Nvidia’s Integration Dreams

Back in 2010, Kyle Conroy wrote a blogpost entitled, What if I had bought Apple stock instead?:

Currently, Apple’s stock is at an all time high. A share today is worth over 40 times its value seven years ago. So, how much would you have today if you purchased stock instead of an Apple product? See for yourself in the table below.

Conroy kept the post up-to-date until April 1, 2012; at that point, my first Apple computer, a 2003 12″ iBook, which cost $1,099 on October 22, 2003, would have been worth $57,900. Today it would be worth $311,973.

I thought of this meme, which pops up every time Apple’s stock hits a new all-time high, while considering the price Apple paid for P.A. Semi back in 2008; for a mere $278 million the company acquired the talent and IP foundation that would undergird its A-series of chips, which have powered every iPad and every iPhone since 2010, and, before the end of the year, at least one Mac (the rest of the line will follow within two years).

So I was curious: what would $278 million in 2008 Apple stock look like today? The answer is $5.5 billion, which, honestly, is still an absolute bargain, and a reminder that the size of an acquisition is not necessarily correlated with its impact.

Nvidia Acquires ARM

Over the weekend Nvidia consummated the biggest chip deal in history when it acquired Arm1 from Softbank for around $40 billion in stock and cash. Nvidia founder and CEO Jensen Huang wrote in a letter to Nvidia employees:

We are joining arms with Arm to create the leading computing company for the age of AI. AI is the most powerful technology force of our time. Learning from data, AI supercomputers can write software no human can. Amazingly, AI software can perceive its environment, infer the best plan, and act intelligently. This new form of software will expand computing to every corner of the globe. Someday, trillions of computers running AI will create a new internet — the internet-of-things — thousands of times bigger than today’s internet-of-people. Uniting NVIDIA’s AI computing with the vast reach of Arm’s CPU, we will engage the giant AI opportunity ahead and advance computing from the cloud, smartphones, PCs, self-driving cars, robotics, 5G, and IoT.

These are big ambitions for a big purchase, and Wall Street apparently agrees; yesterday Nvidia’s market cap increased by $17.5 billion, nearly covering the $21.5 billion in shares Nvidia will give Softbank in the deal. Indeed, it is Nvidia’s stock that is probably the single most important factor in this deal. Back in 2016, when Softbank acquired Arm, Nvidia was worth about $34 billion; after yesterday’s run-up, the company’s marketcap was $318 billion.

The first takeaway is that selling Arm for $32 billion means that the company was yet another terrible investment by Softbank; simply buying Nvidia shares — or, for that matter, an S&P 500 index fund, which is up 55% since then — would have provided a much better return than the ~5% Softbank earned from Arm.

The second takeaway is the inverse: Nvidia is acquiring a company that was its marketcap peer four years ago for a relative pittance. Granted, Nvidia’s stock may not stay at its current lofty height — the company has a price-to-earnings ratio of over 67, well above the industry average of 27 — but that is precisely why a majority-stock acquisition makes sense; Nvidia’s stock may retreat, but Arm will still be theirs.

Nvidia’s Integration

Beginning my analysis with stock prices is not normally what I do; I’m generally more concerned with the strategies and business models of which stock price is a result, not a driver. The truth, though, is that once you start digging into the details of Nvidia and ARM, it is rather difficult to see what strategy might be driving this acquisition.

Start with Nvidia: the company is perhaps the shining example of the industry transformation wrought by TSMC; freed of the need to manufacture its own chips, Nvidia was focused from the beginning on graphics. Its TNT cards, released in the late 1990s, provided 3D graphics for games while also powering Windows (previously hardware 3D graphics were only available via add-on cards); its GeForce line, released in 1999, put Nvidia firmly at the forefront of the industry, a position it retains today.

It was in 2001 that Nvidia released the GeForce 3, which had the first pixel shader; instead of a hard-coded GPU that could only execute a pre-defined list of commands, a shader was software, which meant it could be programmed on the fly. This increased level of abstraction meant the underlying graphics processing unit could be much simpler, which meant that a graphics chip could have many more of them. The most advanced versions of Nvidia’s just-announced GeForce RTX 30 Series, for example, has an incredible 10,496 cores.

This level of scalability makes sense for video cards because graphics processing is embarrassingly parallel: a screen can be divided up into an arbitrary number of sections, and each section computed individually, all at the same time. This means that performance scales horizontally, which is to say that every additional core increases performance.

