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The Sports Linchpin

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

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

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

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

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

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

The Symbiosis of TV and Its Advertisers

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

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

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

The Sports Linchpin

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

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

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

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

Good and Bad News

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

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

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

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

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

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

Walmart and the Multichannel Trap

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

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

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

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

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

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

Walmart in the Middle

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

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

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

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

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

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

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

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

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

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

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

The Multichannel Trap

The problems with Walmart’s original approach were threefold:

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

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

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

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

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

Amazon’s Inevitability

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

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

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

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

  1. In addition to building their own []

The Audacity of Copying Well

One of the more eye-rolling sentiments in tech — thankfully fading — is that every rectangular device with a touchscreen is a rip-off of the iPhone. Well duh! How else would you make a phone post 2007?

That’s why I’ve always had more respect for Samsung than most; I wrote in 2013 in an article called Shameless Samsung:

Every pre-iPhone phone maker is irrelevant, if they even exist, except for Samsung, who is thriving.1 Samsung the copycat was smart enough to realize they needed to change, and quickly, and so they did.

Or maybe it wasn’t being smart. Maybe it was simply not caring what anyone else thought about them, their strategy, or their inspiration. Most successful companies, including Apple, including Google, seem remarkably capable of ignoring the naysayers and simply doing what is right for their company. In the case of smartphones, why wouldn’t you copy the iPhone? Nokia refused and look where that got them!

To be sure, the physical constraints of hardware lead much more quickly to one ideal solution; the infinite malleability of software seems to give a much more expansive canvas for doing something original. And yet, even if it is possible to build just about anything, the ultimate constraint is the attention of the end user: what do they actually want to do, and does your product help them do it?

Instagram’s Complementarity

Snapchat is hardly the first threat Facebook has faced. While the social network got its start by digitizing offline relationships, implicitly encouraging its users to take care to post the best representation of themselves, usage of the service was fueled by photo sharing. And so, when a new social network built entirely around photo sharing started to explode in popularity, Facebook snapped up Instagram for a mere $1 billion.

Instagram has always been a very different product from Facebook: it is photos only, there are no links or text updates (other than textshots), and while the service has added direct messaging and videos, its primary use case of beautiful images and stylized selfies has been largely complementary to Facebook’s albums and status updates.

Still, while the sort of content shared on Instagram has always been a bit different than that shared on Facebook, the job it does for the user is similar in one crucial regard: Instagram is an opportunity to put forward the best representation of yourself, complete with a feedback loop driven by likes.

The Snapchat Threat

What makes the Snapchat threat to Facebook unique is that it does a fundamentally different job: by starting with ephemerality Snapchat gave its users, initially teens eternally eager to escape adults’ prying eyes, permission to be themselves. And so while Snapchat has photos and videos and messaging — just like Facebook and Instagram — it is not complementary but orthogonal.

In a vacuum this is fine: by virtue of doing a different job Snapchat is not really a threat to Facebook’s (or Instagram’s) core use case or primary value proposition, which is owning identity. Advertising-based consumer products don’t live in a vacuum though, because attention is a zero-sum game: as Snapchat gobbles up more and more attention Facebook’s addressable market for advertising is by definition shrinking.

Small wonder Facebook in 2012 released a clone called Poke soon after Snapchat showed initial traction after its 2011 release. Poke was a separate app that let you send expiring text, photo, or video messages to people in your Facebook network, and predictably it failed: the most important feature of any social network app is how many of your friends are using it, and no one used Poke.

A year later Facebook founder and CEO Mark Zuckerberg did what he should have done instead of releasing Poke, offering $3 billion to buy Snapchat outright, but it was already too late: Snapchat founder and CEO Evan Spiegel, perhaps emboldened by the then-widespread realization that Instagram had sold too early, turned the offer down, leaving Facebook to try its hand at Slingshot, another Snapchat clone; that failed too.

Meanwhile, Snapchat was laddering up: just before Facebook’s offer the network added Stories, adding the ability to broadcast (still ephemeral) collections of photos and videos to its core messaging product. It was and remains a killer concept: television for mobile in which users are the star of their own show, and the lack of an explicit “like” feedback loop was a feature, not a bug. Post whatever you like, don’t worry if anyone else agrees, and besides, it will all disappear tomorrow.

Instagram Stories

Yesterday Facebook took their third swing at Snapchat; from the New York Times:

On Tuesday, Instagram introduced Instagram Stories, which lets people share photos and videos that have a life span of no more than 24 hours with friends who follow them. The service bears a striking resemblance — some might say it is a carbon copy — to Snapchat Stories, a photo- and video-sharing format where the stories also disappear after no more than 24 hours.

The similarities go beyond ephemerality: Instagram Stories are most easily accessed by a swipe, you can decorate your snaps with text or drawings, and it’s almost certainly only a matter of time before the technology from Facebook’s recent purchase MSQRD is incorporated to add filters. Instagram Stories are absolutely a rip-off — and that’s the first big reason they might succeed where Facebook’s other Snapchat competitors have failed.

Copying Done Right

The first mistake most incumbents make when building new products in response to threatening new competitors is to attempt to win on features. To return to the phone example, Nokia and Microsoft tried to build something distinctly different from the iPhone, with a completely different user interface, features like Live Tiles, and various content hubs. The effort earned plenty of plaudits from the press and pundits eager for something new, but in practice made it far more difficult to secure the apps that actually mattered for becoming a viable platform.

