The Battle for the Home

If the first stage of competition in consumer technology was the race to be the computer users went to (won by Microsoft and the PC), and the second was to be the computer users carried with them (won by Apple in terms of profits, and Google in terms of marketshare), the outlines of the current battle came sharply into focus over the last month: what company will win the race to be the computer within which users live?

The Announcements

The first announcement came from Amazon three weeks ago: a new high-end Echo Plus, Echo Dots, several Echo devices for use with 3rd party stereos and speakers (or other Echoes), and an updated Echo Show (i.e. an Echo with a screen). All standard fare, and then things got wacky: the company also announced a microwave, a wall clock, smart plugs, a device for the car, and a TV Tuner/DVR, all with Alexa built-in.

Next up was Facebook: earlier this week the company launched the Portal, a video chat device that can track faces, has Alexa integration, and a smattering of 3rd-party apps likes Spotify. The device was reportedly delayed last spring as the company grappled with the fallout of the Cambridge Analytica scandal, and was instead launched in the midst of a data exposure scandal.

Third was Google: yesterday the company announced the Google Home Hub — a Google Home with a screen attached, a la the Echo Show — as well as the Pixel 3 phone and the Pixel Slate tablet, along with far deeper integration between Nest home automation products and the Google Home ecosystem.

And, of course, there is Apple, which launched the HomePod earlier this year, and added a few new capabilities with a software update last month.

Each of these companies brings different strengths, weaknesses, go-to-market strategies, and business models to the fight for the home; a question that is just as important of who will win, though, is to what degree it matters.


Each of these companies’ strengths in the home is closely connected to their success elsewhere.

Amazon: Amazon deserves to go first, in large part because they were first: while Google acquired Nest in 2014, Nest itself was predicated on the smartphone being the center of the connected home. Amazon, though, thanks to its phone failure, had the freedom to imagine what a connected home might look like as its own independent entity, leading the company to launch the Echo speaker and Alexa assistant in late 2014.

I was immediately optimistic, in part because the Echo was everything the failed Fire phone was not: its success depended not on the integration of hardware and software, the refinement of which a service company like Amazon is fundamentally unsuited for, but rather the integration of hardware and service. It also helped that Amazon had a business model that made sense: on one hand, the investments in Alexa would pay off with services for AWS, and on the other, Amazon’s goal of taking a slice of all economic activity was by definition centered around capturing an ever-increasing share of purchases made for and consumed in the home, and Alexa could make that easier.

That led to an early lead in the development of the Alexa ecosystem, both in terms of “Skills” and also in devices that incorporated Alexa. As I noted in 2016, this made Alexa Amazon’s operating system for the home, and today Alexa has over 30,000 skills and is built into 20,000 devices.

That, though, makes Amazon’s recent announcements that much more interesting: Amazon isn’t simply content with being the voice assistant for 3rd-party devices, it also is making those devices directly. This, by extension, perhaps points to Amazon’s biggest strength: because is so dominant, the company can have its cake and eat it too. That is, just as is both a marketplace and a channel for Amazon to sell its own products, Alexa is both a necessary component of 3rd-party devices and also a driver of Amazon’s own devices; the company faces no strategy taxes in its drive to win.

Google: Google was very late to respond to Alexa; the original Google Home wasn’t announced until May 2016, and didn’t ship until November 2016, a full two years after the Echo. The company was, as I noted above — and as you would expect for a market leader — locked into the smartphone paradigm; an app plus Nest was its answer, until Alexa made it clear this was wrong.

Google, though, has started to catch up, and the reason is obvious: if a home device is about the integration of hardware and services, it follows that the company that is best at services — consumer services, anyways — would be very well-placed to succeed. The company still trails Alexa by a lot in actions/skills (around 2,000) and 3rd-party devices (over 5,000), but Google’s core functionality is plenty strong enough to sell devices on its own. There are still more Echoes being sold, but Google Home is catching up.

To that end, one of the more interesting takeaways from yesterday’s Google event was the extent to which Google is leaning on its own services to sell its devices: not only did the company tout the helpfulness of Google Assistant, it also prominently featured YouTube, particularly in the context of the Google Home Hub. This is particularly noteworthy because Google handicapped the YouTube functionality of the Echo Show, clearly with this product in mind. Google is also including six months of YouTube Premium with a Google Home Hub; indeed, every Google product included some sort of YouTube subscription product.

Apple: The HomePod is exactly what you would expect from Apple: the best hardware at the highest price. The sound is excellent and, naturally, even better if you buy two. The HomePod is also — again, as you would expect from Apple — locked into the Apple ecosystem;1 this is from one perspective a weakness, but this is the Strength section, and the reality is that people are more committed to their iPhones — and thus Apple’s ecosystem — than they are to home speakers, meaning that for many customers this limitation is a strength.

Along those lines, Apple is clearly the most attractive option from a privacy perspective: the company doesn’t sell highly-targeted ads, has made privacy a public priority, and is thus the only choice for those nervous about having an Internet-connected microphone in their house.

Facebook: Perhaps the most compelling case for Portal is historical. In the introduction I framed the battle for the home as following the battle for the desk and the battle for the pocket. There were, though, intervening battles that were enabled by those fights for physical spaces. Specifically, the PC created the conditions for the Internet, which in turn made smartphones that could access the Internet so compelling. Smartphones, then, created the conditions for social networking (including messaging) to infiltrate all aspects of life.

Might it be the case, then, that just as the Internet was the key to unlocking the potential of mobile, so might social networking be the key to unlocking the potential of the home? That appears to be Facebook’s bet: sure, the device has some neat hardware features, particularly the ability to follow you around the room or zoom out during a call, but neat hardware features can and will be copied. If Portal is to be a successful venture for Facebook, it will be because the tie-in to Facebook’s social network makes this device compelling.


As is so often the case, each companies’ weakness is the inverse of their strength:

Amazon: Amazon simply isn’t that good at making consumer products. In my experience its devices are worse than the competition2 both aesthetically and in terms of hardware capabilities like sound quality. In addition, Amazon’s brute force skills approach — it is on the user to speak correctly, not on the service to figure it out — lends itself to more skills initially but a potentially more frustrating user experience.

Amazon also has less of a view into an individual user’s life; sure, it knows what kind of toothpaste you prefer, but it doesn’t know when your first meeting is, or what appointments you have. That is the province of Google in particular, and also Apple. What is more valuable: being able to buy things by voice, or being told that you best be leaving for that early meeting STAT?

Google: As a product Google’s offering is remarkably strong (there are other weaknesses, which I will get into below). The company is the best at the core functionality of a home device, and it knows enough about you to genuinely add usefulness. Its products are also more attractive and better-performing than Amazon’s (in my estimation).

Google does face questions about privacy: the company collects data obsessively — right up to the creepy line, as former CEO Eric Schmidt has said — and that could be a hindrance to the company’s ability to penetrate the home. That said, Google has so far escaped Facebook-level scrutiny, and wisely excluded a camera from the Google Home Hub. Google knows its advantage is in providing information; it has sufficient other avenues to collect it, without putting a camera in your bedroom.

Apple: Apple, even more than Google, seemed blinded by its smartphone success. This isn’t a surprise: the ultimate point of Android was to be a conduit to Google’s services; it follows, then, that if home devices are about services, that Google would be more attuned to the opportunity (and the threat). Apple, on the other hand, is and always will be a product company; the company offers services to help sell its hardware, not the other way around, and it follows that the company is heavily incentivized to insist that the iPhone and Apple Watch, which both offer attractive hardware margins and are differentiated by the integration of hardware and software, are better home devices.

That, furthermore, explains Apple’s biggest weakness: the relative performance of Siri as compared to Alexa or Google Assistant. The problem isn’t a matter of trivia, but rather speed and reliability. Siri is consistently slower and more likely to make mistakes in transcription than either Alexa or Google Assistant (and, for the record, more likely to fail trivia questions as well). As always, Apple is the most potent example of how strengths equal weaknesses: just as it was inevitable that a services company like Amazon would be poor at product, a truly extraordinary product company like Apple will face fundamental challenges in services.

Facebook: If the strengths of Facebook Portal were largely theoretical, the weaknesses are extremely real: it is, frankly, mind-boggling that the company would launch Portal given the current public mood around the company. And, to be clear, that mood is largely deserved; I wrote last week about the company as a Data Factory, and one of the telling examples was how Facebook lets advertisers use numbers provided for two-factor authentication for targeting. This strongly suggests that, from Facebook’s perspective, data is data: everything is an input, and while the company may promise that Portal is private, one wonders why anyone would believe them.

That noted, I actually suspect Portal data is private; this seems like more of an attempt to enhance the value of the Facebook graph, and thus the app’s stickiness, than to collect more data. The problem, though, is that Facebook is not in the position to expect nuance, and that this product was launched anyways supports the argument that the company’s executives are indeed out of touch.


The various go-to-market possibilities for these four companies could very well have been folded into strengths-and-weaknesses, but they’re worth highlighting on their own, given how important an effective go-to-market strategy is in consumer products.

Amazon: This is arguably Amazon’s biggest strength: not only does the company have direct access to the top e-commerce site in the world and one of the largest retailers period — and, because it is them, can skip a retailer mark-up — it also gets access to prime real estate:

Amazon's front page featuring an Echo Dot

There is not only no question in a consumer’s mind about where to buy an Echo, it is also nearly impossible that they not know about it. Moreover, Amazon has a second trick up its sleeve: it doesn’t stock any of its competitors’ Google or Apple’s home products, making acquiring them that much more of a hassle.

Google: I highlighted this as a major Google weakness when it launched its #MadeByGoogle line two years ago, but to the company’s credit, it has worked hard to build out its channel. Today Google products are available on most non-Amazon e-commerce sites and in retailers like Best Buy, Target, and Walmart. The company has also invested in advertising to build awareness; there is still a long ways to go, to be sure, and go-to-market remains a Google weakness, but the company has impressed me with its work in this area.

Apple: This is a huge area of strength for Apple as well. The company obviously has a very strong channel, both online and through its retail stores. Both reflect Apple’s biggest strength, which is its brand: there is no company that has more loyal customers, and those customers are tremendously biased to buy an Apple product over a competitor’s; they are also more likely to be receptive to Apple’s privacy message, perhaps because they care, or perhaps because that is the message that plays to Apple’s strengths.

Facebook: It appears the company learned nothing from the Facebook First flop. The Facebook First, if you don’t recall, was Facebook’s ill-fated phone; it was manufactured by HTC and was discontinued within weeks of launch. There simply was no evidence that customers wanted to pay for a product that was predicated on Facebook integration, and there was certainly no effective go-to-market strategy.

It is hard to see how the Portal will be different: again, the defining feature is that the camera follows you around, a feature that is cool in theory but bizarrely out-of-touch with Facebook’s current perception in the market. Is the company really going to spend the millions necessary to market this thing? And if so, where is it going to be available to purchase? I can see why this product was designed; I see little understanding of how it might be sold.

Business Models

This too ties into strengths-and-weaknesses, but like the go-to-market strategies, is worth calling out in its own right:

Amazon: I explained the company’s business model above: Amazon wants to own the home, because it sells a huge number of items that are used in the home. This is why the company is willing to press its advantage as both a platform and retailer when it comes to Alexa devices: winning has a very direct connection to the company’s ultimate upside.

Google: The business model is a bit fuzzier here: Google makes money through ads sold in an auction where the winner is chosen by the user. That is a model that doesn’t work for voice in particular; affiliate fees are less profitable given that they foreclose the possibility of an advertiser forming a direct relationship with the end user. That noted, the introduction of a visual interface does also offer the possibility of ads.

More noteworthy is the incorporation of YouTube: YouTube has seen the addition of more and more subscription services, including YouTube Premium, YouTube TV, and YouTube Music. All of these work in conjunction with Google’s designs on to the home.

The most compelling business case for Google, though, is the same as it ever was: maintaining a dominant presence in all aspects of a user’s life, not just on the go (in the case of Android) but also in the home provides the data for more effective advertising in the places where it makes sense. No, Google may not sell that many voice ads, but voice interaction will affect what ads are shown in Search, and that is worth an awful lot.

Apple: Apple’s business model is the most straightforward: HomePod is clearly sold at a profit, part of Apple’s strategy of increasing its monetization of its current userbase. This is also a limitation: as noted above, the HomePod is significantly more expensive than any of its competitors.

Facebook: The social network company has the weakest business model story of all: there are no add-on services to sell, and the company has promised not to use the Portal for advertising, for now anyway. The best argument is similar to Google: more data and more engagement mean more opportunities to show better-targeted ads on the company’s other products.

Winners and Losers

There are compelling cases to be made for at least three of the four companies:

Amazon: Amazon’s head start is meaningful, and its widespread integration with other products mean it is likely that more people have a device with Alexa integration than not. The company is also highly motivated to win and has the business model to justify it.

Google: I find Google’s case the most compelling. Product is not the only thing that matters, but it is awfully important, and Google is the best placed to deliver the best product. Its services are superior, its knowledge of users the most comprehensive, and its overall product chops have improved considerably. Yes, its go-to-market is worse than Amazon’s and it has a late start, but it is still early.

Apple: The loyalty of Apple’s userbase cannot be overstated, particularly when you remember that the company’s userbase is the most affluent customers of all. This makes it difficult to ever count Apple out, even if their product is late and tied to the worst services.

Facebook: It is hard to envision how Portal won’t be a loser: the company has no natural userbase, has a terrible reputation for privacy, and has no obvious business model or go-to-market strategy.

Does It Matter?

There is one final question that overshadows all-of-this: while the home may be the current battleground in consumer technology, is it actually a distinct product area — a new epoch, if you will? When it came to mobile, it didn’t matter who had won in PCs; Microsoft ended up being an also-ran.

The fortunes of Apple, in particular, depend on whether or not this is the case. If it is a truly new paradigm, then it is hard to see Apple succeeding. It has a very nice speaker, but everything else about its product is worse. On the other hand, the HomePod’s close connection to the iPhone and Apple’s overall ecosystem may be its saving grace: perhaps the smartphone is still what matters.

More broadly, it may be the case that we are entering an era where there are new battles, the scale of which are closer to skirmishes than all-out wars a la smartphones. What made the smartphone more important than the PC was the fact they were with you all the time. Sure, we spend a lot of time at home, but we also spend time outside (AR?), entertaining ourselves (TV and VR), or on the go (self-driving cars); the one constant is the smartphone, and we may never see anything the scale of the smartphone wars again.

  1. You can use the HomePod as an AirPlay speaker for services like Spotify, but then you are just overpaying for a dumb speaker [↩︎]
  2. I haven’t tried Facebook’s Portal [↩︎]

Data Factories

I’m generally annoyed by the cliché “If you’re not paying you’re the product”; Derek Powazek has explained why the implications of this statement are usually misleading and often wrong, something that is particularly problematic in the context of Aggregators. After all, if a company’s market power flows from controlling demand — that is, users — that means said company is incentivized to keep those users satisfied; it is suppliers that have to “take it or leave it”.