It turns out, though, that graphics are not the only embarrassingly parallel problem in computing. Another obvious example is encryption: brute forcing a key entails running the exact same calculation over-and-over again; the chips doing the calculation don’t need to be complex, they simply need as many cores as possible (this is why graphics cards are very popular for blockchain applications; miners are basically endlessly brute-forcing encryption keys).

What is most enticing for Nvidia, though, is machine learning. Training on large datasets is an embarrassingly parallel problem, which means it is well-suited for graphics cards. The trick, though, is in decomposing a machine learning algorithm into pieces that can be run in parallel; graphics cards were designed for, well, graphics, which meant that programmers had to work in graphics programming languages like OpenGL.

This is why Nvidia transformed itself from a modular component maker to an integrated maker of hardware and software; the former were its video cards, and the latter was a platform called CUDA. The CUDA platform allows programmers to access the parallel processing power of Nvidia’s video cards via a wide number of languages, without needing to understand how to program graphics.

Here the kicker: CUDA is free, but that is because the integration is so tight. CUDA only works with Nvidia video cards, in large part because many of the routines are hand-tuned and optimized. It is a tremendous investment that has paid off in a major way: CUDA is dominant in machine learning, and Nvidia graphics cards cost hundreds of dollars ($1500 in the case of the aforementioned RTX 3090). Apple isn’t the only company that understands the power of differentiating premium hardware with software.

Arm’s Neutrality

Arm’s business model could not be more different. The company, founded in 1990 as a joint venture between Acorn Computers, Apple, and VLSI Technology, doesn’t sell any chips of its own; rather, it licenses chip designs to companies which actually manufacture ARM chips. Except even that isn’t quite right: most ARM licensees actually contract with manufacturers like TSMC to make physical chips, which are then sold to OEMs. The entire ecosystem is extremely modular; consider an Oppo smartphone, with a MediaTek chip:

The modular smartphone ecosystem

Arm chips appear in many more devices than smartphones — most micro-controllers in embedded systems are Arm designs — and Arm designs more than CPUs; the company’s catalog includes everything from GPUs to AI accelerator chips. It also licenses less than full designs: Apple, for example, designs its own chips, but uses the ARM Instruction Set Architecture (ISA) to communicate with them. The ARM ISA is the platform that ties this entire ecosystem together; programs written for one ARM chip will run on all ARM chips, and each of those chips results in a licensing fee for Arm.

What makes Arm’s privileged position viable is the same one that undergirds TSMC’s: neutrality. I wrote about the latter in Intel and the Danger of Integration:

In 1987, Morris Chang founded Taiwan Semiconductor Manufacturing Company (TSMC) promising “Integrity, commitment, innovation, and customer trust”. Integrity and customer trust referred to Chang’s commitment that TSMC would never compete with its customers with its own designs: the company would focus on nothing but manufacturing.

This was a completely novel idea: at that time all chip manufacturing was integrated a la Intel; the few firms that were only focused on chip design had to scrap for excess capacity at Integrated Device Manufacturers (IDMs) who were liable to steal designs and cut off production in favor of their own chips if demand rose. Now TSMC offered a much more attractive alternative, even if their manufacturing capabilities were behind.

In time, though, TSMC got better, in large part because it had no choice: soon its manufacturing capabilities were only one step behind industry standards, and within a decade had caught-up (although Intel remained ahead of everyone). Meanwhile, the fact that TSMC existed created the conditions for an explosion in “fabless” chip companies that focused on nothing but design.

Integrated intel was competing with a competitive modular ecosystem

For example, in the late 1990s there was an explosion in companies focused on dedicated graphics chips: nearly all of them were manufactured by TSMC. And, all along, the increased business let TSMC invest even more in its manufacturing capabilities.

That article was about TSMC overtaking Intel in fabrication, but a similar story can be told about Arm overtaking Intel in mobile. Intel was relentlessly focused on performance, but smartphones needed to balance performance with battery concerns. Arm, which had been spending years designing highly efficient processors for embedded applications, had both the experience and the business model flexibility to make mobile a priority.

The end result made everyone a winner (except Intel): nearly every smartphone in the world runs on an ARM-derived chip (either directly or, in the case of companies like Apple, the ARM ISA), which is to say that Arm makes money when everyone else in the mobile ecosystem makes money.