A more pertinent example for this article is Google+. When Google launched their Facebook competitor in 2011 they touted features like Circles to organize your friends, Sparks to find content to share, and Hangouts to video chat. These made Google+ “better” and “differentiated”, which is another way of saying more complicated; meanwhile the most important feature — your friends — was nowhere to be found.

The problem with focusing on features as a means of differentiation is that nothing happens in a vacuum: category-defining products by definition get a lot of the user experience right from the beginning, and the parts that aren’t perfect — like Facebook’s sharing settings or the iPhone’s icon-based UI — become the standard anyways simply because everyone gets used to them.

So good for Instagram: Snapchat’s Stories is a great product that has already gone through years of iterations; why, but for pride, would you build something different?

Still, cloning isn’t enough. The fact features don’t offer useful differentiation does not remove the need for differentiation: the key is figuring out what else can be leveraged. Google, for example, may have largely copied the iPhone’s UI, but the key to Android’s success was the search company’s ability to leverage their advertising-based business model to offer it for free. On the hardware side Samsung leveraged their manufacturing might and long-established distribution channels to dominate the otherwise undifferentiated Android market, at least for a time. And, in perhaps the most famous example of this strategy, Microsoft embraced web standards with Internet Explorer, extended their browser’s capabilities with features like ActiveX, eventually extinguishing the threat when Netscape couldn’t keep up.

Leveraging Instagram

This is why it is so fascinating that Facebook is leveraging Instagram in this way. For all of Snapchat’s explosive growth, Instagram is still more than double the size,2 with far more penetration across multiple demographics and international users. Rather than launch a “Stories” app without the network that is the most fundamental feature of any app built on sharing, 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,3 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.

To that end, kudos to Instagram CEO Kevin Systrom for not only explicitly admitting to TechCrunch that Instagram is copying Snapchat, but also being clear about exactly what he and Zuckerberg are trying to accomplish:

You can’t just recreate another product. But you can say ‘what’s really awesome about a format? And does it apply to our network?’

[…]

You have a completely different audience. If you’re a business, if you’re a celebrity, if you’re an interest-based account, you can have a giant audience. It’s going to feel very different. I don’t believe these two things are substitutes, and that’s okay.

That right there is the tell: 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.

It’s not certain Facebook and Instagram will succeed, and the risk is significant: the only thing harder than rewiring users’ expectations for a massively successful product is ensuring said rewiring doesn’t turn them off from the app entirely, destroying the very value you are trying to leverage (and, frankly, it may be too late).

You can see this tension in yesterday’s update: while Instagram Stories demonstrates the company’s excellent engineering and attention to detail, the overall experience is of two completely separate apps combined into one. To take just one example, a photo taken from Instagram’s photo tab can’t be added to a story (although a photo from your story can be added to your Instagram feed4).

That may be intentional: remember, the entire point of Stories is to deliver the exact opposite experience as your Instagram feed — ephemerality and authenticity, not permanence and perfection — but even that justification elucidates how difficult the task will be. If you want something different, why not use a different app?

Oh right, because of your friends. They’re already on Instagram, and that fact isn’t so easily copied.

  1. I had already noted that Samsung would soon face challenges due to the lack of software differentiation entailed in depending on Android []
  2. This originally said five times, which according to this Bloomberg article is out of date []
  3. I do think Instagram erred by not including MSQRD filters from the start, even if it meant a slight delay in launch; they, like Snapchat’s filters, are simply fun []
  4. This originally mistakenly said the opposite []

Dollar Shave Club and The Disruption of Everything

Probably the most important fact when it comes to analyzing Unilever’s purchase of Dollar Shave Club is the $1 billion price: in the world of consumer packaged goods (CPG) it is shockingly low. After all, only eleven years ago Procter & Gamble (P&G) bought Gillette, the market leader in shaving,1 for a staggering $57 billion.

To be sure Gillette is still dominant — the brand controls 70 percent of the global blades and razors market — but there is little question that Dollar Shave Club is a much better deal, in every sense of the word. Understanding why Dollar Shave Club was cheap means understanding why its blades are cheap, and understanding that means understanding just how precarious the position of P&G specifically and incumbents generally are in the emerging Internet economy.

The P&G Formula

No great company — and P&G is one of the greatest of all time — is built on only one competitive advantage. Rather, the seemingly unassailable profits and ceaseless growth enjoyed by P&G throughout its history — amazingly, the company basically doubled its revenue every decade from 1950 to 2010 — was driven through multiple interlocking advantages that created a whole even greater than the sum of its impressive parts.

  • Research and Development: P&G has long lived by the maxim articulated by former CEO Bob McDonald: “Promotions may win quarters, innovation wins decades.” To that end P&G has always outspent the competition when it comes to R&D: $2 billion in 2014, double Unilever, their next closest competitor, and the company employs over 1,000 Ph.D.’s and a host of ethnographic researchers. This has allowed P&G to consistently come up with new products and brand extensions and charge a premium for them.
  • Branding and Advertising: As inspiring as that McDonald quote may be, P&G also dominates advertising: in 2014 the company spent $10.1 billion in global advertising, 37% more than second-place Unilever. This is hardly a new trend: the company invented soap operas in 1933 to help hawk the cleaning products it was built on, and invented the idea of a brand manager who had a holistic view of products from research to creation to advertising to distribution.
  • Distribution and Retail: P&G’s huge collection of brands and products not only gave the company massive scale efficiencies in manufacturing, but more importantly led to a dominant position in retail. P&G built strong relationships with retailers that let them dominate finite shelf space, the scarcest resource for an industry producing relatively bulky inexpensive products.