This explains why the idea of an Aggregator being a monopoly is hard to get one’s head around; in the physical world where market power comes from controlling distribution — think AT&T, or your local cable company, or a utility company — there is no incentive to treat end users well, because users have no choice in the matter. On the Internet, though, where distribution is effectively free, alternatives are only a click away; Aggregators are extremely motivated to make sure that click doesn’t happen, which means giving the users what they want (the technical term is “increasing engagement”). Users are a priority, not a product.

And yet, as is so often the case, clichés persist because there is some truth to them. Facebook and Google — the two Super Aggregators — make money through ads, and advertisers come to Facebook and Google because they want to reach consumers. From an advertiser perspective users — or to be more precise, access to users’ attention — is a product they are absolutely paying for.

Views on Facebook

This seeming dichotomy — prioritizing users on one hand, and selling access to their attention on the other — makes more sense if you first think of Super Aggregators as two distinct businesses: Aggregator and advertising-seller. To use Facebook as an example (as I will for the rest of the article, although nearly everything applies to Google as well), it is both an Aggregator that content providers clamor to reach, as well as the gatekeeper for consumers advertisers wish to sell to:

Two views on Facebook's business

Still, this isn’t quite right, because Facebook the company is not simply the so-called “Blue App” but also several other businesses, most notably Instagram and WhatsApp (there is also Messenger, but given its user-facing network is the same as the Blue App I don’t really consider it to be distinct). Once you add those to the mix Facebook the company looks like this:

Facebook's conglomerate

You’ll note that I’ve taken to using the term “Blue App” to distinguish Facebook the network from Facebook the company; the question, though, is what exactly is the company anyways?

The Data Factory

At a superficial level, Facebook is a sort of holding company for social networks; back in 2014 I called it The Social Conglomerate. That, though, is very much a user-centric perspective; to that end, if you consider the advertising perspective, you could argue that Facebook the company is an advertising dashboard and sales force.

I think, though, that sells short the functionality of Facebook the company. Specifically, Facebook is a data factory. Wikipedia defines a factory thusly:

A factory or manufacturing plant is an industrial site, usually consisting of buildings and machinery, or more commonly a complex having several buildings, where workers manufacture goods or operate machines processing one product into another.

Facebook quite clearly isn’t an industrial site (although it operates multiple data centers with lots of buildings and machinery), but it most certainly processes data from its raw form to something uniquely valuable both to Facebook’s products (and by extension its users and content suppliers) and also advertisers (and again, all of this analysis applies to Google as well):

  • Users are better able to connect with others, find content they are interested in, form groups and manage events, etc., thanks to Facebook’s data.
  • Content providers are able to reach far more readers than they would on their own, most of whom would not even be aware those content providers exist, much less visit of their own volition.
  • Advertisers are able to maximize the return on their advertising dollar by only showing ads to individuals they believe are predisposed to like their product, making it more viable than ever before to target niches (to the benefit of their customers as well).

And then, in exchange for these benefits that derive from data, Facebook sucks in data from all three entities:

  • Users provide Facebook with data directly, both through information and media they upload, and also through their actions on Facebook properties.
  • Content is not simply data in its own right, but also a catalyst for generating user action data.
  • Advertisers, like content providers, not only provide data in its own right, which acts as a catalyst for generating user action data, but also upload huge amounts of data directly in order to better target prospective customers.

Those aren’t the only avenues through which Facebook collects data: the company has deals with multiple third-party data collection companies, gathering everything from web traffic to offline store receipts, and also has incentivized an untold number of websites — particularly content providers — to include Facebook links on their sites that collect data from those sites.

That results in a much fuller picture of Facebook’s business:

The Facebook Data Factory

Data comes in from anywhere, and value — also in the form of data — flows out, transformed by the data factory.

Regulating the Internet

Two weeks ago, in The European Union Versus the Internet, I argued that effective regulation of tech companies, particularly Super Aggregators like Facebook and Google, had to work with the fundamental principles of the Internet, not against them; otherwise, the likely outcome would be to entrench these Internet giants with little gain to consumers.

First and foremost regulators need to understand that the power of Aggregators comes from controlling demand, not supply. Specifically, consumers voluntarily use Google and Facebook, and “suppliers” like content providers, advertisers, and users themselves, have no choice but to go where consumers are. To that end:

Facebook’s ultimate threat can never come from publishers or advertisers, but rather demand — that is, users. The real danger, though, is not from users also using competing social networks (although Facebook has always been paranoid about exactly that); that is not enough to break the virtuous cycle. Rather, the only thing that could undo Facebook’s power is users actively rejecting the app. And, I suspect, the only way users would do that en masse would be if it became accepted fact that Facebook is actively bad for you — the online equivalent of smoking.

For Facebook, the Cambridge Analytica scandal was akin to the Surgeon General’s report on smoking: the threat was not that regulators would act, but that users would, and nothing could be more fatal. That is because the regulatory corollary of Aggregation Theory is that the ultimate form of regulation is user generated.

If regulators, EU or otherwise, truly want to constrain Facebook and Google — or, for that matter, all of the other ad networks and companies that in reality are far more of a threat to user privacy — then the ultimate force is user demand, and the lever is demanding transparency on exactly what these companies are doing.

What, though, does transparency mean in the context of enabling “user generated regulation”, and what might meaningful regulation look like that achieves the goal of forcing said transparency in a way that fosters competition instead of inhibiting it? The answer goes back to data factories.

Raw Data Versus Processed Data

The first challenge with a data factory is that it is impossible to peer inside. Both Facebook and Google offer customers ways to view their data, but not only is the presentation overwhelming, the data is precisely what you gave them. It is the raw inputs.

Advertisers, interestingly enough, cannot download custom audiences once uploaded, but given that data is (also) their business, it is extremely likely that they retain the list of email addresses they uploaded in the first place; the same thing applies to 3rd party data providers. Websites, meanwhile, are completely in the dark: that Facebook badge or like button may provide a page view or two, but it doesn’t give any data back in return.

What no one gets is the final product: the melding of all that data from all those sources to build a far more detailed profile of every Facebook user than they provided on their own. There is no question, though, that it is happening. Last week Gizmodo had an excellent write-up of a paper in the journal Proceedings on Privacy Enhancing Technologies detailing how Facebook users could be targeted for ads with a whole host of information that was never provided by the user, including landline numbers, unpublished email addresses, and phone numbers provided for two-factor authentication:

They found that when a user gives Facebook a phone number for two-factor authentication or in order to receive alerts about new log-ins to a user’s account, that phone number became targetable by an advertiser within a couple of weeks. So users who want their accounts to be more secure are forced to make a privacy trade-off and allow advertisers to more easily find them on the social network. When asked about this, a Facebook spokesperson said that “we use the information people provide to offer a more personalized experience, including showing more relevant ads.” She said users bothered by this can set up two-factor authentication without using their phone numbers; Facebook stopped making a phone number mandatory for two-factor authentication four months ago.

That quote from the spokesperson is an acknowledgement of the data factory: Facebook doesn’t care where it gets data, it is all just an input in service of the output — a targetable profile.

This lack of care about what precisely goes into a finished product is hardly unique to Facebook. One of the most famous examples is Nike:

A boy sewing Nike soccer balls
According to the Internet, this is the photo from Life Magazine. I could not find a copy to be sure.

That image is from the June, 1986, issue of Life Magazine, which detailed how children in Pakistan were manufacturing soccer balls for pennies a day. Nike executives, in a refrain that is vaguely familiar, were initially aggrieved; after all, soccer balls were not inflated until after they were shipped, which meant the photo was staged.

That was surely correct, and yet such a complaint utterly missed the point: Nike didn’t really care where it got its soccer balls, or shoes or clothes or anything else. It simply paid the factory owners and washed its hands of the problem. That photo, and the decades of protests and boycotts that followed, forced the company to do better.

The Privacy Obstacle

Unfortunately, while Nike could not stop a photographer from traveling to Pakistan (and, truth be told, stage a photo), the general public has no way to see inside the Facebook or Google factories — and this is where regulators come in.

The most important thing that regulators could do is force Facebook and Google — and all data collectors — to disclose their factory output. Give users the ability to see not simply what they put in — which again, Google and Facebook do (and which GDPR requires), but also what comes out after all of the inputs are mixed and matched.

Make no mistake, no company will do this on its own, and not simply for business reasons. Note the Facebook spokesman’s response to Gizmodo when asked about the use of uploaded contact information:

“People own their address books,” a Facebook spokesperson said by email. “We understand that in some cases this may mean that another person may not be able to control the contact information someone else uploads about them.”

This gets at how it is privacy regulations in particular go wrong: in the attempt to make rules that protect people without their agency, those wishing to take said agency cannot even know what exactly Facebook knows about them because, well, privacy. Meanwhile, websites throw up pop-ups and overlays that no one reads, or ban entire continents, not because their users care but because a regulator said so.

Privacy Realities

Here is the other reality regulators need to grapple with: most users don’t care about privacy, particularly if it saves them money. I came across this tweet in response to an interview clip of Tim Cook talking about privacy and it rather succinctly made the point:

A tweet from someone that would sacrifice privacy for cheaper iPhones

Frankly, I don’t blame the apathy of most users: what Facebook and Google and all of the other ad-supported services and sites on the Internet provide is immensely valuable. Moreover, I’m the first (and often only!) to defend personalized ads: I think they are a critical component of building a future where anyone can build a niche business thanks to the Internet making the entire world an addressable market — if only they can find their customers.

At the same time, most users truly have no idea what data these companies hold. Might they change their minds if they actually saw the processed data, not simply the raw inputs? I don’t know, but I do think it is their decision to make.

Moreover, establishing clear requirements that users be able to view not only the data they uploaded but their entire processed profile — the output of the data factory — would be far less burdensome to new and smaller companies that seek to challenge these behemoths. Data export controls could be built in from the start, even as they are free to build factories as complex as the big companies they are challenging — or, as a potential selling point, show off that they don’t have a factory at all. This is much easier than trying to abide by rules that apply to every user — whether they want the protection or not — and which were designed with Facebook and Google in mind, not an understaffed startup.

Indeed, that is the crux of the matter: regulators need to trust users to take care of their own privacy, and enable them to do so — and, by extension, create the conditions for users to actually know what is going on with their data. And, if they decide they don’t care, so be it. The market will have spoken, an outcome that should be the regulator’s goal in the first place.

Instagram’s CEO

In the hours after The New York Times broke the story that Instagram co-founders Kevin Systrom and Mike Krieger had resigned from Instagram, the question quickly turned to why; the immediate culprit was everyone’s favorite punching bag, Facebook CEO Mark Zuckerberg:

  • Bloomberg: The founders of Instagram are leaving Facebook Inc. after growing tensions with Chief Executive Officer Mark Zuckerberg over the direction of the photo-sharing app, people familiar with the matter said.
  • TechCrunch: According to TechCrunch’s sources, tension had mounted this year between Instagram and Facebook’s leadership regarding Instagram’s autonomy. Facebook had agreed to let it run independently as part of the acquisition deal. But in May, Instagram’s beloved VP of Product Kevin Weil moved to Facebook’s new blockchain team and was replaced by former VP of Facebook News Feed Adam Mosseri — a member of Zuckerberg’s inner circle.
  • Recode: Instagram co-founders Kevin Systrom and Mike Krieger are resigning from the company they built amid frustration and agitation with Facebook CEO Mark Zuckerberg’s increased meddling and control over Instagram, according to sources.

All of these stories are interesting, and undoubtedly more details will come out over the next few days. At the same time, by virtue of looking at events that occurred over the past few weeks or months or even years, they all fundamentally miss the point. The date that matters when it comes to understanding these resignations is April 9, 2012, and the people most responsible are Kevin Systrom and Mike Krieger.

Extraordinary Product Leaders

Zuckerberg’s statement about Systrom and Krieger’s resignation was quite terse, and perhaps for that reason, rather revealing:

“Kevin and Mike are extraordinary product leaders and Instagram reflects their combined creative talents. I’ve learned a lot working with them for the past six years and have really enjoyed it. I wish them all the best and I’m looking forward to seeing what they build next.”

Calling Systrom and Krieger “extraordinary product leaders” is high praise, and remarkably enough, an understatement.

Instagram started out as a Foursquare-esque check-in app called Burbn, but when Systrom and Krieger realized that Brbn’s users were not checking in but were sharing photos like crazy, the pair quickly built a new app called Instagram. MG Siegler wrote at the time, in a remarkably prescient synopsis:

Unlike Burbn, Instagram is neither a location-based app (though that is one component), nor is it HTML5-based. But it did spring out of the way co-founders Kevin Systrom and Mike Krieger saw people using Burbn. That is: quick, social sharing — and a desire to share photos from places. That’s the foundation of Instagram.

More specifically, Instagram is a iPhone photo-sharing application that allows you to apply interesting filters to your photos to make them really pop…Once you take a picture and apply a filter (there’s also an option not to), the photo is shared into your Instagram Feed. From here, your friends on the site can “like” or comment on it. But another key to Instagram is that it’s just as easy to share these photos to other social networks — like Twitter, Facebook, and Flickr.

Nearly all of the key pieces were there from the beginning:

  • Instagram had a reason to download: cool filters that, unlike the competition, were free.
  • Instagram had a great user experience: instantaneous sharing to social networks, without jumping through “Save to Camera Roll” hoops.
  • Instagram had the seeds of something much greater than a photo editing app: it was, from the beginning, a social network in its own right; as Chris Dixon describes it, “Come for the tool, stay for the network.”

Instagram took off like a rocket, and had 10 million users in a year; that number would triple within the next six months, and was set to grow even faster when the startup finally launched an Android version, which racked up 1 million downloads in 24 hours. That is when Facebook came in with an offer Systrom and company couldn’t refuse: $1 billion in cash and stock for, well, for what?

Technically speaking, Instagram was a company. In practice, though, Instagram was a product, and its business model was venture capital funding. To be sure, this wouldn’t be the case forever, but on April 9, 2012, the road from popular product to viable company was a long and arduous one. Instagram would not only need to continue growing its user base, it would also have to scale its infrastructure, figure out a business model (ok fine, advertising), build up tools to support that business model (first a sales team, then a self-serve model, plus tracking and targeting capabilities), all while fighting off larger and more established companies — particularly Facebook — that were waking up to the threat Instagram posed to their hold on user attention.

Or Systrom and Instagram could offload all of those responsibilities to Facebook and continue being “extraordinary product leaders”, and pocket $1 billion to boot (and, to be fair to Systrom and team, that understates their gains; that $1 billion included $700 million in Facebook stock, which today is worth nearly $4 billion). It is a defensible choice (for Instagram anyways; not for the regulators that approved the deal), but the implication is that, title notwithstanding, Systrom was never the CEO of Instagram; to be a CEO is to have a company that can stand on its own.