The Nvidia-ARM Mismatch

Notice that an ARM license, unlike the CUDA platform, is not free. That makes sense, though: CUDA is a complement to Nvidia’s proprietary graphics cards, which command huge margins. ARM license fees, on the other hand, can and are paid by everyone in the ecosystem, and in return everyone in the ecosystem gets equal access to Arm’s designs and ISA. It’s not free, but it is neutral.

That neutrality is gone under Nvidia ownership, at least in theory: now Nvidia has early access to ARM designs, and the ability to push changes in the ARM ISA; to put it another way, Nvidia is now a supplier for many of the companies it competes with, which is a particular problem given Nvidia’s reputation for both pushing up prices and being difficult to partner with. Here again Apple works as an analogy: the iPhone maker is notorious for holding the line on margins, prioritizing its own interests, and being litigious about intellectual property; Nvidia has the same sort of reputation. So does Intel, for that matter; the common characteristic is being vertically integrated.

Of course Nvidia is insistent that ARM licensees have nothing to worry about. Huang noted in that letter to Nvidia employees:

Arm’s business model is brilliant. We will maintain its open-licensing model and customer neutrality, serving customers in any industry, across the world, and further expand Arm’s IP licensing portfolio with NVIDIA’s world-leading GPU and AI technology.

Notice that last bit: Huang is not only arguing that Nvidia will serve Arm customers neutrally, but that Nvidia itself will adopt Arm’s business model, licensing its IP to competitive chip-makers. It’s as if this is an acquisition in reverse: the $318 billion acquirer is fitting itself into a world defined by its $40 billion acquisition.

Color me skeptical; not only is Nvidia’s entire business predicated on selling high margin chips differentiated by highly integrated software, but Nvidia’s entire approach to the market is about doing what is best for Nvidia, without much concern for partners or, frankly customers. It is a luxury afforded those that are clearly best in class, which by extension means that sharing is anathema; why trade high margins at the top of the market for low margins and the headache of serving everyone?

In short, this deal feels like the inverse of the P.A. Semi deal not simply in terms of the price tag, but in its overall impact on the acquirer. I have a hard time believing that Nvidia is going to change its approach.

Or maybe that’s the entire point.

Huang’s Dream

By far the best articulation of the upside of this deal came, unsurprisingly, from Huang. What was notable about said articulation, though, was that it came 46 minutes into the investor call about the acquisition, and only then in response to a fairly obvious question: why does Nvidia need to own ARM, instead of simply license it (like Apple, which has a perpetual license to the ARM ISA, and is not affected by this acquisition)?

What was so striking about Huang’s answer was not simply its expansiveness — I’ve transcribed the entire answer below — but also the way in which he delivered it; unlike the rest of the call, Huang’s voice was halting and uncertain, as if he were scared of his own ambition. I know this excerpt is long, but it’s essential:

We were delightful licensees of ARM. As you know we used ARM in one of our most important new initiatives, the Bluefield GPU. We used it for the Nintendo Switch — it’s going to be the most popular and success game console in the history of game consoles. So we are enthusiastic ARM licensees.

There are three reasons why we should buy this company, and we should buy it as soon as we can.

Number one is this: as you know, we would love to take Nvidia’s IP through ARM’s network. Unless we were one company, I think the ability for us to do that and to do that with all of our might, is very challenging. I don’t take other people’s products through my channel! I don’t expose my ecosystem to to other company’s products. The ecosystem is hard-earned — it took 30 years for Arm to get here — and so we have an opportunity to offer that whole network, that vast ecosystem of partners and customers Nvidia’s IP. You can do some simple math and the economics there should be very exciting.

Number two, we would like to lean in very hard into the ARM CPU datacenter platform. There’s a fundamental difference between a datacenter CPU core and a datacenter CPU chip and a datacenter CPU platform. We last year decided we would adopt and support the ARM architecture for the full Nvidia stack, and that was a giant commitment. The day we decided to do that we realized this was for as long as we shall live. The reason for that is that once you start supporting the ecosystem you can’t back out. For all the same reasons, when you’re a computing platform company, people depend on you, you have to support them for as long as you shall live, and we do, and we take that promise very seriously.

And so we are about to put the entire might of our company behind this architecture, from the CPU core, to the CPU chips from all of these different customers, all of these different partners, from Ampere or Marvell or Amazon or Fujitsu, the number of companies out there that are considering building ARM CPUs out of their ARM CPU cores is really exciting. The investments that Simon and the team have made in the last four years, while they were out of the public market, has proven to be incredibly valuable, and now we want to lean hard into that, and make ARM a first-class data center platform, from the chips to the GPUs to the DPUs to the software stack, system stack, to all the application stack on top, we want to make it a full out first-class data center platform.