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

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

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

The Gillette Distillation

Small wonder the company was willing to pay a fortune for Gillette; “More blades for more money” was perhaps the purest distillation of P&G’s growth strategy, and Gillette opened the door to the men’s market that P&G had to that point largely ignored.

To be sure, that distillation was easy-to-mock; in 2004 The Onion famously wrote an article entitled Fuck Everything, We’re Doing Five Blades:

The market? Listen, we make the market. All we have to do is put her out there with a little jingle. It’s as easy as, “Hey, shaving with anything less than five blades is like scraping your beard off with a dull hatchet.” Or “You’ll be so smooth, I could snort lines off of your chin.” Try “Your neck is going to be so friggin’ soft, someone’s gonna walk up and tie a goddamn Cub Scout kerchief under it.”

I know what you’re thinking now: What’ll people say? Mew mew mew. Oh, no, what will people say?! Grow the fuck up. When you’re on top, people talk. That’s the price you pay for being on top. Which Gillette is, always has been, and forever shall be, Amen, five blades, sweet Jesus in heaven.

That’s exactly what had happened with the Mach 3, Gillette’s previous top-of-the-line model: Gillette increased blade and razor revenue by nearly 50% with basically no change in underlying demand, easily making back the $750 million it cost to research and develop the razor, simply through its ability to charge a premium for new technology, create awareness and demand through advertising, and capture consumers through retail shelf dominance.

Surprisingly, though, when the Onion’s satire became reality — Gillette launched the five blade Fusion with a 40% price premium in 2006, after being acquired — sales were slower than expected: many customers decided that three blades were good enough. Still, things weren’t that bad for Gillette and P&G: customers just kept buying the Mach 3. No business model worth $57 billion falls apart just because one component hits a soft spot!

The Dollar Shave Club Disruption

There was another product launch in 2006 that I’m sure no one at P&G even noticed: Amazon Web Services. Even if they did notice, I doubt the executives focused on the Fusion launch appreciated that P&G’s seemingly unassailable advantages were on the verge of declining precipitously.

AWS made it easy and cheap to start an online company; YouTube, launched a year earlier, made it cheap and easy to share video; Facebook, launched in 2004, made it possible to spread said video to millions of people. All three came together with the 2011 founding of Dollar Shave Club and its 2012 launch with one of the best introductory videos of all time:

Do watch if you haven’t — it’s really that good — but also look carefully at exactly what founder Michael Dubin is saying:

I’m Mike, founder of DollarShaveClub.com. What is DollarShaveClub.com? Well, for a dollar a month we send high quality razors right to your door. Yeah! A dollar! Are the blades any good? No, our blades are fucking great.

Gillette’s model and P&G’s formula generally cost a lot of money: R&D cost money, TV advertising cost money, and wholesalers and retailers had to earn a margin as well, and that’s before P&G realized the return on their investment. The result was that cartridges that cost less than a quarter to manufacture and package were sold for $4 or more. That worked as long as P&G’s other advantages in technical superiority, advertising, and distribution held, but were they ever to falter, it was eminently viable to sell cartridges for less and still make a healthy margin.

Each razor has stainless steel blades and [an] aloe vera lubricating strip and a pivot head so gentle a toddler could use it. And do you like spending $20/month on brand name razors? $19 go to Roger Federer! I’m good at tennis. And do you think your razor needs a vibrating handle, a flashlight, a back-scratcher, and ten blades? Your handsome-ass grandfather had one blade AND polio. Looking good Pop-pop!

This is a direct attack on Gillette having over-served the shaving market: P&G’s first advantage, their willingness to spend money on research and development, was neutralized because razors were already good enough.

Stop paying for shave tech you don’t need. And stop forgetting to buy your blades every month. Alejandra and I are going to ship them right to you…

AWS and Amazon itself, having both normalized e-commerce amongst consumers and incentivized the creation of fulfillment networks, made the creation of standalone e-commerce companies more viable than ever before. This meant that Dollar Shave Club, hosted on AWS servers, could neutralize P&G’s distribution advantage: on the Internet, shelf space is unlimited. More than that, an e-commerce model meant that Dollar Shave Club could not only be cheaper but also better: having your blades shipped to you automatically was a big advantage over going to the store.

That left advertising, and this is why this video is so seminal: for basically no money Dollar Shave Club reached 20 million people. Some number of those people became customers, and through responsive customer service and an ongoing focus on social media marketing, Dollar Shave Club created an army of brand ambassadors who did for free what P&G had to pay billions for on TV: tell people that their razors were worth buying for a whole lot less money than Gillette was charging.

The net result is that thanks to the Internet every P&G advantage, save inertia, was neutralized, leading to Dollar Shave Club capturing 15% of U.S. cartridge share last year.