The difference from Zuckerberg — Instagram’s real CEO — is stark. Facebook launched in February, 2004, and sold its first ad two months later. True, “Facebook Flyers” bear little resemblance to the News Feed ads that power the company today, but Zuckerberg’s immediate instinct to build not just a product but a company is notable. Indeed, it casts a new light on the brash CEO’s (in)famous business cards:

A fictionalized version of Mark Zuckerberg's business card
A recreation of Mark Zuckerberg’s infamous business card from the movie The Social Network. The actual card looked like this, with the caption in the lower left corner. They were also not Zuckerberg’s primary business cards.

He was indeed, in title and in practice. To be CEO — to have control — is, at least in the long run, not simply about building a great product. It is about finding and developing a business model that lets you determine your own destiny.

How the Snapchat Threat Was Vanquished

Probably the pinnacle of Systrom and Zuckerberg’s collaboration — extraordinary product leader and ruthless CEO — was Instagram Stories. Systrom freely admitted that the concept was copied from Snapchat; as I noted at the time, that would certainly be good enough given Instagram’s larger network:

Instagram and Facebook are smart enough to know that Instagram Stories are not going to displace Snapchat’s place in its users lives. What Instagram Stories can do, though, is remove the motivation for the hundreds of millions of users on Instagram to even give Snapchat a shot.

Getting consumer adoption of new products is hard; when that adoption requires a network, it’s harder still, at least if most of your network is not using said product; on the flipside, those same difficulties become massive accelerants once the product passes a certain threshold of your friends. Snapchat has passed that threshold amongst teenagers and increasingly young adults in the United States, and every day gets closer with other demographics and geographies.

Instagram, though, is already there, but with a product that does Facebook’s job of presenting your best self. What makes this move so audacious is Zuckerberg and Systrom’s bet that they can refashion Instagram into a product for being yourself, at least to a sufficient degree to hold off Snapchat’s ongoing suction of attention.

That article was mostly spot-on; my primary error was underestimating just how good Instagram’s product would be. Instagram Stories from day one were a better experience than Snapchat Stories, particularly in terms of speed; the product differences only grew from there. Ultimately, Instagram Stories didn’t simply stem Snapchat’s growth; it actually accelerated Instagram’s:

Instagram's Monthly Active Users

Meanwhile, Zuckerberg and Facebook’s ad team were cutting off Snapchat’s monetization oxygen, as I explained in Facebook’s Lenses:

Facebook spent years building out News Feed advertising — not simply the display and targeting technology but also the entire back-end apparatus for advertisers, connections with non-Facebook data sources and points-of-sale, relationships with ad buyers, etc. — and then simply plugged Instagram into that infrastructure.

The payoff of this integrated approach cannot be overstated. Instagram got to scale in terms of monetization years faster than they would have on their own, even as the initial product team had the freedom to stay focused on the user experience. Facebook the app benefited as well, because Instagram both increased the surface area for Facebook ad campaigns even as it increased Facebook’s targeting capabilities.

The biggest impact, though is on potential competition. It is tempting to focus on the “R” in “ROI” — the return on investment — and as I just noted Instagram + Facebook makes that even more attractive. Just as important, though, is the “I”; there is tremendous benefit to being a one-stop shop for advertisers, who can save time and money by focusing their spend on Facebook. The tools are familiar, the buys are made across platforms, and as Zuckerberg and Sandberg alluded to with regard to Stories, the ads themselves only need to be made once to be used across multiple platforms. Why even go to the trouble to advertise anywhere else?

This dynamic, by the way, was very much apparent when Snap IPO’d a year-and-a-half ago; indeed, Snap CEO Evan Spiegel, often cast as the anti-Systrom — the CEO that said “No” to Facebook — arguably had the same flaw. Systrom offloaded the building of a business to Zuckerberg; Spiegel didn’t bother until it was much too late.

Instagram’s Challenge

Still, as good as the Instagram Stories product was, it is difficult to overstate the built-in advantage that came from Instagram’s larger network, and impossible to overstate the importance of having a shared advertising backend with Facebook. To put it another way, Instagram’s two biggest advantages relative to Snapchat, or any other competitors that may arise, didn’t have much to do with product — Systrom’s speciality — at all.

There is no better example than IGTV. Three months ago Systrom announced Instagram’s new long-form video offering with a presentation that exuded product sensibility. I marveled at the time:

In just a few minutes Systrom brilliantly and, to my mind, accurately, explained how video consumption was changing for teenagers in particular, highlighted how current solutions (i.e. YouTube) fell short, and set out the principles that should guide the creation of a better service (mobile first, simple, and high quality videos). And, naturally, that better service was IGTV.

It doesn’t seem to have mattered in the slightest. Josh Constine wrote a smart article about IGTV’s struggles last month on TechCrunch:

It’s indeed too early for a scientific analysis, and Instagram’s feed has been around since 2010, so it’s obviously not a fair comparison, but we took a look at the IGTV view counts of some of the feature’s launch partner creators. Across six of those creators, their recent feed videos are getting roughly 6.8X as many views as their IGTV posts. If IGTV’s launch partners that benefited from early access and guidance aren’t doing so hot, it means there’s likely no free view count bonanza in store from other creators or regular users. They, and IGTV, will have to work for their audience. That’s already proving difficult for the standalone IGTV app. Though it peaked at the #25 overall US iPhone app and has seen 2.5 million downloads across iOS and Android according to Sensor Tower, it’s since dropped to #1497 and seen a 94 percent decrease in weekly installs to just 70,000 last week.

The one big surprise of the launch event was where IGTV would exist. Instagram announced it’d live in a standalone IGTV app, but also as a feature in the main app accessible from an orange button atop the home screen that would occasionally call out that new content was inside. It could have had its own carousel like Stories or been integrated into Explore until it was ready for primetime. Instead, it was ignorable. IGTV didn’t get the benefit of the home screen spotlight like Instagram Stories. Blow past that one orange button and avoid downloading the separate app, and users could go right on tapping and scrolling through Instagram without coming across IGTV’s longer videos. View counts of the launch partners reflect that.

I’m not arguing that product doesn’t matter. It does, incredibly so. But it is not the only thing that matters, and its relative importance decreases over time as things like network effects and business models come to bear. To that end, the single most important issue facing Instagram — the company that is, or, more accurately, Facebook — is Stories monetization. I wrote last month in Facebook’s Story Problem — and Opportunity:

That’s the thing about Stories, though: while more people may use Instagram because of Stories, some significant number of people view Stories instead of the Instagram News Feed, or both in place of the Facebook News Feed. In the long run that is fine by Facebook — better to have users on your properties than not — but the very same user not viewing the News Feed, particularly the Facebook News Feed, may simply not be as valuable, at least for now.

This is the context for whatever dispute drove Systrom and Krieger’s resignation: not only do they not actually control their own company (because they don’t control monetization), they also aren’t essential to solving the biggest issue facing their product. Instagram Stories monetization is ultimately Facebook’s problem, and in case it wasn’t clear before, it is now obvious that Facebook will provide the solution.

I don’t write any of this to denigrate Systrom and Krieger in the slightest. If anything my appreciation for their incredible product sense has only grown over the last few years. Both are truly extraordinary, as is their creation.

Controlling one’s own destiny, though, takes more than product or popularity. It takes money, which is to say it takes building a company, working business model and all. That is why I mark April 9, 2012, as the day yesterday became inevitable. Letting Facebook build the business may have made Systrom and Krieger rich and freed them to focus on product, but it made Zuckerberg the true CEO, and always, inevitably, CEOs call the shots.

I wrote a follow-up to this article in this Daily Update.

The European Union Versus the Internet

Earlier this summer the Internet breathed a sigh of relief: the European Parliament voted down a new Copyright Directive that would have required Internet sites to proactively filter uploaded content for copyright violations (the so-called “meme ban”), as well as obtain a license to include any text from linked sites (the “link tax”).

Alas, the victory was short-lived. From EUbusiness:

Internet tech giants including Google and Facebook could be made to monitor, filter and block internet uploads under amendments to the draft Copyright Directive approved by the EU Parliament Wednesday. At their plenary session, MEPs adopted amendments to the Commission’s draft EU Copyright Directive following from their previous rejection, adding safeguards to protect small firms and freedom of expression…

Parliament’s position toughens the Commission’s proposed plans to make online platforms and aggregators liable for copyright infringements. This would also apply to snippets, where only a small part of a news publisher’s text is displayed. In practice, this liability requires these parties to pay right holders for copyrighted material that they make available.

At the same time, in an attempt to encourage start-ups and innovation, the text now exempts small and micro platforms from the directive.

I chose this rather obscure source to quote from for a reason: should Stratechery ever have more than either 50 employees or €10 million in revenue, under this legislation I would likely need to compensate EUbusiness for that excerpt. Fortunately (well, unfortunately!), this won’t be the case anytime soon; I appreciate the European Parliament giving me a chance to start-up and innovate.

This exception, along with the removal of an explicit call for filtering (that will still be necessary in practice), was enough to get the Copyright Directive passed. This doesn’t mean it is law: the final form of the Directive needs to be negotiated by the EU Parliament, European Commission, and the Council of the Europe Union (which represents national governments), and then implemented via national laws in each EU country (that’s why it is a Directive).

Still, this is hardly the only piece of evidence that EU policy makers have yet to come to grips with the nature of the Internet: there is also the General Data Protection Regulation (GDPR), which came into effect early this year. Much like the Copyright Directive, the GDPR is targeted at Google and Facebook, but as is always the case when you fundamentally misunderstand what you are fighting, the net effect is to in fact strengthen their moats. After all, who is better equipped to navigate complex regulation than the biggest companies of all, and who needs less outside data than those that collect the most?

In fact, examining where it is that the EU’s new Copyright Directive goes wrong — not just in terms of policy, but also for the industries it seeks to protect — hints at a new way to regulate, one that works with the fundamental forces unleashed by the Internet, instead of against them.

Article 13 and Copyright

Forgive the (literal) legalese, but here is the relevant part of the Copyright Directive (the original directive is here and the amendements passed last week are here) pertaining to copyright liability for Internet platforms:

Online content sharing service providers perform an act of communication to the public and therefore are responsible for their content and should therefore conclude fair and appropriate licensing agreements with rightholders. Where licensing agreements are concluded, they should also cover, to the same extent and scope, the liability of users when they are acting in a non-commercial capacity…

Member States should provide that where right holders do not wish to conclude licensing agreements, online content sharing service providers and right holders should cooperate in good faith in order to ensure that unauthorised protected works or other subject matter, are not available on their services. Cooperation between online content service providers and right holders should not lead to preventing the availability of non-infringing works or other protected subject matter, including those covered by an exception or limitation to copyright…

This is legislative fantasizing at its finest: Internet platforms should get a license from all copyright holders, but if they don’t want to (or, more realistically, are unable to), then they should keep all copyrighted material off of their platforms, even as they allow all non-infringing work and exceptions. This last bit is a direct response to the “meme ban” framing: memes are OK, but the exception “should only be applied in certain special cases which do not conflict with normal exploitation of the work or other subject-matter concerned and do not unreasonably prejudice the legitimate interests of the rightholder.”1 That’s nearly impossible for a human to parse; expecting a scalable solution — which yes, inevitably means content filtering — is absurd. There simply is no way, especially at scale, to preemptively eliminate copyright violations without a huge number of mistakes.

The question, then, is in what direction those mistakes should run. Through what, in retrospect, are fortunate accidents of history,2 Internet companies are mostly shielded from liability, and need only respond to takedown notices in a reasonable amount of time. In other words, the system is biased towards false negatives: if mistakes are made, it is that content that should not be uploaded is. The Copyright Directive, though, would shift the bias towards false positive: it mistakes are made, it is that allowable content will be blocked for fear of liability.

This is a mistake. For one, the very concept of copyright is a government-granted monopoly on a particular arrangement of words. I certainly am not opposed to that in principle — I am obviously a benefactor — but in a free society the benefit of the doubt should run in the opposite direction of those with the legal right to deny freedom. The Copyright Directive, on the other hand, requires Internet Platforms to act as de facto enforcement mechanisms of that government monopoly, and the only logical response is to go too far.

Moreover, the cost of copyright infringement to copyright holders has in fact decreased dramatically. Here I am referring to cost in a literal sense: to “steal” a copyrighted work in the analog age required the production of a physical product with its associated marginal costs; anyone that paid that cost was spending real money that was not going to the copyright holder. Digital goods, on the other hand, cost nothing to copy; pirated songs or movies or yes, Stratechery Daily Updates, are very weak indicators at best of foregone revenue for the copyright holder. To put it another way, the harm is real but the extent of the harm is unknowable, somewhere in between the astronomical amounts claimed by copyright holders and the zero marginal cost of the work itself.

The larger challenge is that the entire copyright system was predicated on those physical mediums: physical goods are easier to track, easier to ban, and critically, easier to price. By extension, any regulation — or business model, for that matter — that starts with the same assumptions that guided copyright in the pre-Internet era is simply not going to make sense today. It makes far more sense to build new business models predicated on the Internet.

The music industry is a perfect example: the RIAA is still complaining about billions of dollars in losses due to piracy, but many don’t realize the industry has returned to growth, including a 16.5% revenue jump last year. The driver is streaming, which — just look at the name! — depends on the Internet: subscribers get access to basically all of the songs they could ever want, while the recording industry earns somewhere around $65 per individual subscriber per year with no marginal costs.3 It’s a fantastic value for customers and an equally fantastic revenue model for recording companies; that alignment stems from swimming with the Internet, not against it.

This, you’ll note, is not a statement that copyright is inherently bad, but rather an argument that copyright regulation and business models predicated on scarcity are unworkable and ultimately unprofitable; what makes far more sense for everyone from customers to creators is an approach that presumes abundance. Regulation should adopt a similar perspective: placing the burden on copyright holders not only to police their works, but also to innovate towards business models that actually align with the world as it is, not as it was.

Article 11 and Aggregators

This shift from scarcity to abundance has also had far-reaching effects on the value chains of publications, something I have described in Aggregation Theory (“Value has shifted away from companies that control the distribution of scarce resources to those that control demand for abundant ones“). Unfortunately the authors of the Copyright Directive are quite explicit in their lack of understanding of this dynamic; from Article 11 of the Directive:

The increasing imbalance between powerful platforms and press publishers, which can also be news agencies, has already led to a remarkable regression of the media landscape on a regional level. In the transition from print to digital, publishers and news agencies of press publications are facing problems in licensing the online use of their publications and recouping their investments. In the absence of recognition of publishers of press publications as rightholders, licensing and enforcement in the digital environment is often complex and inefficient.

In this reading the problem facing publishers is a bureaucratic one: capturing what is rightfully theirs is “complex and inefficient”, so the Directive provides for “the exclusive right to authorise or prohibit direct or indirect, temporary or permanent reproduction by any means and in any form, in whole or in part” of their publications “so that they may obtain fair and proportionate remuneration for the digital use of their press publications by information society service providers.”4

The problem, though, is that the issue facing publishers is not a problem of bureaucracy but of their relative position in a world characterized by abundance. I wrote in Economic Power in the Age of Abundance:

For your typical newspaper the competitive environment is diametrically opposed to what they are used to: instead of there being a scarce amount of published material, there is an overwhelming abundance. More importantly, this shift in the competitive environment has fundamentally changed just who has economic power.

