Jim Cramer, who coined the “FANG” acronym as a descriptor for the high-flying Facebook, Amazon, Netflix, and Google group of tech stocks that have dramatically outperformed the market, made clear yesterday that his endorsement wasn’t necessarily connected to the underlying companies:

A note on these stocks. I picked them largely because over the years they have become anointed by a group of go-go managers, meaning managers who like to be affiliated with the stocks of companies with the most momentum. I by no means have said “buy these stocks” because they represent great value. What I have been saying is that because of the scarcity of actual high-growth stocks these have become default names that managers naturally gravitate to.

It’s not an unreasonable position: the demand for growth in a low-interest-rate environment flooded with capital, plus a healthy dose of FOMO (Fear of Missing Out) has certainly played a role in the rise of unicorns; it makes sense that the same dynamics would play out in the stock market as well. It’s also a position that has had the good fortune of being right: in 2015 the FANG group accounted for more than the entire return of the S&P 500.¹

In fact, though, Cramer was more right than he apparently knows: the performance of the FANG group is entirely justified because of the underlying companies, or, to be more precise, because the underlying companies are following the exact same playbook. Sometimes the market does get it right.²

The State of FANG

Each of the FANG companies is in a similar position in their respective industries: they haven’t so much disrupted incumbents as they have subsumed them:

• Facebook: The late David Carr, who first broke the news about Facebook’s Instant Articles initiative back in 2014, worried that “media companies would essentially be serfs in a kingdom that Facebook owns.” However, as I noted in The Facebook Reckoning, publishers already are. Facebook’s status as the Internet’s home page means that publishers have no choice but to accommodate themselves to the social network, whether that be Instant Articles or an increased focus on video.

• Amazon: While the biggest driver of Amazon’s increased valuation has almost certainly been AWS, the e-commerce side of the business continues to grow like gangbusters as well, taking over half of every additional dollar spent by U.S. consumers online, and a quarter of all retail growth online or off. The vast majority of those sales are actually from 3rd-party merchants using Amazon as a discovery and fulfillment platform, but these merchants’ market power relative to Amazon is not unlike publishers relative to Facebook, because Amazon.com is where the buyers are.

  From a certain perspective this paradigm applies to AWS as well: the reason why AWS’s profitability increases along with growth is that Amazon achieves economies of scale, which is another way to say that AWS’s suppliers have no choice but to be squeezed in order to indirectly serve the customers they used to sell to directly

• Netflix: The Internet — and Netflix — made fun of an NBC executive who claimed that “The reports of our death have been greatly exaggerated.” Here’s the thing, though: he’s right, in part thanks to Netflix. According to this February 2015 list, 42 past and present NBC shows are streamable on Netflix, for which the latter is certainly paying a material amount. Indeed, perhaps the most fascinating aspect of Netflix’s meteoric rise is the fact that the same content producers who are ultimately threatened in the battle for attention are increasingly unable to stop themselves from selling their content to Netflix: the streaming company has too many customers adding to a pile of content money that is too big to ignore.

• Google: Google’s position is similar to Facebook’s: any business that wants to be discovered by potential customers has no choice but to follow the search company’s directives, whether that be cleaning up dubious SEO strategies, making their pages mobile-friendly, or soon, adopting Accelerated Mobile Pages. Every now and then someone, usually a set of publishers, tries to defy the search engine’s influence, only to come crawling back within weeks once traffic craters. The reality is that most people find most web pages through Google, which means Google calls the shots — and sells the most expensive advertising of all.

There is a clear pattern for all four companies: each controls, to varying degrees, the entry point for customers to the category in which they compete. This control of the customer entry point, by extension, gives each company power over the companies actually supplying what each company “sells”, whether that be content, goods, video, or life insurance.

How FANG Started

There are also striking similarities to how each FANG company started, particularly when it comes to the pre-existing resources each leveraged:

• Facebook: Facebook didn’t launch to the world: it launched to Harvard only. In other words, Facebook started with a preexisting network and, for all intents and purposes, a preexisting infrastructure (Harvard-provided Internet access).³ What Zuckerberg added was an entry point that provided a much more effective and enjoyable way to tap into and connect with that network.