Value Destruction

Note that metric: cartridge share. According to the traditional way of measuring marketshare Dollar Shave Club only has 5% of the U.S.; the discrepancy is due to the massive price difference between Dollar Shave Club and Gillette. And yet, the price difference is the entire point: in a world with good enough products (Dollar Shave Club imports their blades from Korean manufacture Dorco) that can be bought on zero marginal cost websites and shipped to your home directly there is no reason to charge more.

The implications of this go far beyond P&G: fewer Gillette razors also mean less TV advertising and no margin to be made for retailers, who themselves are big advertisers; this is why I argued last month that the entire TV edifice is not only threatened by services like Netflix, but also the disruption of its advertisers, of which P&G is chief.

More broadly, while razors with their huge gross margins and high replacement rate were a particularly good match for the Dollar Shave Club subscription model,2 I suspect this sort of disruption will not be a one-off: the Internet (and e-commerce) has so profoundly changed the economics of business that it is only a matter of time before other product categories are impacted, with all the second order effects that entails.

Perhaps the biggest of these second order effects is on value, and that’s where I come back to this purchase price: the tech community is celebrating the massive return for Dollar Shave Club’s investors, but $1 billion for a 16% unit share of a market dominated by a brand that cost $57 billion is startlingly small. Indeed, that’s why buying Dollar Shave Club was never an option for P&G: even if their model is superior P&G’s shareholders would never permit the abandonment of what made the company so successful for so long; a company so intently focused on growing revenue is incapable of slicing one of their most profitable lines by half or more.

For their part, Unilever is fortunate they don’t have a shaving business to protect, because being an incumbent is going to increasingly be the worst place to be. Dollar Shave Club’s motto may be “Shave Money Shave Time,” but just how many shareholders and policy makers are prepared for the shaving of value that this acquisition suggests is coming sooner rather than later?

  1. Schick is the other major CPG brand; I won’t mention them again although they face the same issues as Gillette []
  2. I’ll write more about why Dollar Shaving Club wasn’t eaten by Amazon like so many other e-commerce companies in tomorrow’s Daily Update []

A Technical Glitch

One week ago, moments after her boyfriend Philando Castile was shot by a police officer during a routine traffic stop, Diamond Reynolds flipped on Facebook’s live streaming feature. The resultant video, with Reynolds documenting what had happened, as well as her interaction with the police officer, immediately started to spread like wildfire.

And then it was gone.

Approximately an hour later, the video was back, this time with a “Warning — Graphic Video” label attached:

Screen Shot 2016-07-13 at 4.17.47 AM

When asked why the video had temporarily disappeared, Facebook simply said “It was down to a technical glitch.” The company had no further comment on the matter.

Facebook Versus Journalism

One needn’t travel far on the Internet to find a think piece bemoaning how Facebook has destroyed journalism, with a whiff of nostalgia for a time when The New York Times decided what news was fit to print and Walter Cronkite declared nightly “That’s the way it is.” It’s a viewpoint that is problematic in two regards.

First, the destruction of journalism is about the destruction of journalism’s business model, which was predicated on scarcity. In the case of newspapers, printing presses, delivery trucks, and a healthy subscriber base made them the lowest common denominator when it came to advertising, right down to four line classified ads that represented some of the most expensive copy on a per-letter basis in the world.

TV news, meanwhile, in large part existed to fulfill broadcaster obligations under the Fairness Doctrine, which required licensors of publicly-owned radio frequencies to devote airtime to matters of public interest, and to air opposing views of those matters. The Fairness Doctrine was revoked in 1987, for reasons that were the canary in the coal mine for news’ business model. The New York Times reported at the time:

In explaining the conclusion that its fairness rules were “no longer necessary to achieve diversity of viewpoint,” Ms. Killory, the commission’s counsel, noted the major growth of broadcast outlets in recent years.

There are now more than 1,300 television stations and more than 10,000 radio stations in the United States — in contrast to 1,700 daily newspapers — and 95 percent of viewers receive five or more television signals. Radio listeners in the biggest 25 markets receive an average of 59 radio stations.

Two decades later the average American home received 189 TV channels, and thanks to the Internet, an effectively infinite number of news websites. Scarcity was gone, and the publishing bubble is popping as a result. That Facebook has been the most effective service in collecting and funneling attention to the abundance of news on the Internet is a separate story.

More importantly, the nostalgia for a world of journalistic gatekeepers is nostalgia for a world where the death of Philando Castile would be little more than a one paragraph snippet in the Minneapolis Star Tribune that would have sounded a lot like the initial police report that dryly noted “shots were fired”, and that would have been that.

Crucially, though, it’s not that, thanks to Facebook. On the conservative site Daily Caller Matt Lewis wrote:

In the era of Facebook Live and smart phones, it’s hard to come to any conclusion other than the fact that police brutality toward African-Americans is a pervasive problem that has been going on for generations. Seriously, absent video proof, how many innocent African-Americans have been beaten or killed over the last hundred years by the police—with little or no media coverage or scrutiny?

Those old business models were great for journalists; they weren’t so great for those not deemed worth covering. Those nostalgic for the “good old days” are likely wishing for far more problems than they realize.