In a world defined by scarcity, those who control the scarce resources have the power to set the price for access to those resources. In the case of newspapers, the scarce resource was reader’s attention, and the purchasers were advertisers…The Internet, though, is a world of abundance, and there is a new power that matters: the ability to make sense of that abundance, to index it, to find needles in the proverbial haystack. And that power is held by Google. Thus, while the audiences advertisers crave are now hopelessly fractured amongst an effectively infinite number of publishers, the readers they seek to reach by necessity start at the same place — Google — and thus, that is where the advertising money has gone.

This is the illustration I use to show the shift in publishing specifically (this time using Facebook):

A drawing of Aggregation Theory - Facebook and Newspapers

This is why the so-called “link tax” is doomed to failure — indeed, it has already failed every time it has been attempted. Google, which makes no direct revenue from Google News,5 will simply stop serving Google News to the EU, or dramatically curtail what it displays, and the only entities that will be harmed — other than EU consumers — are the publications that get traffic from Google News. Again, that is exactly what happened previously.

There is another way to understand the extent to which this proposal is a naked attempt to work against natural market forces: Google’s search engine respects a site’s robot.txt file, wherein a publisher can exclude their site from the company’s index. Were it truly the case that Google was profiting unfairly from the hard word of publishers, then publishers have a readily-accessible tool to make them stop. And yet they don’t, because the reality is that while publishers need Google (and Facebook), that need is not reciprocated. To that end, the only way to characterize money that might flow from Google and Facebook (or a €10-million-in-revenue-generating Stratechery) to publishers is as a redistribution tax, enforced by those that hold the guns.

Here again the solution ought to flow in the opposite direction, in a way that leverages the Internet, instead of fighting it. An increasing number of publishers, from large newspapers to sites like Stratechery, are taking advantage of the massive addressable market unlocked by the Internet, leveraging the marketing possibilities of free social media and search engine results, and connecting directly with readers that care — and charging them for it.

I do recognize this is a process that takes time: it is particularly difficult for publishers built with monopoly-assumptions to change not just their business model but their entire editorial strategy for a world where quality matters more than quantity. To that end, if the EU wants to, as they say in the Copyright Directive, “guarantee the availability of reliable information”, then make the tax and subsidy plan they effectively propose explicit. At least then it would be clear to everyone what is going on.

The GDPR and the Regulatory Corollary of Aggregation

This brings me to a piece of legislation I have been very critical of for quite some time: GDPR. The intent of the legislation is certainly admirable — protect consumer privacy —although (and this may be the American in me speaking) I am perhaps a bit skeptical about just how much most consumers care relative to elites in the media. Regardless, the intent matters less than the effect, the latter of which is to entrench Google and Facebook. I wrote in Open, Closed, and Privacy:

While GDPR advocates have pointed to the lobbying Google and Facebook have done against the law as evidence that it will be effective, that is to completely miss the point: of course neither company wants to incur the costs entailed in such significant regulation, which will absolutely restrict the amount of information they can collect. What is missed is that the increase in digital advertising is a secular trend driven first-and-foremost by eyeballs: more-and-more time is spent on phones, and the ad dollars will inevitably follow. The calculation that matters, then, is not how much Google or Facebook are hurt in isolation, but how much they are hurt relatively to their competitors, and the obvious answer is “a lot less”, which, in the context of that secular increase, means growth.

This is the conundrum that faces all major Internet regulation, including the Copyright Directive; after all, Google and Facebook can afford — or have already built — content filtering systems, and they already have users’ attention such that they can afford to cut off content suppliers. To that end, the question is less about what regulation is necessary and more about what regulation is even possible (presuming, of course, that entrenching Google and Facebook is not the goal).

This is where thinking about the problems with the Copyright Directive is useful:

  • First, just as business models ought to be constructed that leverage the Internet instead of fight it, so should regulation.
  • Second, regulation should start with the understanding that power on the Internet flows from controlling demand, not supply.

To understand what this sort of regulation might look like, it may be helpful to work backwards. Specifically, over the last six months Facebook has made massive strides when it comes to protecting user privacy. The company has shut down third-party access to sensitive data, conducted multiple audits of app developers that accessed that data, added new privacy controls, and more. Moreover, the company has done this for all of its users, not just those in the EU, suggesting its actions were not driven by GDPR.

Indeed, the cause is obvious: the Cambridge Analytica scandal, and all of the negative attention associated with it. To put it another way, bad PR drove more Facebook action in terms of user privacy than GDPR or a FTC consent decree. This shouldn’t be a surprise; I wrote in Facebook’s Motivations:

Perhaps there is a third motivation though: call it “enlightened self-interest.” Keep in mind from whence Facebook’s power flows: controlling demand. Facebook is a super-aggregator, which means it leverages its direct relationship with users, zero marginal costs to serve those users, and network effects, to steadily decrease acquisition costs and scale infinitely in a virtuous cycle that gives the company power over both supply (publishers) and advertisers.

It follows that Facebook’s ultimate threat can never come from publishers or advertisers, but rather demand — that is, users. The real danger, though, is not from users also using competing social networks (although Facebook has always been paranoid about exactly that); that is not enough to break the virtuous cycle. Rather, the only thing that could undo Facebook’s power is users actively rejecting the app. And, I suspect, the only way users would do that en masse would be if it became accepted fact that Facebook is actively bad for you — the online equivalent of smoking.

For Facebook, the Cambridge Analytica scandal was akin to the Surgeon General’s report on smoking: the threat was not that regulators would act, but that users would, and nothing could be more fatal. That is because:

The regulatory corollary of Aggregation Theory is that the ultimate form of regulation is user generated.

If regulators, EU or otherwise, truly want to constrain Facebook and Google — or, for that matter, all of the other ad networks and companies that in reality are far more of a threat to user privacy — then the ultimate force is user demand, and the lever is demanding transparency on exactly what these companies are doing.

To that end, were I a regulator concerned about user privacy, my starting point would not be an enforcement mechanism but a transparency mechanism. I would establish clear metrics to measure user privacy — types of data retained, types of data inferred, mechanisms to delete user-generated data, mechanisms to delete inferred data, what data is shared, and with whom — and then measure the companies under my purview — with subpoena power if necessary — and publish the results for the users to see.

This is the way to truly bring the market to bear on these giants: not regulatory fiat, but user sentiment. That is because it is an approach that understands the world as it is, not as it was, and which appreciates that bad PR — because it affects demand — is a far more effective instigator of change than a fine paid from monopoly profits.

I wrote a follow-up to this article in this Daily Update.

  1. Full text of the “meme exception”:

    Despite some overlap with existing exceptions or limitations, such as the ones for quotation and parody, not all content that is uploaded or made available by a user that reasonably includes extracts of protected works or other subject-matter is covered by Article 5 of Directive 2001/29/EC. A situation of this type creates legal uncertainty for both users and rightholders. It is therefore necessary to provide a new specific exception to permit the legitimate uses of extracts of pre-existing protected works or other subject-matter in content that is uploaded or made available by users. Where content generated or made available by a user involves the short and proportionate use of a quotation or of an extract of a protected work or other subject-matter for a legitimate purpose, such use should be protected by the exception provided for in this Directive. This exception should only be applied in certain special cases which do not conflict with normal exploitation of the work or other subject-matter concerned and do not unreasonably prejudice the legitimate interests of the rightholder. For the purpose of assessing such prejudice, it is essential that the degree of originality of the content concerned, the length/extent of the quotation or extract used, the professional nature of the content concerned or the degree of economic harm be examined, where relevant, while not precluding the legitimate enjoyment of the exception. This exception should be without prejudice to the moral rights of the authors of the work or other subject-matter. [↩︎]

  2. That link is about Section 230, which is a U.S. law shielding Internet platforms from liability for what their users upload, but the same principle broadly speaking applies in the E.U. presently [↩︎]
  3. That $65 figure is an estimate of the amount paid out by streaming services like Spotify; the total number per listener is lower, thanks to family plans and shared accounts [↩︎]
  4. The first quotation is from EU Directive 2001/29/EC which is explicitly evoked in the new Copyright Directive, from whence comes the second quotation. [↩︎]
  5. The company does, of course, collect data to be used in advertising elsewhere [↩︎]

The iPhone Franchise

Apple released a new flagship iPhone yesterday, the iPhone XS. This isn’t exactly ground-breaking news: it is exactly what the company has done for eleven years now (matching the 11-year run of non-iOS iPods, by the way1). To that end, what has always interested me more are new-to-the-world non-flagship models: the iPhone 5C in 2013, the iPhone 8 last year (or was it the iPhone X?), and the iPhone XR yesterday. Each, I think, highlights critical junctions not only in how Apple thinks about the iPhone strategically, but also about how Apple thinks about itself.

The iPhone 5C

It’s hard to remember now, but the dominant Apple narrative in 2013, after a five-year iPhone run that saw the company’s stock price increase around 700%, was that the company was at risk of low-end disruption from Android and high-end saturation now that smartphone technology was “good enough”.

Apple's stock price during the iPhone era

This was, for me, rather fortuitous: Stratechery launched in the middle of the Apple-needs-a-cheap-iPhone era, providing plenty of fodder not only for articles defending Apple’s competitive position,2 but also multiple articles speculating on what the iPhone 5C would cost and how it would be positioned.

For the record, I guessed wrong, and I knew I was wrong Two Minutes, Fifty-six Seconds into the keynote.

It was at two minutes, fifty-six seconds that Tim Cook said there would be a video – a video! – about the iTunes Festival.

And it was awesome.

In case you didn’t watch the whole video (and you really should – it’s only a couple of minutes; due to a copyright claim I had to embed Apple’s full-length keynote), this clip of the ending captures why it matters:

Message: Apple is cool.
Message: Apple is cool.

This was Apple, standing up and saying to all the pundits, to all the analysts, to everyone demanding a low price iPhone:


No, we will NOT compete on price, we will offer something our competitors can’t match.

No, we are NOT selling a phone, we are selling an experience.

No, we will NOT be cheap, but we will be cool.

No, you in the tech press and on Wall Street do NOT understand Apple, but we believe that normal people love us, love our products, and will continue to buy, start to buy, or aspire to buy.

Oh, and Samsung? Damn straight people line up for us. 20 million for a concert. “It’s like a product launch.”

Apple's iTunes Festival video on the left, Samsung's Galaxy SIII commercial mocking those standing in line on the right
Apple’s iTunes Festival video on the left, Samsung’s Galaxy SIII commercial mocking those standing in line on the right

This attitude and emphasis on higher-order differentiation — the experience of using an iPhone — dominated the entire keynote and the presentation of features, with particularly emphasis throughout on the interplay between software and hardware.

In fact, that understated Apple’s position in the market: as I discussed last year the iPhone 5C — which in retrospect, was really just an iPhone 5 replacement in Apple’s trickle-down approach to serving more price-sensitive customers — was a bit of a failure: Apple customers only wanted the best iPhone, and those that couldn’t afford the current flagship preferred a former flagship, not one that was “unapologetically plastic”.

Thus the first lesson: Apple wouldn’t go down-market, nor did its customers want it to.

The iPhone X

Last year, meanwhile, was in many respects the opposite of the iPhone 5S and 5C launch, at least from a framing perspective. The iPhone 8 was the next in line after the iPhone 7 and all of the iPhones before it; it was the iPhone X that was presented as being out-of-band — “one more thing”, to use the company’s famous phrase. The iPhone X was the “future of the smartphone”, with a $999 price tag to match.

A year on, it is quite clear that the future is very much here. CEO Tim Cook bragged during yesterday’s keynote that the iPhone X was the best-selling phone in the world, something that was readily apparent in Apple’s financial results. iPhone revenue was again up-and-to-the-right, not because Apple was selling more iPhones — unit growth was flat — but because the iPhone X grew ASP so dramatically:

iPhone Revenue, Units, and ASP on a TTM basis

This was the second lesson: for Apple’s best customers, price was no object.

The iPhone XR

To be clear, the overall strategy and pricing of the iPhones XS and XR were planned out two to three years ago; that’s how long product cycles take when it comes to high-end smartphones. Perhaps that is why the lessons of the iPhone 5C seem so readily apparent in the iPhone XR in particular.

First off, while the XR does not have stainless steel edges like the iPhones X or XS, it is a far cry from plastic: the back is glass, like the high end phones, and the aluminum sides not only look premium but will be hidden when the phone is in a case, as most will be. What really matters is that the front looks the same, with that notch: this looks like a high-end iPhone, with all of the status that implies.

Second, the iPhone XR is big — bigger than the XS (and smaller than the XS Max, and yes, that is its real name). This matters less for 2018 and more for 2020 and beyond: presuming Apple follows its trickle-down strategy for serving more price-sensitive markets, that means in two years its lowest-end offering will not be a small phone that the vast majority of the market rejected years ago, particularly customers for whom their phone is their only computing device, but one that is far more attractive and useful for far more people.

Third, that 2020 iPhone XR is going to be remarkably well-specced. Indeed, probably the biggest surprise from these announcements (well, other than the name “XS Max”) is just how good of a smartphone the XR is.

  • The XR has Apple’s industry-leading A12 chip, which is so far ahead of the industry that it will still be competitive with the best Android smartphones in two years, and massively more powerful than lower-end phones.
  • The XR has the same wide-angle camera as the XS, and the same iteration of Face ID. Both, again, are industry-leading and will be more than competitive two years from now.
  • The biggest differences from the XS are the aforementioned case materials, an LCD screen, and the lack of 3D Touch. Again, though, aluminum is still a premium material, Apple’s LCD screens are — and yes there is a theme here — the best in the industry, and 3D Touch is a feature that is so fiddly and undiscoverable that one could make the case XR owners are actually better off.

There really is no other way to put it: the XR is a fantastic phone, one that would be more than sufficient to maintain Apple’s position atop the industry were it the flagship. And yet, in the context of Apple’s strategy, it is best thought of as being quite literally ahead of its time.

The iPhone XS

There is, of course, the question of cannibalism: if the XR is so great, why spend $250 more on an XS, or $350 more for the giant XS Max?

This is where the iPhone X lesson matters. Last year’s iPhone 8 was a great phone too, with the same A11 processor as the iPhone X, a high quality LCD screen like the iPhone XR, and a premium aluminum-and-glass case (and 3D Touch!). It also had Touch ID and a more familiar interface, both arguably advantages in their own right, and the Plus size that so many people preferred.

It didn’t matter: Apple’s best customers, not just those who buy an iPhone every year, but also those whose only two alternatives are “my current once-flagship iPhone” or “the new flagship iPhone” are motivated first-and-foremost by having the best; price is a secondary concern. That is why the iPhone X was the best-selling smartphone, and the iPhone 8 — which launched two months before the iPhone X — a footnote.