Well, before we do that, it would be great to own it. We’re going to accrue so much value to this architecture in the world of data centers, before we make that gigantic investment and gigantic focus, why don’t we own it. That’s the second reason.

Third reason, we want to go invent the future of cloud to edge. The future of computing where all of these autonomous systems are powered by AI and powered by accelerated computing, all of the things we have been talking about, that future is being invented as we speak, and there are so many great opportunities there. Edge data centers — 5G edge data centers — autonomous machines of all sizes and shapes, autonomous factories, Nvidia has built a lot of software as you guys have seen — Metropolis, Clara, Isaac, Drive, Jarvis, Aerial — all of these platforms are built on top of ARM, and before we go and see the inflection point, wouldn’t it be great if we were one company.

And so the timing is really quite important. We’ve invested so much across all of these different areas, that we felt that we really had to take the opportunity to own the company and collaborate deeply as we invent the future. That’s the answer.

It turns out this is very much an Nvidia vision after all. Nvidia is not setting out to be a partner, someone that gets along with everyone in exchange for a couple of pennies in licensing fees. Quite the opposite: Huang wants to own it all.

In this vision Nvidia’s IP is the CUDA to its graphics chips — the complement to its grander ambitions. Huang has his sights set firmly on Intel, but while Intel has leveraged its integration of design and manufacturing, Nvidia is going to leverage its integration of chip design and software. Huang’s argument is that it is the lack of software — a platform, as opposed to simply a chip or a core — that is limiting ARM in the data center, and that Nvidia intends to build that software.

On one hand, this is exciting for ARM licensees, particularly companies like Amazon that have invested in ARM chips for the data center; note, though, that Nvidia isn’t doing this out of charity. Huang twice mentioned the importance of capturing the upside he believes Nvidia will generate, which ultimately means increased license fees. Sure, Nvidia will be able to make more changes to ARM to suit the data center than they could have as licensor, but the real goal is to tie ARM into an Nvidia software platform until licensees have no choice but to pay what will undoubtedly be ever-increasing licensing fees (which, it should be noted, will still result in chips that less expensive than Intel’s).

I don’t know if it will work; data centers are about the density of processing power, which is related to but still different than performance-per-watt, ARM’s traditional advantage relative to Intel, and there are a huge amount of 3rd-parties involved in such a transition. There is a lot about this vision that is out of Nvidia’s control — it’s more of a dream. What is comforting in a way, though, is just how true this dream is to what makes Nvidia unique: this isn’t about adopting ARM’s approach, it’s about co-opting it for a vision of integration that makes Nvidia an object of inevitability, not affection.

And, to return to the beginning, it is a bet that is a relatively free one. If Nvidia’s stock is over-priced, then it is buying Arm for an even bigger discount than it seems; the vision Huang laid out, though, is a reason to believe Nvidia’s stock price is actually correct. Might as well roll the dice on a P.A. Semi-type outcome.


Three additional notes about this transaction:

  • As I noted above, Apple has a perpetual license to ARM. The specific details of this license are unknown — we now know that Apple can extend the ISA for its own uses — but my understanding is that the terms are locked in. That is why Apple didn’t feel any motivation to acquire ARM itself, even if Nvidia, a company that Apple does not get along with, was the alternative suitor.
  • This vision of Arm’s future is in many ways incompatible with ARM’s neutral past, but the truth is Arm is already facing disruption of its own. RISC-V is an open-source ISA that is increasingly popular for embedded controllers in particular, in large part because it not only gets rid of Arm control, but also Arm license fees. I would expect investment in RISC-V to accelerate on this news, but it’s worth noting that it is just that — an acceleration of what was inevitable in the long run.
  • One of the biggest regulatory questions around this acquisition is China. On one hand, China has reason to fear an American company — which is subject to U.S. export controls — acquiring more processor technology. On the other hand, Arm China is actually a joint venture, the CEO of which has gone rogue; it’s not clear if Arm is actually in control. It’s possible that this acquisition happens without China’s approval and without ARM China, which is 20% of Arm’s sales. Huang’s dream, though, is perhaps enough to justify this nightmare.
  1. Throughout this article I will write “Arm” when I am referring to the company, and “ARM” when I am referring to said company’s IP []

Rethinking the App Store

It seems appropriate that the first ruling in Epic v. Apple was a split decision: Fortnite remains out of the App Store,1 but Epic may continue to use Apple’s developer tools in order to support Unreal Engine.