Launching Facebook Live

On April 6, the day that Facebook Live launched for everyone, BuzzFeed ran a feature that included an interview with Facebook CEO Mark Zuckerberg:

“Because it’s live, there is no way it can be curated,” [Zuckerberg] said. “And because of that it frees people up to be themselves. It’s live; it can’t possibly be perfectly planned out ahead of time. Somewhat counterintuitively, it’s a great medium for sharing raw and visceral content.”

A week later, during the opening keynote of Facebook’s F8 developer conference, Zuckerberg enthused:

Just the other week I saw a live video of a woman and her kids skiing down a hill. It was just mesmerizing! I watched it for a few minutes because I was like ‘I just want to make sure these kids get down this hill.’ There’s usually people who are playing music or dancing in there, but every once in a while there’s something that is really important and special happening. Like a couple of days ago a woman named Lena commented on one of my posts to tell me that when her mother was sick in the hospital she streamed her wedding on live so her mother and her friends across the country could not only see it but could be there with them. Now that’s pretty meaningful.

Raw, visceral, meaningful. That’s a pretty good way of describing Reynolds’ video. Newsworthy is another, and that’s where things get a whole lot more complicated for Facebook.

Facebook the Journalism Company

I noted above that Facebook is not necessarily to blame for the destruction of journalism’s business model, but with live video the social network has moved from feasting on what remains of publishing to becoming a journalistic company in their own right: Facebook’s 1.6 billion users have been deputized to not only chronicle their ski trips and weddings but also killings by police and, a day later, the killings of police.

In retrospect, given this reality, what is so striking about the aforementioned BuzzFeed feature and all of Facebook’s public comments about live video is how little thought seems to have been given to this use case. There is talk about recruiting engineers (150 in a week), all of the features that had to be built, the huge technical problems involved, and of course the potential payoff for Facebook:

Live solves a lot of problems for Facebook. It gives people an easy way to create video content that doesn’t require scripting or much production. Which in turn creates more content for Facebook. Live also helps the company tap into real-time events, an area where it’s struggled compared to Twitter…

One recent trend in social media has been a move away from highly produced content, particularly video…This is precisely what Snapchat is so good at, and why it has become such a threat to Facebook. And it’s clearly something that’s been on Zuckerberg’s mind as well.

“People look at live video and they think this is a lot of pressure because it’s live; it takes a lot of courage to go live and put yourself out there. But what we’re finding is the opposite,” Zuckerberg said in a phone interview the day before the Live relaunch. “A lot of the biggest innovations have been things that take some of the pressure out of posting a photo or video.”

I wrote after this year’s F8 about how Facebook from the very beginning had always been about projecting your best self online; given that, I wondered if the focus on Live Video might ultimately prove to be a distraction from what Facebook was good at (owning identity online). This last week is validating that concern in a far more profound way than I appreciated.

The risk is this: Facebook’s control over what the vast majority of people see online — news included — is overwhelming. Before the advent of Live Video, though, Facebook could more easily claim to be a neutral provider, simply serving up 3rd-party stories via an allegedly objective algorithm that was ultimately directed by the user itself, and using that user direction to build the best identity repository in the world to sell ads against. And while the reality of Facebook’s News Feed is in fact not objective at all — algorithms are designed by people — actually creating the news will, I suspect, change the conversation about Facebook’s journalistic role in a way that the company may not like.

Facebook and the Fairness Doctrine

Back in 1949, when the Fairness Doctrine was established, the FCC wrote in a report entitled In the Matter of Editorializing by Broadcast Licensees:

We do not believe, however, that the licensee’s obligations to serve the public interest can be met merely through the adoption of a general policy of not refusing to broadcast opposing views where a demand is made of the station for broadcast time. If, as we believe to be the case, the public interest is best served in a democracy through the ability of the people to hear expositions of the various positions taken by responsible groups and individuals on particular topics and to choose between them, it is evident that broadcast licensees have an affirmative duty generally to encourage and implement the broadcast of all sides of controversial public issues over their facilities, over and beyond their obligation to make available on demand opportunities for the expression of opposing views. It is clear that any approximation of fairness in the presentation of any controversy will be difficult if not impossible of achievement unless the licensee plays a conscious and positive role in bringing about balanced presentation of the opposing viewpoints.

Facebook is not a broadcaster: they don’t depend on a government-granted monopoly over radio frequencies that comes with strings attached. And frankly, even were I inclined to agree that the end of the Fairness Doctrine contributed in some way to the United States’ increased polarization, the clear free speech issues inherent in its application, combined with the explosion in media outlets, lead me to believe the FCC was right to revoke it.

That said, Facebook’s influence over what most people see quite clearly rivals that of television broadcasters circa 1949, and the vast majority of jurisdictions in which Facebook operates have much less absolute free speech laws than the United States. The more that Facebook is perceived as a media entity, not simply a neutral platform, the more likely it is that the company will face calls for regulation of the News Feed in particular, in language that will likely sound a lot like the Fairness Doctrine.

Facebook and Transparency

Two weeks ago Facebook took an important step in dealing with the increased scrutiny it will inevitably face, posting a document detailing “News Feed Values”. For the first time Facebook offered a hint of transparency about how its algorithm works, making clear that “friends and family come first”, but also that “your feed should inform” and “your feed should entertain.”