To be sure, the iPhone X had the advantage of being something truly new, not just the hardware but also the accompanying software. It was the sort of phone an Apple fan might buy a year sooner than they had planned, or that someone more price sensitive might choose over a cheaper option. The XS will face headwinds in both regards: it is faster than the iPhone X, has a better camera, comes in gold — it’s an S-model, in other words — but it’s hard to see it pulling forward upgrades; it’s more likely natural XS buyers were pulled forward by the X. And, as noted above, the XR is a much more attractive alternative to the X than the 8 was to the X; most Apple fans may want the best, but some just want a deal, and the XR is a great one.

Apple should be fine though: overall unit sales may fall slightly, but the $1,099 XS Max will push the average selling price even higher. Note, too, that the XR is only available starting at $749; the longstanding $650 iPhone price point was bumped up to $699 last year, and is now a distant memory.3

Apple's Fall 2018 iPhone Lineup

To put it another way, to the extent the XR cannibalizes the XS, it cannibalizes them with an average selling price equal to Apple’s top-of-the-line iPhone from two years ago; the iPhone 8 is $50 higher than the former $550 price point as well.

Mission Impossible iPhone

This is what I meant when I said Apple’s second iPhone models capture how the company has changed not only its strategy but how the company seems to view itself:

  • 2013 was a time of uncertainty, with a sliding stock price and a steadily building clamor heralding Apple doom via low-end disruption; the company, though, found its voice with the 5C and declared its intentions to be unapologetically high-end; the 5C’s failure, such that it was, only cemented the rightness of that decision.
  • In 2017 the company, for the first time in ten years, started to truly test the price elasticity of demand for the iPhone: given its commitment to being the best, just how much could Apple charge for an iPhone X?
  • This year, then, comes the fully-formed iPhone juggernaut: an even more expensive phone, with arguably one of the weaker feature-driven reasons-to-buy to date, but for the fact it is Apple’s newest, and best, iPhone. And below that, a cheaper iPhone XR that is nearly as good, but neatly segmented primarily by virtue of not being the best, yet close enough to be a force in the market for years to come.

The strategy is, dare I say, bordering on over-confidence. Apple is raising prices on its best product even as that product’s relative differentiation from the company’s next best model is the smallest it has ever been.

Here, though, I thought the keynote’s “Mission: Impossible”-themed opening really hit the mark: the reason why franchises rule Hollywood is their dependability. Sure, they cost a fortune to make and to market, but they are known quantities that sell all over the world — $735 million-to-date for the latest Tom Cruise thriller, to take a pertinent example.

That is the iPhone: it is a franchise, the closest thing to a hardware annuity stream tech has ever seen. Some people buy an iPhone every year; some are on a two-year cycle; others wait for screens to crack, batteries to die, or apps to slow. Nearly all, though, buy another iPhone, making the purpose of yesterday’s keynote less an exercise in selling a device and more a matter of informing self-selected segments which device they will ultimately buy, and for what price.

I wrote a follow-up to this article in this Daily Update.

  1. Specifically, the original iPod was released in October, 2001, and the 7th generation iPod Nano in September, 2012; the last iPod Touch was released in July, 2015 [↩︎]
  2. I.e. Two Bears and What Clayton Christensen Got Wrong [↩︎]
  3. Hilariously, Senior Vice President of Worldwide Marketing Phil Schiller said in reference to the $749 price point, “That’s less than the iPhone 8 Plus. I’m really proud of the work the team has done on that”; Apple shareholders are surely proud that the price is $50 higher than the iPhone 8! [↩︎]

Uber’s Bundles

With Uber, nothing is easy.

Start with profitability, or the lack thereof: two weeks ago the company reported its quarterly “earnings”,1 and once again the losses were massive: $891 million on $2.8 billion in revenue. Clearly the business is failing, no?

Well, like I said, it’s not that easy: unlike a company like MoviePass, Uber has positive unit economics — that is, the company makes money on each ride. This is clear intuitively: Uber keeps somewhere between 20%–30% of each fare,2 from which it pays insurance costs, credit card fees, etc., and keeps the rest.3 According to last quarter’s numbers “the rest” totaled $1.5 billion, for a gross profit margin of 55% (13% of Uber’s total bookings). Moreover, margin is improving — it was 47% a year ago — mostly because Uber is managing to both take a higher percentage of fares even as it has reduced its spending on promotions and driver incentives (Cost of Revenue, meanwhile, appears to correspond very closely to gross bookings).

The problem for Uber is trifold: first, the company continues to spend massive amounts of money on “below-the-line” costs: $2.2 billion for Operations and Support, Sales and Marketing,4 Research and Development, General and Administrative, and Depreciation and Amortization. Second, it seems likely that a good portion of the company’s improving margin stems from exiting more difficult markets like Russia and Southeast Asia, as opposed to improvements in its core markets in the United States, Europe, and Oceania. And most concerning of all, Lyft seems to be outgrowing Uber.

Uber’s Lyft Problem

Lyft is a problem for Uber with riders, investors, and drivers.

From a rider perspective, Lyft has, unsurprisingly, benefited from the self-inflicted disaster that was 2017 (although to be fair, 2017 was the year of revelations of problems that had been in place for years). The consumer benefit of services like Uber and Lyft has always been clear, and Uber’s aggressive expansion paid off when the service became the default choice for a large portion of the market, something that is critical for a commodity offering with two-sided network effects. The problem is that Uber gave riders plenty of reasons to question their default choice with not just a sexual harassment scandal, and not just a lawsuit alleging the theft of intellectual property from Google, and not just allegations of brazenly circumventing local regulators, but all three (and honestly, this understates things).

This was particularly problematic because that two-sided network effect wasn’t that strong: sure, Uber was more likely to monopolize driver time given its larger user base, but as long as drivers are independent contractors Uber can’t do anything to prevent them from multihoming, that is, being available on both Uber and Lyft’s networks at the same time. Lyft was ready-and-able to absorb unhappy Uber riders, because they were effectively using Uber’s drivers to accommodate them.

The timing could not have been worse: it was only a few months prior that Lyft appeared to be for sale and unable to find a buyer; it seemed that former-CEO Travis Kalanick was going to win one of his biggest gambles, turning down an offer to acquire Lyft in 2014 in exchange for 18% of Uber.

It proved to be Kalanick’s biggest mistake, at least from a business perspective: within weeks of the Uber scandal explosion Lyft raised $600 million, and a month later formed a partnership with Waymo, Google’s self-driving car company. Suddenly the best way to invest in the most promising self-driving technology was Lyft; unsurprisingly Lyft has since raised an additional $2.3 billion, including an investment from Google Capital.

Uber’s Competitive Context

The reason this context matters is that a proper analysis of Uber’s business is fundamentally different today than it was two years ago — or four years ago, when I wrote Why Uber Fights. That is when I made the argument that even though Uber’s two-sided network effects were relatively weak thanks to the lack of driver lock-in, the fact that ride-sharing was a commodity market meant its head start and brand would lead to slow-but-steady growth in marketshare, eventually starving Lyft due to an inability to raise funds based on increasingly inferior financial results.

I stand by that analysis: it is exactly what happened, and Uber came very close to knocking Lyft out. At the same time, it is also no longer applicable, because Lyft no longer has any problem raising money, while Uber appears to be having a hard time holding onto its market share (as an indirect indicator of Uber’s waning power with consumers, note Uber’s recent inability to defeat a cap on ride-sharing in New York, after doing just that three years ago). To that end, the prospect of Lyft being present in the market for the foreseeable future means Uber’s needs a new strategy than simply squeezing Lyft dry.

Welcome to bundles, Uber-style.

Uber’s Consumer Bundle: Transportation-as-a-Service

Uber CEO Dara Khosrowshahi laid out a new vision for the Uber app in an interview with Kara Swisher earlier this year at the Code Conference:

DK: We are thinking about alternative forms of transport. If you look at Jump, the dockless bicycle startup Uber acquired earlier this year, the average length of a trip at Jump is 2.6 miles. That is, 30 to 40 percent of our trips in San Francisco are 2.6 miles or less. Jump is much, much cheaper than taking an UberX. To some extent it’s like, “Hey, let’s cannibalize ourselves.” Let’s create a cheaper form of transportation from A to B, and for you to come to Uber, and Uber not just being about cars, and Uber not being about what the best solution for us is, but really being about the best solution for here.

KS: So bikes, scooters?

DK: Bikes, perhaps scooters. I wanna get the bus network on. I wanna get the BART, or the Metro, etc., onto Uber. So, any way for you to get from point A to B.

KS: Wait, you wanna start your own BART? No.

DK: No, no, no. We’re not gonna go vertical. Just like Amazon sells third-party goods, we are going to also offer third-party transportation services. So, we wanna kinda be the Amazon for transportation, and we want to offer the BART as an alternative. There’s a company called Masabi that is connecting Metro, etc., into a payment system. So we want you to be able to say, “Should I take the BART? Should I take a bike? Should I take an Uber?” All of it to be real-time information, all of it to be optimized for you, and all of it to be done with the push of a button.

KS: So, any transportation?

DK: Any transportation, totally frictionless, real time.

In case you had any question about how serious Khosrowshahi is about the concept, he told the Financial Times in an interview yesterday:

During rush hour, it is very inefficient for a one-tonne hulk of metal to take one person 10 blocks…We’re able to shape behaviour in a way that’s a win for the user. It’s a win for the city. Short-term financially, maybe it’s not a win for us, but strategically long term we think that is exactly where we want to head…

We are willing to trade off short-term per-unit economics for long-term higher engagement…I’ve found in my career that engagement over the long term wins wars and sometimes it’s worth it to lose battles in order to win wars.

This is very much a bundle, and like any bundle, what makes the economics work in the long run is earning a larger total spend from consumers even if they spend less on any particular item. To that end, as Khosrowshahi notes, the real enemy is the car in the garage; to the extent Uber can replace that the greater its opportunity is.

Uber's consumer bundle

Moreover, the more that Uber can handle all of an end user’s transportation needs through the sort of complexity inherent in building such a service, the stickier Uber becomes for consumers. Granted, Lyft is promising to build the same thing, but Uber is a bit ahead and still has the bigger war chest, which may prove more helpful in a land grab as opposed to the current war of attrition. Moreover, Uber still has a significant geographic advantage over Lyft, which only just started expanding internationally, making it a better option for travelers.

Uber’s Driver Bundle: Uber Eats

Uber Eats, meanwhile, has the potential to be a very attractive business in its own right: Khosrowshahi said at Code Conference that the business has “a $6 billion bookings run rate, growing over 200 percent.” Uber takes 30% of that ($1.6 billion), as well as a $5 delivery fee from customers, out of which it pays drivers a pickup fee, drop-off fee, and per-mile rate (of which it keeps 25%); according to The Information, the service isn’t making money yet, but it is much more profitable than Uber’s ride-sharing business was at a similar scale.

Leaving aside the drivers for a moment, this is a classic aggregation play, where owning consumer demand gives Uber the ability to attract suppliers, increasing consumer demand in a virtuous cycle. Jason Droege, the Uber Vice President and Head of UberEverything, told Eater in an interview this past summer:

I think that we’re all here to service the consumer, right? And the eater. And I think eaters today want convenience, they want value, they want flexibility, and they want choice. And delivery offers all of those things. And restaurants choose to participate in delivery. And so if they don’t believe it’s valuable as a channel to connect to their consumers, or maybe new consumers, or reach new people with their brand, then that’s okay. We’re here to provide a conduit between the two. Not to tell them how to run their business.

It certainly is an open question as to whether services like Uber Eats help or hurt established restaurants; this New Yorker article recounts a number of anecdotes about restauranteurs who are a bit fuzzy on exactly how much Uber Eats is costing them, much like Uber drivers that forget to account for the wear-and-tear on their cars. At the same time, Uber is creating entirely new opportunities for restaurants focused on delivery, just as it did for drivers that only wanted to work sometimes, or couldn’t find any other job at all, as well as companies to service them like HyreCar.

Moreover, Uber Eats has a leg-up in the space because of Uber itself: the latter can acquire customers from the former (both because of owned-and-operated advertising as well as reducing drop-off because Uber already has payment details), and all of those huge marketing and G&A expenses from building out teams in every city Uber operates is easily leveraged for Uber Eats. This of course applies to driver acquisition costs as well.

The biggest payoff, though, comes from effectively bundling opportunities for drivers. The problem for any standalone restaurant delivery app is that the vast majority of orders come at lunch and dinner, but the driver may wish to work at other times of the day as well. With Uber that is easy: just pick up riders (Uber drivers can drive for just Uber, just Uber Eats, or both). In other words, Uber has more and more ways to monopolize a driver’s time, to the driver’s benefit personally and Uber’s benefit competitively.

Uber's driver bundle

To be sure a GrubHub driver, to take one Uber Eats competitor at random, could also drive for Lyft (or Uber, for that matter), but that is where rewarding drivers for a certain number of rides in a given time period is particularly effective: because drivers can complete their “Quests” with Uber ride-sharing trips or Uber Eats trips, it often makes more sense to simply stick with Uber.

More broadly, the challenge Uber faces with drivers derives from the same fungibility that makes the service possible in the first place. To that end, the best way to approach the driver market is not to compete against this reality but to embrace it, and having multiple services that utilize the same driver pool accomplishes exactly that.

Self-Driving Cars: A Bundle as the Way Forward

Self-driving cars, meanwhile, remain Uber’s white whale. The company received a $500 million investment from Toyota yesterday, and will work to incorporate its technology into Toyota Sienna minivans.

This is definitely not the divesture of the unit that The Information says has been mooted; the unit has apparently cost Uber $2 billion over the last two years. Of course, as I noted above, that cost pales in comparison to the strategic impact of losing Google as a potential partner to Lyft.

Still, it is never too late to consider doing the right thing: I continue to believe that Uber’s investment in self-driving cars was a strategic mistake. Yes, its biggest cost is drivers, and a theoretical Google ride-sharing service could, were it at scale, completely undercut Uber, but that is the shallowest possible way to analyze how this market might have played out.

Keep in mind the point I just made about drivers: sure it sounds attractive to convert your most expensive supply input, which must be paid on a marginal basis and that you don’t control, into a fixed cost that you have exclusive rights to. That, though, means massively more capital expenditures for a business that is currently losing around a billion dollars a quarter. Worse, it means competing with Google in an area — machine learning — where the search giant has a massive advantage.

Moreover, in the long run it seems unlikely that Google would want to build up a vertical Uber competitor: it remains far more logical, both financially and in terms of Google’s historical margin profile, to license out their technology. To be sure, if Waymo’s technology were superior, they would have wholesale transfer pricing power, which Tren Griffin describes as:

The bargaining power of company A that supplies a unique product XYZ to Company B which may enable company A to take the profits of company B by increasing the wholesale price of XYZ

Here’s the thing though: Uber is better equipped than anyone else to deal with Waymo’s potential ability to extract margin for superior self-driving technology. After all, the company is already paying for driving technology — the technology just happens to be a human!

