moat: appliances are a lot more expensive than software, and much longer lasting, which means everyone who buys something that works with Alexa is much less likely to switch

That leaves the business model, and this is perhaps Amazon’s biggest advantage of all: Google doesn’t really have one for voice, and Apple is for now paying an iPhone and Apple Watch strategy tax; should it build a Siri-device in the future it will likely include a healthy significant profit margin.

Amazon, meanwhile, doesn’t need to make a dime on Alexa, at least not directly: the vast majority of purchases are initiated at home; today that may mean creating a shopping list, but in the future it will mean ordering things for delivery, and for Prime customers the future is already here. Alexa just makes it that much easier, furthering Amazon’s goal of being the logistics provider — and tax collector — for basically everyone and everything.

  1. Remember, software has basically no marginal costs []
  2. To be clear, AWS was not built using spare Amazon.com capacity, but was built to provide a services infrastructure for Amazon.com []

The 2016 Stratechery Year in Review

2016 has been quite the year for the world at large and for tech specifically; it has certainly been a productive one for Stratechery. This year I wrote 143 Daily Updates (including tomorrow) and 46 Weekly Articles, and, as per tradition, today I summarize the most popular and most important posts of the year.

You can find previous years here: 2015 | 2014 | 2013

Here is the 2016 list.

The Five Most-Viewed Articles:

  1. Dollar Shave Club and The Disruption of Everything — Dollar Shave Club is a textbook example of how the new Internet economy will destroy value in incumbent industries.
  2. It’s a Tesla — Tesla is not a disruptor, but then again, neither is Apple, the closest comparison: both succeed by building a brand around being the best (Editor’s Note: That’s not to say that Tesla will have Apple’s success; there are lots of reasons for skepticism ($) especially after the unjustifiable Solar City acquisition ($)).
  3. Apple’s Organizational Crossroads — A core part of what makes Apple Apple is its organization structure; Tim Cook has said it will never change. However, if Apple is serious about being a services company, change it must.
  4. How Google is Challenging AWS — AWS seems to have a dominant position in enterprise computing, but Google is trying to change the rules to favor their inherent strengths; they just might succeed (see also: Google’s Go-to-Market Gap and Google and the Limits of Strategy).
  5. The Future of Podcasting — Podcasting is stuck between the open model of the past and the push for monetization in the future. Might there be a third way that actually benefits publishers?

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Five Big Ideas

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Five Posts About Media and Politics

  • The Voters Decide — An apolitical analysis of what is happening in U.S. politics through the lens of Aggregation Theory (Editor’s Note: I’m biased but believe more than ever that this is a critical piece to understanding what is happening in western democracies).
  • The Brexit Possibility — Brexit’s downsides are clear; might tech help realize upsides in building something new based on a new world order? (Editor’s Note: This could have been written after Donald Trump’s election as well).
  • Antitrust and Aggregation — The European Commission’s antitrust case against Google is likely to be the first of many against aggregators, because the end game of Aggregation Theory is monopoly.
  • The Reality of Missing Out — Tech is entering a period of inequality where the big winners lift the sector as a whole even as smaller companies suffer. The best example is Facebook, Google, and digital advertising (Editor’s note: Over the last year this has gone from projection to reality).
  • Fake News — Facebook is under fire for fake news and filter bubbles; they are a problem, but most of the proposed solutions are far worse (see also: The Real Problem with Facebook and the News and Why Twitter Must Be Saved).

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Five Company-Specific Posts

  • The Amazon Tax — Amazon is building a lot of businesses that look like AWS: taxes on major industries that work to everyone’s benefit. The reason, though, is that AWS is a lot like Amazon itself.
  • Snapchat’s Ladder — Snapchat is on the verge of conquering the toughest messaging market in the world: the United States. The way they did it is by laddering-up (see also: Snapchat Spectacles and the Future of Wearables).
  • Beyond the iPhone — Apple’s event may have been lacking on the surface, but it laid the groundwork for innovations that will be revealed in time. And yes, it was courageous.
  • Facebook, Phones, and Phonebooks — There are two types of social networks, and Facebook wants to be both. The problem is that the company already chose public sharing over private communication (See also: The Audacity of Copying Well).
  • Oracle’s Cloudy Future — Larry Ellison has declared that Oracle is a cloud company, but their customer offering seems more suited to the world that was.

See also: The FANG Playbook

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Fifteen Daily Updates

I slightly expanded this list this year, in part because Daily Updates have continued to become even more in-depth; they are still very timely in covering the news of the day but contain their own strategic insights as well (please note that these are subscriber-only links; you can sign-up here).

  • January 4 — Augmented vs Virtual Reality
  • January 7 — Netflix Goes Global
  • February 16 — Kanye West and Tidal, The Problem with Exclusivity
  • February 17 — Apple Versus the FBI, Understanding iPhone Encryption, The Risks for Apple and Encryption (See also this Weekly Article: Apple, the FBI, and Security)
  • February 25 — Stripe Atlas, An Interview with Stripe CEO Patrick Collison
  • March 7 — Amazon Echo Expands, The Nest Failure
  • March 21 — The Significance of AlphaGo, Google to Sell Boston Dynamics, Google’s Self-Driving Car Will Take Awhile
  • April 28 — Facebook and New Market Disruption
  • May 4 — Doubting the iPhone Revisited, What Has Changed, On Being Bearish
  • May 16 — Apple, Didi, and Occam’s Razor; Uber in China (See also: August 1 — Didi Acquires Uber China, Why Uber China Was Doomed, Was Uber China Worth It?)
  • June 9 — Apple Makes Major Changes to App Store, The App Store and Apple’s Nature, Additional Notes
  • September 20 — Does Uber Have a Strategy Problem?, Netflix and Aggregation Theory
  • October 3 — Nutanix and Hyper-Convergence, The Conservation of Attractive Data-Center Profits
  • October 10 — Coupa IPOs — and Pops, Why (Most) IPOs are Under-Priced, Why the IPO Process Doesn’t Change
  • November 9 — Donald Trump is the President-Elect, Tech Under Trump, The Big Picture
  • December 20 — Uber Losses (But China Gains?), Uber and Unit Economics, Reconsidering Uber

Merry Christmas and Happy New Year. I’m looking forward to a great 2017!