To be sure the document does nothing to address the question of providing both sides of an issue; quite the opposite, in fact. The document states:

We are not in the business of picking which issues the world should read about. We are in the business of connecting people and ideas — and matching people with the stories they find most meaningful. Our integrity depends on being inclusive of all perspectives and view points, and using ranking to connect people with the stories and sources they find the most meaningful and engaging.

We don’t favor specific kinds of sources — or ideas. Our aim is to deliver the types of stories we’ve gotten feedback that an individual person most wants to see. We do this not only because we believe it’s the right thing but also because it’s good for our business. When people see content they are interested in, they are more likely to spend time on News Feed and enjoy their experience.

You may think this is problematic for society (as I do), but at least Facebook is being honest about it; transparency is the company’s best tool to remain free of regulation.

It’s also why the “technical glitch” was so disappointing. The reasons why Reynolds’ video was taken down are probably innocuous — I suspect the video was flagged for graphic content by a Facebook user and removed by a contracted content reviewer (like these in the Philippines), and then restored by someone at Facebook headquarters — and the company is probably both embarrassed that it happened and shy about revealing the degree to which it farms out content review. The most powerful journalistic entity in the world, though, doesn’t get the luxury of sweeping such significant editorial decisions under the rug: that rug will be pulled back at some point, and it would be far better for society and for Facebook were they to do so themselves.

One thing is for sure: this won’t be the last time something truly raw, visceral, and meaningful happens on Facebook Live. Zuckerberg has gotten his wish, even if the implications will ultimately be more than he bargained for: all of the eyes on those live videos will only increase the number of eyes on Facebook itself. It’s a classic case of unintended consequences: Facebook’s attempt to capture Snapchat’s private gestalt has only solidified its position as a public platform with the added component of a newsmaker in its own right, and while that carries clear benefits for society, society will expect more transparency from Facebook, willingly delivered or not.

The Brexit Possibility

The TV upfronts that I wrote about last week may seem like an odd entry point to discuss Brexit and its relationship to technology, but the core insight in that piece is critical. From my follow-up in The Daily Update:

While it is fine and useful to look at industries like TV or transportation or consumer packaged goods or retail in isolation, if you step back far enough all of these industries are interconnected and symbiotic. TV and our modern transportation system and big consumer packaged goods conglomerates and brick-and-mortar retail all came of age in the post World War II era, and all were built with the same assumptions like the importance of scale, controlling distribution, and crucially, that each other existed. There were positive feedback loops driving the growth of all of them together (and many other industries as well).

The implication of this symbiosis is that just as these different industries rose together, they will assuredly fall together as well, and indeed that is slowly but surely happening for all the reasons I detailed last week. For now, though, leave these particulars to the side; I’ll return to them later.

The key takeaway, and my starting point, is the realization that no single issue or company or industry or country stands alone: everything operates in systems, and both influences and is influenced by the system within which it operates. By extension, any change to one part of the system must impact and change other parts of the system: the greater the change, the greater the upheaval until the system can return to equilibrium. Sometimes, though, the change destroys the system completely.

The Old System

During the 20th century, particularly the post World War II era, the United States led the formation of a multinational system that balanced the government, large corporations, and labor.

stratechery Year One - 283

The U.S. focused its foreign policy on the interrelated goals of containing communism, preventing inter-European wars, and creating markets for the massive industries that had sprung up during World War II and now needed to accommodate millions of returning soldiers. In Europe the headlining effort was the Marshall Plan that combined aid used primarily to buy American-produced goods with an insistence on reducing trade barriers; the General Agreement on Tariffs and Trade came a year later. The Marshall Plan was administered by the Organisation for European Economic Co-operation, one of the first pan-European bodies that started the continent on the long road to the European Union (a road that was paved with U.S. government money1). This dual mission of peace through bureaucracy paid for with trade has endured.

For their part, increasingly massive corporations built out the U.S.’s military power, manufactured most of the industrial and agricultural equipment on which Marshall Plan money was spent, and produced all of the accoutrements of a booming middle class: said middle class worked at those massive corporations, building everything from tanks to cars to washing machines, and spending their money on the same.

The implicit deal was this: the government created markets for the corporations, who in turn provided not just employment but also security for their employees, funding health insurance and pensions, while employees (and corporations) paid for the government: in 1960 the lowest income bracket paid 20%, while the highest paid 90%, and the corporate tax rate was 52%. Europe followed a similar model, but spared of the burden of a huge military, nationalized most social security programs, especially health care but also pensions. And, for two decades, the systems were in equilibria.

How Globalization Upended the System

Globalization is by no means a recent phenomena: the idea of trading goods with other groups, so as to realize the benefits of comparative advantage2 dates back to the earliest recorded human civilizations in the third millennium B.C.E. More pertinent to this discussion, the combination of the industrial revolution (which supercharged the idea of specialization) and steamships massively increased trade in the 19th century, where the freedom of movement of goods was primarily guaranteed by colonialism: colonies supplied the raw materials and bought the finished goods, giving colonial powers massive trade surpluses that could be used to fight intermittent wars with each other.

This system was utterly destroyed by two World Wars, resulting in the U.S.-dominated system above; still, though, the flow of goods was similar: the U.S., the world’s new superpower, was a net exporter, even as Europe and Japan in particular built up their own industrial base first with U.S. funds, and then by selling goods both to the U.S. and to each other. The deal was intact.