Of course that doesn’t mean Uber should settle for paying Waymo instead of drivers: the ride-sharing service remains the best possible way to go-to-market for everyone working on self-driving technology. To that end Uber should be willing to partner with anyone and everyone — and to share its technology with whoever wants it. In the long run Uber has market power thanks to its network, and it will best exploit that power to the extent it can engender competition amongst suppliers in the self-driving car space.

Uber's self-driving bundle

Moreover, it seems certain that whenever self-driving cars come along (and even Waymo is having trouble), they will not be suitable for all of the environments Uber operates in. That makes Uber uniquely suited to bundle self-driving car service with traditional Uber car service, as well as all of the other transportation services it plans to offer to consumers. This “bundle” will allow self-driving technology to come-to-market gradually when and where it makes sense, while still giving riders the confidence they can get from anywhere to anywhere.

To be fair, Khosrowshahi has signaled the desire to partner with multiple self-driving partners, including Google. I suspect, though, that will be hard to accomplish as long as Uber is pursuing its own exclusive technology. To that end Khosrowshahi should cut the cord with Uber’s self-driving program sooner rather than later, or perhaps even open-source it; the money savings are in fact the second most important potential benefit.

There was a certain satisfying simplicity to the brutality of Uber’s original strategy under Kalanick: be as aggressive as possible to establish an early lead, and then leverage Uber’s seemingly limitless ability to raise money to spend its competitors into submission. In the end, though, that same brutality did Kalanick in, and his strategy along with it.

That left Khosrowshahi with a much more complicated situation: not only did he need to fix Uber internally, he needed to create an entirely new strategy to win in a market that was fundamentally altered because of Uber’s crisis. The bundling of services for users, of opportunities for drivers, and ideally of technologies for self-driving makes sense as an alternative.

This strategy is, though, befitting the nature of the situation, considerably more complicated, and the commensurate chances of success — and ultimately, of profitability — a fair bit lower. In other words, Uber’s boardroom drama may be over, but the company remains perhaps the most compelling in tech.

I wrote a follow-up to this article in this Daily Update.

  1. Uber voluntarily shares high level numbers with media outlets (the Wall Street Journal has collected them here), but the numbers are selective, unaudited, and come with no financial documents [↩︎]
  2. The company now deducts the amount spent on driver incentives and promotions, in addition to driver earnings on a percentage basis, from its overall bookings; this is a very welcome improvement to the company’s reporting. Previously it was unclear whether or not this spending was accounted for correctly [↩︎]
  3. You can see an old breakdown from a 2015 leaked document here [↩︎]
  4. As noted in an earlier footnote, Uber does appear to be deducting promotional expenses that apply to specific rides from booking, so these are non-unit marketing costs [↩︎]

Facebook’s Story Problem — and Opportunity

This is hardly the first Stratechery article about Facebook to start with Snapchat. The “camera company” née social network reported earnings that were, as they say, mixed. Revenue beat expectations by 5%, but user growth, after slowing considerably for two years, went in the opposite direction: Snap’s Daily Active Users were still up 9% year-over-year, but for the first time declined sequentially (by 2%):

Snapchat's Daily Active Users

So what happened?

Snap’s Growth Excuses

Snap’s stated rationale for its slowing growth has shifted over those two years:

  • In its S-1, filed in February 2017, the company blamed “technical issues”:

    In mid-2016, we launched several products and released multiple updates, which resulted in a number of technical issues that diminished the performance of our application. We believe these performance issues resulted in a reduction in growth of Daily Active Users in the latter part of the quarter ended September 30, 2016.

  • During the pre-IPO roadshow, CEO Evan Spiegel blamed Snapchat’s performance on Android:

    I think broadly speaking if you look at rest of world growth as a proxy for Android, you can start getting an understanding for the performance issues we face on Android in the last two quarters.

  • On the company’s first earnings call, Spiegel pointed to the company’s restraint:

    I’d love to speak a little bit to the DAU question, because it’s a question that we get all the time. And I think one of the reasons why it’s such a popular question is because there’s a lot of this thing in our industry called growth hacking, where you send a lot of push notifications to users or you try to get them to do things that might be unnatural or something like that. And I think while that’s the easy way to grow daily actives quickly, we don’t think that those sorts of techniques are very sustainable over the long term. And I think that can ultimately impact our relationship with the customer.

  • A year ago, on the company’s third conference call, Spiegel blamed a shift in measurement:

    This quarter, we grew our Daily active users at a lower rate than we would have liked, adding 4.5 million new users. This can be partially attributed to our decision to report our daily active users as an average over the entire quarter, where a strong September was offset by the more modest months of July and August. Ultimately though, we want to drive more user growth in 2018.

  • In March the blame was put on Snapchat’s re-design, along with that old bugaboo Android:

    As we have mentioned on our past two earnings calls, a change this big to existing behavior comes with some disruption, especially given the high frequency of daily engagement of our community. While we had an average of 191 million daily active users in Q1, our March average was lower, but still above our Q4 average. We are already starting to see early signs of stabilization among our iOS users as people get used to the changes, but still have a lot of work to do to optimize the new design, especially for our Android users.

  • Last quarter the re-design again took center stage:

    While our monthly active users continue to grow this quarter, we saw 2% decline in our daily active users. This was primarily driven by a slightly lower frequency of use among our user base due to the disruption caused by our redesign. It has been approximately six months since we broadly rolled out the redesign of our application and we have been working hard to iterate and improve Snapchat based on the feedback from our community.

Note that this last explanation is a bit different than the others: Snap was admitting that its core users were using the product less. The problem is that while social networks making blunders in the user experience is hardly a new phenomenon, the difference between Snapchat and, well, Facebook, is the lack of growth — going on for two years now — to make up for it.

And, of course, there is the reason for slowing growth that Snap’s executives can’t bring themselves to acknowledge: Instagram Stories.

Copying Audacity Redux

In August 2016, when Instagram launched what its own executives admitted was a rip-off of Snapchat’s Stories feature, I wrote in The Audacity of Copying Well that the effect would not be to steal Snapchat’s users, at least not yet; rather, Instagram Stories looked poised to kill Snapchat’s growth:

Facebook is leveraging one of their most valuable assets: Instagram’s 500 million users. The results, at least anecdotally, speak for themselves: I’ve seen more Instagram stories in the last 24 hours than I have Snapchat ones. Of course a big part of this is the novelty aspect, which will fade, and I follow a lot more people on Instagram than I do on Snapchat. That last point, though, is, well, the point: I and my friends are not exactly Snapchat’s target demographic today, but for the service to reach its potential we will be eventually. Unless, of course, Instagram Stories ends up being good enough…

Instagram and Facebook are smart enough to know that Instagram Stories are not going to displace Snapchat’s place in its users lives. What Instagram Stories can do, though, is remove the motivation for the hundreds of millions of users on Instagram to even give Snapchat a shot.

Unfortunately for Snap, Instagram Stories were more than good enough: they were soon significantly better, particularly once you take performance into account (not just on Android, but on iOS too). In fact, they were so good that Instagram’s user growth actually accelerated after their introduction, despite starting from a base of over 500 million users:1

Instagram's Monthly Active Users

In short, Instagram Stories not only prevented users from defecting to Snapchat, it also took all of Snapchat’s growth, and now, after Snapchat’s re-design snafu, is likely taking users away.

Long-term Versus Short-term

Two weeks ago, after Facebook experienced the largest single day market-cap decline in U.S. corporate history, I argued that, if you looked at the company through any lens but a financial one, the company was stronger than ever.

For all of the company’s travails and controversies over the past few years, its moats are deeper than ever, its money-making potential not only huge but growing both internally and secularly; to that end, what is perhaps most distressing of all to would-be competitors is in fact this quarter’s results: at the end of the day Facebook took a massive hit by choice; the company is not maximizing the short-term, it is spending the money and suppressing its revenue potential in favor of becoming more impenetrable than ever.

That reference to “taking a hit by choice” was primarily about the reduced margins Facebook is projecting thanks to its dramatically increased spending on security; it certainly hurts in the short-term, but keeping people on the platform and regulators away has massive long-term value.

It should be noted, though, that Instagram Stories in particular (along with Stories on Facebook’s app) are in a similar vein: their strategic impact, particularly in terms of Facebook’s competitive position relative to Snapchat, will be felt for years. There is a financial impact in the short-to-medium term, though, and it may be significant.

The News Feed Ad Unit

The foundation of Facebook’s advertising business is the News Feed ad, which I described five years ago as the best display advertising unit ever:

It’s better for an advertising business to not be a platform. There are certain roles and responsibilities a platform must bear with regards to the user experience, and many of these work against effective advertising. That’s why, for example, you don’t see any advertising in Android, despite the fact it’s built by the top advertising company in the world.

So a Facebook app owns the entire screen, and can use all of that screen for what benefits Facebook, and Facebook alone.

Something like this:

The News Feed Ad

You can’t help but see the advertising, which makes it particularly attractive to advertisers. Brand advertising, especially, is all about visuals and video (launching soon!), but no one has been able to make brand advertising work as well on the web as it does on TV or print. There is simply too much to see on the screen at any given time.

This is the exact opposite experience of a mobile app. Brand advertising on Facebook’s app shares the screen with no one. Thanks to the constraints of mobile, Facebook may be cracking the display and brand advertising nut that has frustrated online advertisers for years.

To be sure, the fact that News Feed ads take over the screen isn’t the only reason Facebook’s stock is, even with the recent drop, up 148% since that article: in the intervening years the company has doubled its userbase, increased ad load in the News Feed, and managed to increase its price-per-ad thanks to Facebook’s superior targeting capabilities.

Still, the ad unit itself matters:

Facebook Advertising Growth Metrics

That huge anomaly between 2014 and 2016 marked the dramatic reduction in Facebook’s side-bar ads, which had been the company’s chief money-maker for years; that reduced the number of impressions, but the resultant shift in ad inventory mix to News Feed ads led to an even more dramatic increase in Facebook’s reported price-per-ad.2

The years after the mix shift have only reinforced just how good the News Feed ad unit is: by 2016 the shift was complete and Facebook just grew and grew, quarter after quarter (remember, that chart is growth rates; a chart of absolute numbers would be up-and-to-the-right3). 2017 was even more interesting: the company said it would stop increasing ad load in the News Feed, which is why impressions fell, but the price-per-ad increased in response. This demonstration of pricing power is as clear an indication as you can get that Facebook’s News Feed ad was highly differentiated.

The Stories Challenge

That’s the thing about Stories, though: while more people may use Instagram because of Stories, some significant number of people view Stories instead of the Instagram News Feed, or both in place of the Facebook News Feed. In the long run that is fine by Facebook — better to have users on your properties than not — but the very same user not viewing the News Feed, particularly the Facebook News Feed, may simply not be as valuable, at least for now.

Facebook CFO David Wehner said as much multiple times on Facebook’s recent earnings call (all emphasis mine):

  • In his prepared remarks:

    There are several factors contributing to [revenue growth] deceleration. For example, we expect currency to be a slight headwind in the second half versus the tailwinds we have experienced over the last several quarters. We plan to grow and promote certain engaging experiences like Stories that currently have lower levels of monetization, and we are also giving people who use our services more choices around data privacy, which may have an impact on our revenue growth.

  • In response to a question about monetizing Instagram:

    Instagram has more heavy usage of Stories, so that’s an area of continued growth opportunity because the effective levels of monetization in Stories are lower. On the demand side, we see a good traction across both platforms, and we’re rolling out more ability for advertisers to leverage ads in Stories with more formats and the like. So that’s, again, an important opportunity for growth is just continuing to build out more products on the demand side for Stories.

  • In response to a question about declining revenue growth:

    We’re going to be focusing on growing engaging new experiences like Stories and promoting those. And that’s going to have a negative impact on revenue growth.

COO Sheryl Sandberg summarized the fundamental question with regard to Stories:

We’ve seen great progress with Stories as a format for people to share on our platforms. We have 400 million people sharing with Instagram Stories, 450 million with WhatsApp Status. Facebook is newer, but we’re seeing good progress there. The question is will this monetize at the same rate as News Feed? And we honestly don’t know.

Nor do investors.

The Downside of Stories

In fact, there are two good reasons to be pessimistic: one from a user perspective and one from an advertiser perspective.

From a user perspective Story ads are far easier to skip: simply tap the screen, much as the user has probably already been doing for the last several minutes feverishly trying to catch up on their Story backlog. Part of what makes Stories such fantastic drivers of engagement is the combination of their disappearing nature — better check frequently to not miss anything! — combined with the simple mechanic of viewing them: tap tap tap. An absence of friction, though, is always a challenge when it comes to monetization.

Moreover, effective Story ads are more difficult to make: still photos can be used, but the most engaging ads will be video, which increases the production difficulty significantly — particularly when you remember the importance of grabbing the user’s attention immediately! This is a particular problem for Facebook because so much of its advertising comes from small- and medium-sized businesses. Sheryl Sandberg said on an earnings call a year-and-a-half ago:

We’re really excited to announce today that 65 million businesses are using our free Pages product and 5 million are using Instagram Business profiles. More and more of these businesses are becoming advertisers with over 4 million advertising on Facebook and over 500,000 on Instagram. As a result, our revenue base is becoming more diverse. In Q4, our top 100 advertisers represented less than a quarter of our ad revenue, which is a decline from Q4 last year.

This is tremendous diversification, particularly in comparison to traditional advertising, as this chart from MoffettNathanson shows:

This is another reason why News Feed ads are so effective: advertising is measured on ROI — return on investment — and the “I” is just as important as the “R”; the investment necessary to achieve a favorable return is so much lower for News Feed ads than nearly any other medium, and experimentation is cheap-and-easy. Small wonder small- and medium-sized businesses flock to Facebook (and a reminder that Facebook’s advertising platform is a critical piece of building the economy of the future); to that end, though, it is fair to wonder just how much of Facebook’s advertiser base will flock to Instagram Stories, even as its users do exactly that.

Stories’ Potential Upside

That noted, Stories potentially have significant value for Facebook beyond strategic positioning. First and foremost, the fact that users find Stories even more engaging than the News Feed suggests there is at least the possibility to create even more engaging advertising as well.

That is particularly compelling because attentive readers may have realized my 2013 excerpt above about the effectiveness of News Feed ads got one thing wrong: I was convinced that taking over the screen would be valuable because of the potential for brand advertising; in fact, most of Facebook’s business is in direct response ads, where the goal is driving user action (app install, product purchase, newsletter signup, etc.) as opposed to simply building brand affinity. The latter remains very television-centric even as young people desert the medium, and every tech company is working feverishly to capture their share of that television money that will be going digital any day now!

Might Stories be an ad unit that works for brand advertising? Sandberg tried to make the case:

With 1 billion active people on the platform, I think Instagram is definitely both a direct response opportunity and an opportunity for discovery. Part of it’s the format. The format is so visually appealing and people are telling stories with pictures, so we see both anecdotally and in the data that this is a great place for people to become aware of a product in the first place.