• Amazon: Amazon’s roots were equally humble: the company sold only books and held no inventory; when an order was placed Amazon would order the book from pre-existing book distributors and then ship it on using pre-existing parcel shippers to the end user. What Jeff Bezos and team added was an entry point to a far more extensive selection of books than any offline bookstore could provide and lower prices to boot. Once you bought from Amazon, why would you buy anywhere else?

• Netflix: Netflix’s also began with pre-existing assets: off-the-shelf DVDs and the U.S. Postal Service, providing a benefit similar to Amazon’s — a wide selection and delivery to your doorstep. It took a year to figure out the subscription model, which meant lower prices for heavy users and less stress about things like late fees for everyone, and Netflix slowly became the gateway to entertainment for more and more customers.

• Google: Google didn’t create any of the pages accessible through its search engine, nor the means of accessing those pages (the browser). Rather, by basing its algorithm on the link (instead of content) it offered a dramatically more effective way to find exactly what you were looking for, making it the natural first stop for anyone looking for anything on the Internet.

None of the FANG companies created what most considered the most valuable pieces of their respective ecosystems; they simply made those pieces easier for consumers to access, so consumers increasingly discovered said pieces via the FANG home pages. And, given that Internet made distribution free, that meant the FANG companies were well on their way to having far more power and monetization potential than anyone realized.

FANG and Aggregation Theory

Last July I described the theoretical underpinning for this shift in power and monetization potential in Netflix and the Conservation of Attractive Profits. By owning the consumer entry point — the primary choke point — in each of their respective industries the FANG companies have been able to modularize and commoditize their suppliers, whether those be publishers, merchants and suppliers, content producers, or basically anyone who needs to be found on the Internet.

Over time, each of the FANG companies has leveraged their ownership of the customer relationship to expand their arena of control, whether that be by expanding their offerings like Amazon or integrating backwards into the previously valuable components of their ecosystem (Facebook owns their network completely, Netflix creates their own content, and Google increasingly monetizes by keeping people on Google properties). All of those moves, though, were predicated on owning the customer relationship.

Long-time readers know that I already summed up this phenomenon in Aggregation Theory, but in some respects I think my chosen name does this idea injustice: the word “theory” sounds abstract and disconnected from the real world, when in fact the elements of Aggregation Theory are not only very much real phenomena but also the connective tissue tying the FANG companies together.

Moreover, understanding where these companies started and how they grew fleshes out the advice I gave at the end of last week’s article Cars and the Future:

Startups looking to disrupt other decades or century old industries should take note: be patient, get your business model and core user base right, and wait for the fundamental changes wrought by the Internet and mobile to come to you.

Each of the FANG companies was technically innovative in their own way (especially Google, the exception that proves the rule), but each of them — like Uber, which that paragraph referenced — also depended to an incredible degree on products and infrastructure that already existed. The key to their now or future dominance was their proximity to customers, superior user experience, and new business models that simply weren’t possible before the Internet.

Note that none of these companies are “disruptors” in the Christensen sense. They are not offering low-margin good-enough products that appeal to customers who are over-served by incumbent companies. Rather, they are “aggregators” who start with the best customers and don’t really compete with incumbent companies, at least in the beginning. In fact, incumbents nearly universally benefit from the presence of aggregators, at least at first (publishers benefited from Facebook, merchants from Amazon, content makers from Netflix, web businesses of all types from Google). It is only when the aggregators’ consumer base becomes dominant that the inevitable squeeze on incumbents — specifically, on their profit margins — begins, and it is in the long-run irreversible.

That, Mr. Cramer, represents incredible value.

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1. I.e. without these four stocks the S&P 500 would have been significantly more than barely down for the year ↩

2. Actually, I think in the long run, it almost always does. As legendary investor Benjamin Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ↩

3. Facemash, the “hot-or-not” app that Mark Zuckerberg built even before Facebook, even included pre-existing content (photos of students)  ↩