Then, in the years leading up to the 1970s, three technological advances completely transformed the meaning of globalization:

  • In 1963 Boeing produced the 707-320B, the first jet airliner capable of non-stop service from the continental United States to Asia; in 1970 the 747 made this routine
  • In 1964 the first transpacific telephone cable between the United States and Japan was completed; over the next several years it would be extended throughout Asia
  • In 1968 ISO 668 standardized shipping containers, dramatically increasing the efficiency with which goods could be shipped over the ocean in particular

These three factors in combination, for the first time, enabled a new kind of trade. Instead of manufacturing products in the United States (or Europe or Japan or anywhere else) and trading them to other countries, multinational corporations could invert themselves: design products in their home markets, then communicate those designs to factories in other countries, and ship finished products back to their domestic market. And, thanks to the dramatically lower wages in Asia (supercharged by China’s opening in 1978), it was immensely profitable to do just that.

It is difficult to overstate the positive impact of this particular period of globalization. Billions of people were lifted out of abject poverty, especially in China but also throughout Asia, and the United States and other western countries became significantly richer as well; trade is absolutely a win-win. Critically, though, while everyone benefited from cheaper goods, the profits were not shared equally: the managers of multinational corporations and their owners reaped the vast majority of the benefits, even as their employee base effectively shifted from their domestic markets to Asia.

This undid the post-World War II deal: middle class jobs began to disappear, and along with them the economic and social security that had been provided by corporations. It took time, to be sure, but the ascension of China to the WTO in 2001 dramatically accelerated this shift, and while its full effects were hidden by a massive expansion in credit fueled by a housing bubble, once that came crashing down in 2008 the former middle classes of developed countries came to realize just how deep was the hole they fell into.

The Inevitable Fallout

Remember, everything is a system. And, given the changes wrought by the post 1970s wave of globalization, it is foolish to think that a core component of society — labor — can be fundamentally changed without there being knock-on effects on the other components of that system. The first murmurs were the 2009 rise of the Tea Party on the right, and the 2011 Occupy Wall Street movement on the left. While the participants of the two groups couldn’t be more different — indeed, they loathe each other — both were outraged at “the System”.

Both movements have flowered this election cycle, both in the United States and the United Kingdom: an old-school leftist was elected the leader of the U.K.’s Labour Party, and another nearly nominated by the Democratic Party. On the right the Republican Party has nominated Donald Trump, aided in no small part by the dramatic weakening of media institutions, while the U.K., in a campaign led by Conservative Party insurgents and the far-right U.K. Independence party, has just voted to leave the European Union with the support of many traditional Labour voters. In both cases there is a new cleavage: less right versus left, and more elites who have benefited from globalization and a middle class that has been left behind.

Again, there are clear differences between the left and right: the former sees Wall Street or The City as the villain, while the latter blames immigration. Both, though, in their own way, want a return to the old deal: honest work for an honest wage, and an increasing sense of having nothing-to-lose until it happens.3

Tech and A New System

A return to the old deal won’t happen, of course, nor should we want it to: the last thirty years have made both the world generally and developed countries in particular richer than ever. What is needed, though, is a new system, and here the tech industry has a critical role to play.

While the first twenty years of the modern tech industry (starting with the personal computer) primarily benefited corporations, the last fifteen years have dramatically improved the quality of life for consumers. The defining quality of technology, particular Internet-based companies, has been the generation of massive amounts of consumer surplus. How much is it worth to have access to all of the world’s information in the palm of your hand, or to be connected with friends and family wherever they are, or to make new connections with people you have never met? Far, far more than however much one pays for a smartphone and a data plan.

That this largesse is financially viable for tech companies is a testament to their tremendous scale. While the old order was about multinationals, Google and Facebook and the rest are supranational: their addressable market is the world.4 Moreover, consumers’ benefit is incumbents’ pain: as I detailed above the new world order is slowly but surely drowning the old one. The question is just how transformative will that new world order be?

If the old system was defined by the government, big corporations, and labor, the new system should be about government, technology, and individuals. It looks something like this:

stratechery Year One - 284

Government

The first implication of the supranational nature of technology is that unlike the old multinationals, there is no need for government support to open markets and guarantee trade; for the most part, the less government involvement the greater maximization there will be of the consumer surplus that is already being generated. Rather, it is the government that ought take a much more active role in supporting individuals.

At the most basic level this should include security: while universal health care would be ideal, for lots of reasons both practical and political it may not be viable in the U.S. Given that, Obamacare is a huge step in the right direction; other developed countries like the U.K. are obviously well ahead here.