This is in fact another way to look at that chart about the top 200 advertisers: the biggest spenders are brand advertisers, and while it is to Facebook’s credit that they serve the long tail, there remains a significant opportunity the company has mostly not tapped into, and oh-by-the-way, those are the advertisers best equipped to spend the money to make an effective Stories ad; after all, they’re already spending the money on TV.

That noted, it is possible the pot of brand advertising gold that tech companies are chasing may end up being at the end of the proverbial rainbow, always pursued and never obtained. Do big brands stick with TV because the medium is that much better for advertising, or because they were built for a mass market that on the Internet increasingly doesn’t exist? Indeed, one can make the case — as I have — that the fortunes of traditional television and its advertisers are completely intertwined; unsurprisingly, the disruptors of the latter use Facebook.

There was one small bit of good news for Snap in this analysis: a significant challenge for the company was the de facto requirement that advertisers devote outsized resources to the platform, killing any long-term ROI proposition. The issue is formatting: Snapchat ads are vertical, ideally video, and it was so much easier to simply buy a News Feed ad on Facebook and run it on Instagram. Now, though, an advertiser’s investment in vertical video ads can, at least in theory, be used on both Instagram and Snapchat (and all of Facebook’s other properties after its attempt to put Stories everywhere).

This is small solace to be sure: Instagram has a larger audience — including most of Snapchat’s — the entire Facebook advertising apparatus behind it, and all of the trends are in its favor. That is the sort of long-term gain for which Facebook is rightfully willing to bear the short-term pain; the question now is just how substantial that long-term gain may be, and relatedly, how long the short-term pain will persist.

  1. Facebook has only ever released Instagram MAUs at certain milestones; the growth rate was calculated based on the time in months between those milestones. Also note that Snap, to their credit, releases daily active users, which depresses their numbers relative to Instagram’s monthly active users [↩︎]
  2. The year-over-year increase in price-per-ad growth peaks at 335% in Q4 2014 [↩︎]
  3. Also, such a chart is impossible: Facebook doesn’t actually release the absolute number of impressions or price-per-ad [↩︎]

Free Daily Update: An Interview with Patreon CEO Jack Conte and Memberful CEO Drew Strojny

Stratechery occasionally conducts interviews; these are always in the subscriber-only Daily Update, in part as a benefit for subscribers, but also because Weekly Articles are more representative of what potential subscribers should expect if they choose to receive the Daily Update.

I am making an exception in this case: Patreon just announced that they are acquiring Memberful, the membership software that I use on Stratechery. It is an acquisition and space that is not only pertinent to the business of Stratechery, but also some of the major concepts that I talk about, particularly the evolution of media. To that end, and given the timeliness, this Daily Update is available for anyone to read here.

Facebook Lenses

While I was mostly unplugged on my vacation last week, with the news of Facebook’s disappointing earnings report and subsequent stock decline — the largest one-day loss by any company in U.S. stock market history — I couldn’t resist chiming in on Twitter:

I do regret the tweet a tad, and not only because “chiming in on Twitter” is always risky. Back when Stratechery started I wrote in the very first post that one of the topics I looked forward to exploring was “Why Wall Street is not completely insane”; I was thinking at the time about Apple, a company that, especially at that time, was regularly posting eye-popping revenue and profit numbers that did not necessarily lead to corresponding increases in the stock price, much to the consternation of Apple shareholders. The underlying point should be an obvious one: a stock price is about future earnings, not already realized ones; that the iPhone maker had just had a great quarter was an important signal about the future, but not a determinant factor, and that those pointing to the past to complain about a price predicated on the future were missing the point.

Of course that is exactly what I did in that tweet.

It’s worth noting, though, that while the explicit reasoning of those Apple stockholders may have been suspect, their sentiment has proven correct: in April 2013 Apple reported quarterly revenue of $43.6 billion and profit of $9.5 billion, and the day I started Stratechery the stock price was $63.25; five years later Apple reported quarterly revenue of $61.1 billion and profit of $13.8 billion, and on Friday the stock price was $190.98.

To be clear, I agreed with the Apple-investor sentiment all along: several of my early articles — Apple the Black Swan, Two Bears, and especially What Clayton Christensen Got Wrong — were about making the case that Apple’s business was far more sustainable with much deeper moats than most people realized, and it was that sustainability and defensibility that mattered more than any one quarter’s results.

The question is if a similar case can be made for Facebook: certainly my tweet taken literally was naive for the exact reasons those Apple investor complaints missed the point five years ago; what about the sentiment, though? Just how good of a business is Facebook?

As with many such things, it all depends on what lens you use to examine the question.

Lens 1: Facebook’s Finances

As is often the case with earnings, the move in Facebook’s stock was only a bit about the results and whole lot about future expectations. On Wednesday, Facebook’s stock closed at $217, but then its earnings showed revenue of $13.2 billion, slightly below Wall Street’s expectations; unsurprisingly, the stock slid about 8% in after-hours trading to around $200. The real drop was spurred by two comments on the earnings call from Facebook CFO Dave Wehner about Facebook’s expectations going forward.

First, with regards to revenue:

Turning now to the revenue outlook; our total revenue growth rate decelerated approximately 7 percentage points in Q2 compared to Q1. Our total revenue growth rates will continue to decelerate in the second half of 2018, and we expect our revenue growth rates to decline by high-single digit percentages from prior quarters sequentially in both Q3 and Q4.

Second, with regards to operating margin:

Turning now to expenses; we continue to expect that full-year 2018 total expenses will grow in the range of 50% to 60% compared to last year…Looking beyond 2018, we anticipate that total expense growth will exceed revenue growth in 2019. Over the next several years, we would anticipate that our operating margins will trend towards the mid-30s on a percentage basis.

From a purely financial perspective, both pieces of news are are less than ideal but at least understandable. In terms of revenue, Facebook’s growth is from a very large base, which means that this quarter’s 42% year-over-year revenue growth to $13.2 billion from $9.3 billion is, in absolute terms, 36% greater than the year ago’s 45% revenue growth (from $6.4 billion). To put it in simpler terms, massive growth rates inevitably decline even as massive absolute growth remains; as a point of comparison, Google in the same relative timeframe (14 years after incorporation) grew 35 percent to $12.21 billion (i.e. Facebook is better on both metrics).

As far as the operating margin decline, in a normal company — i.e. one with marginal costs — a revenue decrease would not necessarily lead to a meaningful decline in margin since selling fewer products would mean lower costs of goods sold. Facebook, of course, is not a normal company: the only marginal costs for the ads they sell are credit card fees; like most tech companies the vast majority of costs are “below the line” (mostly in Research & Development, but also Sales & Marketing and General & Administrative); it follows, then, that a decrease in revenue growth would, absent an explicit effort to decrease unrelated (to revenue) expense growth, lead to lower operating margins.

In fact, Facebook is not only not decreasing expenses, they are going in the opposite direction; expenses are growing faster than ever, even as revenue growth clearly fell off:

Facebook's revenue growth is decreasing even as its expense growth increases

I suspect it is this chart, more than anything else, that explains the drop in Facebook’s stock price: it’s not one thing or the other; it is both revenue growth slowing and expenses accelerating at the same time, with all indications from management are that the trends will continue.

Again, relatively speaking Facebook is in great shape financially — I already noted the company had better revenue and growth numbers than Google at a similar point, and their operating margins are substantially better as well — but there’s no question this is a pretty substantial shift in the company’s longterm outlook. The financial lens still provides a pretty positive view, but it is indeed less positive than before.

Lens 2: Facebook’s Products

It is always a bit confusing to write about Facebook, because there is both Facebook the company and Facebook the product, and there is no question the greatest amount of negativity has, for several years now, been centered around the latter. To that end, it is tempting to conflate the two; for example, the New York Times wrote in an article headlined Facebook Starts Paying a Price for Scandals:

For nearly two years, Facebook has appeared bulletproof despite a series of scandals about the misuse of its giant social network. But the Silicon Valley company’s streak ended on Wednesday when it said that the accumulation of issues was starting to hurt its multibillion-dollar business — and that the costs are set to continue playing out for months.

This is true as far as it goes, particular when it comes to expenses: Facebook is on pace to increase its security and content review teams to 20,000 people, a three-fold increase in 18 months; that is why CEO Mark Zuckerberg warned on an earnings call last year:

I’ve directed our teams to invest so much in security on top of the other investments we’re making that it will significantly impact our profitability going forward, and I wanted our investors to hear that directly from me. I believe this will make our society stronger, and in doing so will be good for all of us over the long term. But I want to be clear about what our priority is. Protecting our community is more important than maximizing our profits.

What is much less clear is what effect, if any, Facebook’s controversies have had on the top line. There were three factors that for many years made Facebook a monster when it came to revenue growth:

  • The number of users was increasing
  • Ad load (the number of ads shown in the News Feed) was increasing
  • The price-per-ad was increasing

A year ago, though, Facebook stopped increasing ad load; as I have documented, this did result in an even sharper increase in the price paid per-ad, but it was still a retardant on growth.

Then, over the last year, Facebook’s user growth started to slow, and in the most-profitable North American region, has effectively plateaued. That, though, isn’t because of Facebook’s controversies: it is because the app has run out of people! The company has 241 million monthly active users in the US & Canada, 65% of the total population of 372 million (including children who aren’t supposed to have accounts before the age of 13).

Given that degree of nearly total penetration, what is more important when it comes to evaluating Facebook’s health is that there is no indication the company is losing users. Sure, the numbers in North America decreased by a million in Q4 2017, but now that million is back; I expect something similar when it comes to the million users the company lost in Europe when it required affirmative consent from users to continue using the app because of GDPR.

The fact of the matter is that nothing has happened to diminish Facebook’s moat when it comes to attracting and retaining users: the number one feature of a social network is how many people are on it, and for all intents and purposes everyone is on Facebook — whether they like it or not.

Interestingly, Facebook is working to deepen that moat even further with its focus on Groups. Zuckerberg said on the earnings call:

There are more than 200 million people that are members of meaningful groups on Facebook, and these are communities that, upon joining, they become the most important part of your Facebook experience and a big part of your real world social infrastructure. These are groups for new parents, for people with rare diseases, for volunteering, for military families deployed to a new base and more.

We believe there is a community for every one on Facebook. And these meaningful communities often spend online and offline and bring people together in person. We found that every great community has an engaged leader. But running a group can take a lot of time. So we have a road map to make this easier. That will enable more meaningful groups to get formed, which will help us to find relevant ones to recommend to you, and eventually achieve our five-year goal of helping 1 billion people be a part of meaningful communities.

Zuckerberg is referring to his 2017 manifesto Building a Global Community; it is a particularly attractive goal from Facebook’s perspective because it makes the product stickier than ever.

All that noted, the most important reason to view Facebook through the lens of the company’s products is that the sheer scale of Facebook the app makes it easy to lose site of the still substantial growth potential of those other products. Instagram in particular recently passed 1 billion users, which is an incredible number that is still less than half of Facebook the app’s total users; by definition Instagram has reached less than half of its addressable market.

Moreover, Instagram has not only been untouched by Facebook’s controversies, it is such a compelling product that, anecdotally speaking, most “Facebook-nevers” or “Facebook-quitters” readily admit to using the service daily. The app also hasn’t come close to reaching its monetization potential: while the feed carries the same ad load as Facebook, the SnapChat-inspired Stories format that has exploded in usage has barely been monetized; in fact, Facebook’s executives attributed some of the company’s slowing revenue growth to increased Stories usage (instead of the feed). From a purely financial perspective this is certainly a cause for concern, but from a strategic perspective it means that Instagram is in an even stronger position that it was previously. Remember, revenue and profit are lagging indicators, and the explosion in Instagram Stories is an extreme example of why that is such an important fact to keep in mind.

WhatsApp is increasingly compelling as well: not only does the app remain the dominant communications medium in much of the world, but the addition of WhatsApp Status updates and Stories dramatically increases the monetization potential of the service — a potential that Facebook hasn’t even started to realize.1

There is some degree of long-term risk when it comes to products: Facebook acquired both Instagram and WhatsApp, but the company should not be allowed to acquire another social network of similar size and velocity to those two, and I doubt they would be. That concern, though, is very far in the future: for now the product lens suggests that Facebook is as strong as ever.

Lens 3: Facebook’s Advertising Infrastructure

This lens takes the exact opposite perspective of Lens 2; looking at the company from a product perspective shows four different apps, but looking at the company from an advertising perspective shows a single integrated machine.

This was a point Facebook executives touched on repeatedly in last week’s earnings call. Here is Wehner (emphasis mine):

In terms of Facebook versus Instagram, they’re obviously both contributing to revenue growth. Instagram is growing more quickly and making an increasing contribution to growth. And we’ve been pleased with how Instagram is growing. Facebook and Instagram are really one ads ecosystem.


We’re also making progress developing Stories into a great format for ads. We’ve made the most progress here on Instagram, but this quarter, we started testing Stories ads on Facebook too…

COO Sheryl Sandberg added:

Since we have so many different places where you have Stories formats in Instagram and WhatsApp and Facebook, as volume increases of the opportunity, advertisers get more interested.

Zuckerberg and Sandberg were obviously talking about the potential for advertising in Stories, but that potential is simply a repeat of what has already happened with Feed ads: Facebook spent years building out News Feed advertising — not simply the display and targeting technology but also the entire back-end apparatus for advertisers, connections with non-Facebook data sources and points-of-sale, relationships with ad buyers, etc. — and then simply plugged Instagram into that infrastructure.

The payoff of this integrated approach cannot be overstated. Instagram got to scale in terms of monetization years faster than they would have on their own, even as the initial product team had the freedom to stay focused on the user experience. Facebook the app benefited as well, because Instagram both increased the surface area for Facebook ad campaigns even as it increased Facebook’s targeting capabilities.

The biggest impact, though is on potential competition. It is tempting to focus on the “R” in “ROI” — the return on investment — and as I just noted Instagram + Facebook makes that even more attractive. Just as important, though, is the “I”; there is tremendous benefit to being a one-stop shop for advertisers, who can save time and money by focusing their spend on Facebook. The tools are familiar, the buys are made across platforms, and as Zuckerberg and Sandberg alluded to with regard to Stories, the ads themselves only need to be made once to be used across multiple platforms. Why even go to the trouble to advertise anywhere else?

This is why the advertising lens is perhaps the most useful when it comes to understanding just how strong Facebook’s business remains, and why the Instagram acquisition in particular was such a big deal. For all the discussion of Facebook the app’s lock-in, it is very reasonable to wonder if engagement is decreasing over time, particularly amongst young people, or if controversies may drive down usage — or worse. Were Instagram a separate company, advertisers might find themselves with no choice but to spread out their advertising to multiple companies, and once their advertising was diversified, it would be a much smaller step to target users on other networks like SnapChat or Twitter. As it stands there is no reason to leave Facebook the advertising platform, no matter what happens with Facebook the app.

Lens 4: Facebook’s Multiplying Moats

Facebook’s advertising moat may be its most important, and its network moat its strongest, but the company has actually added moats, particularly in the last year.

The first is GDPR; this may seem counter-intuitive, given that Facebook said last week the regulation cost them a million users, and that one of the factors that would hurt revenue growth was the increased controls the company was giving users when it comes to controlling their personal information. Keep in mind, though, that GDPR applies to everyone, not just Facebook, and as Sandberg noted on the call (emphasis mine):

Advertisers are still adapting to the changes, so it’s early to know the longer-term impact. And things like GDPR and other privacy changes that may happen from us or may happen with regulation could make ads more relevant. One thing that we know that’s not going to change is that advertisers are always looking for the highest ROI opportunity. And what’s most important in winning budget is our relative performance in the industry, and we believe we’ll continue to do very well on that.

I made this exact point previously:

While GDPR advocates have pointed to the lobbying Google and Facebook have done against the law as evidence that it will be effective, that is to completely miss the point: of course neither company wants to incur the costs entailed in such significant regulation, which will absolutely restrict the amount of information they can collect. What is missed is that the increase in digital advertising is a secular trend driven first-and-foremost by eyeballs: more-and-more time is spent on phones, and the ad dollars will inevitably follow. The calculation that matters, then, is not how much Google or Facebook are hurt in isolation, but how much they are hurt relatively to their competitors, and the obvious answer is “a lot less”, which, in the context of that secular increase, means growth.

Secondly, all of those costs that Facebook are incurring for security and content review that are reducing operating margin? Perhaps the stock market would feel better if they were characterized as moat expansion, because that’s exactly what they are: any would-be Facebook competitor is going to have to make a similar investment, and do it from a dramatically lower revenue base.

Moreover, just as Facebook benefits from scaling its ad infrastructure to all of its products, it can do the same with its security efforts. Zuckerberg stated:

More broadly, our strategy is to use Facebook’s computing infrastructure, business platforms and security systems to serve people across all of our apps…We’re using AI systems in our global community operations team to fight spam, harassment, hate speech, and terrorism across all of our apps to keep people safe. And this is incredibly useful for apps like WhatsApp and Instagram as it helps us manage the challenges of hyper-growth there more effectively.

This is why the lens with which you view Facebook matters so much: the exact same set of facts viewed from a financial perspective are a clear negative; from a moat perspective they are a clear positive.

Lens 5: Facebook’s Raison D’être

Needless to say, once you view Facebook through anything but a financial lens the health of the business is hard to argue with (and frankly, the finances went from phenomenal to fantastic, but it’s all relative). That’s why I can’t help but wonder if there is something more fundamental about both the collapse in Facebook’s stock and the general celebration that followed.

To return to the early years of Stratechery, it was striking how widespread Facebook skepticism was; I first tried to argue otherwise five years ago today, and in 2015 felt compelled to write The Facebook Epoch that begins like this:

I’m fond of saying that few companies are as underrated as Facebook is, especially in Silicon Valley. Admittedly, it seems strange to say such a thing about a $245 billion company with a trailing 12-month P/E ratio of 88, but that is Wall Street sentiment; in the tech bubble many seem to simply assume the company is ever on the brink of teetering “just like MySpace”, never mind the fact that the social network pioneer barely broke 100 million registered users, less than 10% of the number of active users Facebook attracted in a single day late last month. Or, as more sober minds may argue, sure, Facebook looks unstoppable today, but then again, Google looked unstoppable ten years ago when social seemingly came out of nowhere: surely the Facebook killer is imminent!

That sentiment sure seems to be back in full force!

At the risk of veering into broad-based psychoanalysis, I think a lot of the Facebook skepticism is because so much of the content seems so shallow and petty, or in the case of the last few years, actively malicious. How can such a product survive?

In fact, it survives for the very reason it exists: Facebook began in Zuckerberg’s Harvard dorm room by quite literally digitizing offline relationships that already existed, both in real life and in actual physical “facebooks”. Facebook is so powerful because of this direct connection to the real world: it is shallow and petty and sometimes malicious — and yes, often good — because we humans are shallow and petty and sometimes malicious — and yes, often good.

By extension, to insist that Facebook will die any day now is in some respects to suggest that humanity will cease to exist any day now; granted, it is a company and companies fail, but even if Facebook failed it would only be a matter of time before another Facebook rose to replace it.

That seems unlikely: for all of the company’s travails and controversies over the past few years, its moats are deeper than ever, its money-making potential not only huge but growing both internally and secularly; to that end, what is perhaps most distressing of all to would-be competitors is in fact this quarter’s results: at the end of the day Facebook took a massive hit by choice; the company is not maximizing the short-term, it is spending the money and suppressing its revenue potential in favor of becoming more impenetrable than ever.

“Utter disaster” indeed.

  1. There is Messenger as well; I am more dubious of its long-term monetization potential because its natural advertising space — status updates and stories — are basically what Facebook is [↩︎]

The European Commission Versus Android

To understand how Google ended up with a €4.3 billion fine and a 90-day deadline to change its business practices around Android, it is critical to keep one date in mind: July 2005.1 That was when Google acquired a still in-development mobile operating system called Android, and to put the acquisition in context, Steve Jobs was, at least publicly, “not convinced people want to watch movies on a tiny little screen”. He was, of course, referring to the iPod; Apple would go on to release an iPod with video playback a few months later, but the iPhone was still a year-and-a-half away from being revealed.

In other words, Android, at least at the beginning, wasn’t a response to Apple;2 the real target was Microsoft (and to a lesser extent Blackberry), which seemed poised to dominate smartphones just as they had the desktop. That was an untenable situation for Google; then Vice-President of Product Management Sundar Pichai wrote on the Google Public Policy blog about the company’s challenges on PCs:

Google believes that the browser market is still largely uncompetitive, which holds back innovation for users. This is because Internet Explorer is tied to Microsoft’s dominant computer operating system, giving it an unfair advantage over other browsers. Compare this to the mobile market, where Microsoft cannot tie Internet Explorer to a dominant operating system, and its browser therefore has a much lower usage.

What mattered to Google was access to end users: that is what makes the Aggregation flywheel turn. On PCs the company had succeeded through a combination of flat-out being better, the fact that it was very simple to visit a new URL (and make it your homepage), and deals with OEMs to set Google as the homepage from the beginning. All would be more difficult to achieve on mobile, at least mobile as it was understood in 2005: applications were notoriously difficult to find and install, and Microsoft and Blackberry had locked down their operating systems to a much greater extent than Microsoft had on the PC.

Thus the Android gambit: Google decided to take on Microsoft directly in mobile operating systems, and its most powerful tool would not be the quality of the operating system, but the business model. To that end, while Google did, naturally, retool Android’s user interface once the iPhone was announced, the business model remained Microsoft kryptonite: whereas Microsoft charged a per-device licensing fee, just as it had with Windows, Android would not only be free and open-source, Google would actually share search revenue derived from Android with OEMs that installed the operating system.

Of course Android also ended up being a much better experience than Windows Mobile in the post-iPhone world, and the deal was irresistible to OEMs flailing for a response to the iPhone: get a (somewhat) comparable (sort-of) touch-based operating system for free, and even make money after the initial sale! Indeed, not only did Android effectively kill Microsoft’s mobile efforts, it went on to take over the world via a massive ecosystem of device makers and mobile carriers that competed to drive down costs and increase distribution.

Android’s Success

That Android increases competition was the focus of Pichai’s — now the CEO of Google — latest blog post in response to the ruling:

Today, the European Commission issued a competition decision against Android, and its business model. The decision ignores the fact that Android phones compete with iOS phones, something that 89 percent of respondents to the Commission’s own market survey confirmed. It also misses just how much choice Android provides to thousands of phone makers and mobile network operators who build and sell Android devices; to millions of app developers around the world who have built their businesses with Android; and billions of consumers who can now afford and use cutting-edge Android smartphones. Today, because of Android, there are more than 24,000 devices, at every price point, from more than 1,300 different brands…

What Pichai doesn’t say is that this competition is not so much a feature as it was the point: open-sourcing Android commoditized smartphone development meaning anyone could enter, even as few were in a position to profit over time. That included Google, at least at the beginning, which was by design: remember, the point of Android was not to make money like Windows, it was to stop Windows or any other operating system from getting between Google and users. Venture capitalist Bill Gurley explained in a 2011 post entitled The Freight Train That Is Android:

Android, as well as Chrome and Chrome OS for that matter, are not “products” in the classic business sense. They have no plan to become their own “economic castles.” Rather they are very expensive and very aggressive “moats,” funded by the height and magnitude of Google’s castle [(search advertising)]. Google’s aim is defensive not offensive. They are not trying to make a profit on Android or Chrome. They want to take any layer that lives between themselves and the consumer and make it free (or even less than free). Because these layers are basically software products with no variable costs, this is a very viable defensive strategy. In essence, they are not just building a moat; Google is also scorching the earth for 250 miles around the outside of the castle to ensure no one can approach it. And best I can tell, they are doing a damn good job of it.

Indeed they were, but the strategy had a built-in problem: Android was, well, open source, and just as that helped Android spread, it could just as easily be forked into an initially compatible operating system that didn’t connect to Google’s services — the castle that Google was trying to protect all along. Google needed a wall for its moat, and found one in the Google Play Store.

The Google Play Store and Google Play Services

The Google Play Store, not unlike Android’s user interface, was a response to the iPhone, specifically the highly successful launch of the App Store in 2008. And while the Play Store often lagged the App Store when it came to cutting-edge apps, particularly in the early days, it quickly became one of Google’s most valuable services, both in terms of making Android useful as well as making Google money.

Note, though, that the Play Store is not a part of Android: it has always been closed-source and exclusive to Google’s version of Android, just like other Google services like Gmail, Maps, and YouTube. The problem Google had with all of those apps, though, was that they were updated with the operating system, and OEMs and carriers — who only made money when a device was initially sold — were not particularly incentivized to update the operating system.

Google’s solution was Google Play Services; first released in 2010 as a part of Android 2.2 Froyo, Google Play Services was distributed via the Play Store and provided an easily updatable API layer that would, in the initial version, allow Google to update its own apps independent of operating system updates. It was an elegant solution to a real problem inherent in the free-wheeling model Google had taken for Android distribution: widespread fragmentation. Soon all of Google’s apps were built on top of Google Play Services, and then, in 2012, Google started opening it up to developers.

The initial version was quite modest; here is the announcement on Google+:

At Google I/O we announced a preview of Google Play services, a new development platform for developers who want to integrate Google services into their apps. Today, we’re kicking off the full launch of Google Play services v1.0, which includes Google+ APIs and new OAuth 2.0 functionality. The rollout will cover all users on Android 2.2+ devices running the latest version of the Google Play store.

Over the next several years, though, Google devoted more and more of its effort — and its most interesting APIs, like location and maps and gaming services — to Google Play Services; meanwhile, whatever equivalent service was in the open-source version of Android was effectively frozen in time. The net result is incredibly significant to teasing out this case: Google Play Services silently shifted ever more apps from Android apps to Google Play apps; today, no Google app will function on open-source Android without extensive reworking, and the same applies to ever more 3rd-party apps as well.

That noted, it is hard, in my estimation, to see this as being an antitrust violation. The fact of the matter is that Google was addressing a legitimate problem in the Android ecosystem, and the company didn’t make any developer use Google Play Services APIs instead of the more basic ones still available even today.

The European Commission Case

The European Commission found Google guilty of breaching EU antitrust rules in three ways:

  • Illegally tying Google’s search and browser apps to the Google Play Store; to get the Google Play Store and thus a full complement of apps, OEMs have to pre-install Google search and Chrome and make them available within one screen of the home page.
  • Illegally paying OEMs to exclusively pre-install Google Search on every Android device they made.
  • Illegally barring OEMs that installed Google’s apps from selling any device that ran an Android fork.

Taken in isolation, these seem to run from least problematic to most problematic.

  • The Google Play Store has always been an exclusive Google app; it seems that Google ought to be able to distribute it exclusively as part of a bundle if it so chooses.
  • Pinning all revenue from Google Search to exclusivity on all devices quite obviously makes it very difficult for alternative search services to build share (as they lack access to pre-installs, one of the most effective channels for customer acquisition); this seems to be more of a Google Search dominance issue than an Android dominance issue though.
  • Predicating the availability of any of Google’s apps, including the Google Play Store, on OEMs not taking advantage of the open source nature of Android on devices that will not include Google apps seems much more problematic than Google insisting its apps be distributed in a bundle. The latter is Google’s prerogative; the former is dictating OEM actions just because Google can.

This is where the history of Android matters; before Google Play Services, the primary challenge in building a competitive fork of Android would have been convincing developers to upload their apps to a new app store (since Google would obviously not want to put its apps, including the Play Store, on said fork). That fork, though, never materialized because of Google’s contractual terms barring OEMs from selling any devices built on such a fork.

Today the situation is very different: that contractual limitation could go away tomorrow (or, more accurately, in 90 days), and it wouldn’t really matter because, as I explained above, many apps are no longer Android apps but are rather Google Play apps. To run on an Android fork is by no means impossible, but most would require more rework than simply uploading to a new App Store.

In short, in my estimation the real antitrust issue is Google contractually foreclosing OEMs from selling devices with non-Google versions of Android; the only way to undo that harm in 2018, though, would be to make Google Play Services available to any Android fork.

The Commission’s Remedies

To be sure, that’s not exactly what the European Commission ordered (in fact, “Google Play Services” does not appear a single time in the press release); the Commission seems to feel that the three issues do stand alone. That means that Google has to respond to each individually:

  • Google has to untie the Play Store from Search and the Chrome browser
  • Google has already stopped paying OEMs for portfolio-wide search exclusivity
  • Google can no longer stop OEMs from selling devices with Android forks

The most momentous by far is the first (despite the fact it is the weakest allegation, in my estimation). Samsung, or any other OEM, could in 90 days sell a device with Bing search only and the Google Play Store (where of course Google Search could be downloaded). This will likely accrue to consumers’ benefit: Microsoft, Google, and other providers will soon be bidding to be the default search option, and, given the commoditized nature of Android devices, it is likely that most of what they are willing to pay will go towards lower prices.

Still, it is an unsatisfying remedy: Google built Android for the express purpose of monetizing search, and to be denied that by regulatory edict feels off; Google, though, bears a lot of the blame for going too far with its contracts.

More broadly, the European Commission continues to be a bit too cavalier about denying companies — well, Google, mostly — the right to monetize the products they spend billions of dollars at significant risk to develop; this was my chief objection to last year’s Google Shopping case. In this case I narrowly come down on the Commission’s side almost by accident: I think Google acted illegally by contractually foreclosing Android competitors at a time when it might have made a difference, but I am concerned that the Commission’s publicly released reasoning doesn’t seem to grasp exactly how Android has developed, the choices Google made, and why.

That noted, I highly doubt Google would do anything differently: when it comes to the company’s goals, Android could not be a bigger success — if anything, this ruling is evidence of just how successful the product was.

  1. The exact date of the acquisition is unknown [↩︎]
  2. For those wondering, then-Google CEO Eric Schmidt didn’t join Apple’s Board of Directors until August 2006 [↩︎]