Second, instead of trying to recreate a 1950s fantasy of employment for life on an assembly line, the goal should be to create a far more dynamic labor market with a defined floor and significantly greater upside than the old system:

  • First, a universal basic income, facilitated by the government, should be set at the lower bounds of what is necessary to escape poverty. Globalization may have been the first shoe to fall on the middle class, but automation is the other, and it will affect just as many jobs as manufacturing, including — especially — white collar ones
  • Second, the government should be loosening regulations on the “gig” economy: technology has dramatically increased the degree to which work can be segmented, and that’s a good thing. Moreover, these sorts of jobs provide the upside to a universal basic income’s floor: our goal should be to make it vastly easier for individuals to better themselves if they choose to do so (while the basic income provide protection against the gig economy’s inherent uncertainty)
  • Third, there should be a significant loosening of the regulations and taxation around business creation. One of the many benefits of technology and the Internet has been to make all kinds of new businesses far more viable than ever before, but it is far too hard to get started, and the bookkeeping requirements are far too onerous. This sort of loosening, combined with the reduction in risk resulting from a better safety net and basic income, plus the possibility of building working capital through gigs, could lead to an explosion in creativity and entrepreneurial activity

Each of these factors is critical: a universal basic income alone offers some degree of financial security, but it does not offer dignity to the recipient, or any return for society beyond a reduction in guilt. What is most important, and what offers the highest return, is enabling more and better ways to work and ultimately create: that requires fewer regulations and simpler taxation.

Individuals

I purposely changed the name of this part of the system from “labor” to “individuals”. While collective action was absolutely appropriate in a world where employment was dominated by massive corporations, collectiveness and the work it was appropriate for has its costs: a ceiling on the individual, both in terms of income and also creativity.

What makes today’s world so different than the 1950s are the means with which ambition and creativity can be realized. I can write a newsletter without owning a printing press; someone else can create jewelry without a physical storefront; another can make music without a recording studio, and distribute it without a record label. Those are the easy examples — who knows what sorts of products and services might result from an emboldened and secure middle class?

Young people in particular should relish this new world of opportunities: yes, the world of your parents is gone, but it does not automatically follow that the alternative is worse. Even with today’s mess there are far more entrepreneurial opportunities than ever before, and the younger one is the more one can accept the unnecessary risks that unfortunately still exist. And, on the flipside, opportunities predicated on the old system are themselves riskier than they have ever been.

Tech

It’s understandable why so many in tech are dismissive of the old order: beyond the consumer surplus being generated, and the systematic destruction of incumbents, the industry is increasingly the primary economic driver of the United States in particular, which offers a certain sense of invincibility. It would be against the self-interest of both consumers and politicians to hold tech back.

And yet, there is an aspect of that calculation not far removed from measuring computers based on speeds and feeds. Yes, any rational calculation about the impact of the tech industry shows how indispensable it is, but people are not always rational, especially when they are desperate. It is absolutely in the industry’s best interests to not only participate in but lead the creation of a new system that works to the benefit of all.

To that end, technology executives and venture capitalists should lead the campaign for the type of reforms I have listed above. More importantly, they should match their rhetoric with actions: companies like Apple and Google should strive to be technology leaders, not tax avoidance ones. Successful entrepreneurs and their investors should champion increased capital gains taxes with a bias towards much longer-term investment: this both encourages the long view even as it accounts for the massive return that comes to investors and shareholders in a winner-take-all world. VCs in particular should be willing to close the carried interest loophole, and everyone in the industry should be willing to shoulder higher tax rates.

The payoff is equilibrium: the chance to build fabulously successful businesses that go with the current, not against it. The alternative is far worse: once automation arrives, guess who is going to be the scapegoat?

Brexit: Wrong Reasons, Right Results?

To be clear, this is a package deal: higher tax rates to fuel a misguided attempt to recreate the 1950s would be just as much of a disaster as undoing the old deal has been for the middle class. The world has changed.

Indeed, this is why I’m not quite prepared to join in the panic over Brexit, although I understand and acknowledge the very real downsides. I keep coming back to the fact that the European Union is a product of the old order — a world where government entities existed to enable trade for multinationals and rules for everyone else. Small wonder the EU has been the most hostile to the changes wrought by tech! There is no question that undoing 40+ years of integration will be extremely painful — if indeed the U.K. leaves the EU at all — but given that the old order has already been disrupted, how much is to be gained by continuing to pretend that nothing has changed? Alternatively, might there be potential in building something new?

To be sure, there is no evidence that Brexit was driven by a vision of a new world order; quite the opposite in fact. And, unlike many Brexit voters, I am mindful of the elite consensus about the problems with a withdrawal: trade still matters, and the loss of access to the European market, plus the internal side effects with regards to Scotland and Northern Ireland, are huge problems (and I can read a stock ticker!). But then again, the very definition of who is elite, and why, is as much a part of the system as anything else, and the fact there are so few voices even acknowledging the increased restrictiveness of the EU, or its complete lack of economic growth, much less grappling with why it is the EU came to be and how deeply entwined that is with the old system,5 is to my mind a missed opportunity to at least think about how things could be different.

Everything is connected, everything is a system — and a crisis is a terrible thing to waste.

  1. The CIA financed nearly all the various organizations and individuals pushing for political integration []
  2. Comparative advantage is the idea that collective productivity can be maximized if every person/group/country specializes in what they are best at, and then trade for what else they need, as opposed to every person/group/country being entirely self-sufficient. This is one of the most important factors underlying economic progress; to take a very fundamental example, few of us grow our own food, as it is more efficient for farmers to do that at scale. We, in turn, sell our specialization to others giving us the means to buy food. []
  3. Is there a racial component to the opposition to immigration? Almost certainly. But I suspect the ugly manifestations of whatever darkness lies in people’s hearts would be much less common in a thriving economy []
  4. Except China, thanks to the Great Firewall []
  5. Above and beyond a desire to keep the peace, which is deeply meaningful []