Apple v. Epic

The truth is that, from a philosophical perspective, both Epic and Apple make valid points. Epic CEO Tim Sweeney wrote in an email to Apple announcing that Epic was offering its own payment processor in Fortnite, that this case was about the freedom to use your smartphone in whatever way you wished:

We choose to follow this path in the firm belief that history and law are on our side. Smartphones are essential computing devices that people use to live their lives and conduct their business. Apple’s position that its manufacture of a device gives it free rein to control, restrict, and tax commerce by consumers and creative expression by developers is repugnant to the principles of a free society. Ending these restrictions will benefit consumers in the form of lower prices, increased product selection, and business model innovation…

We hope that Apple will reflect on its platform restrictions and begin to make historic changes that bring to the world’s billion iOS consumers the rights and freedoms enjoyed on the world’s leading open computing platforms including Windows and macOS.

Apple Fellow Phil Schiller, in a declaration to the court, argued Apple’s approach gave users a different sort of freedom, that of having entrusted Apple to deliver an excellent user experience:

The App Store’s monetization model is rooted in Apple’s overall philosophy of putting the user and user experience first. This focus on user experience is reflected in Apple’s overall business model and offerings to consumers, which prioritize quality (e.g., distinctive design, innovative technology), security (e.g., protection from malware), and privacy (e.g., safeguarding of personal and payment data). This philosophy can also be seen in Apple’s strategy of integrating its proprietary hardware, software, and services across the range of its products to ensure a high quality user experience, in contrast to many of its competitors.

Schiller’s declaration included a letter from Apple’s Associate General Counsel that explained how this approach benefited developers, including Epic:

Because of Apple’s rules and efforts, iOS and the App Store are widely recognized as providing the most secure consumer technology on the planet. And as a result, consumers can download and pay for an app and in-app content without worrying that it might break their device, steal their information, or rip them off. This level of security benefits developers by providing them with an active and engaged marketplace for their apps.

As I noted last week, there is a lot of credence to Apple’s claims, particularly when it comes to the size of the app market; while the convenience and accessibility of smartphones are the more important reason why iOS and Android are far larger markets than the Windows and macOS platforms Sweeney wishes iOS would emulate, the confidence users have in installing smartphone apps far exceeds the confidence they have doing the same on traditional PCs. That confidence, it should be noted, is well placed: the likelihood of installing malware or performance-destroying applications on your smartphone is far less than on even modern Windows and macOS computers, much less those back in the 2000s when the App Store first launched.

This was something that former Apple CEO Steve Jobs was very focused on; he told the New York Times in 2007:

“We define everything that is on the phone,” he said. “You don’t want your phone to be like a PC. The last thing you want is to have loaded three apps on your phone and then you go to make a call and it doesn’t work anymore. These are more like iPods than they are like computers”…

“These are devices that need to work, and you can’t do that if you load any software on them,” he said. “That doesn’t mean there’s not going to be software to buy that you can load on them coming from us. It doesn’t mean we have to write it all, but it means it has to be more of a controlled environment.”

At the same time, everything is a trade-off, and the fact that iOS is so much more important in 2020 than it was in 2008 raises the costs inherent in Apple’s model. Smartphones are not adjuncts to computers, like iPods were; they are the primary computer for nearly everyone, including those that might invent the future. Francisco Tolmasky, who was on the original iPhone team, noted on Twitter:

This is the chief reason why, if I had to choose a victor in this case, I would choose Epic; Apple is a brilliant company, but they hardly have a monopoly on invention and innovation. My overriding concern is that their monopoly on iOS (and duopoly with Google, which copies many of their App Store practices) will prevent the invention and innovation of others.

The problem for Epic — and, I suppose, for me — is that to this observer it seems exceedingly likely that Apple is going to win this case, last night’s decision notwithstanding. Current Supreme Court jurisprudence is very clear that businesses — including monopolies — have no duty to deal with third parties,2 and if they do choose to deal with them (or are even compelled to), that they can choose the terms on which to do so.3 The only exceptions are if the monopoly in question changes the rules in an unprofitable way with the express purpose of driving out a competitor4, or if any company — not even a monopoly — changes access to after-market parts and services5

In short, what is needed are new laws built for the Internet, which is why it was encouraging that Congress is holding hearings about these issues, and also frustrating that Apple received relatively little attention.

WordPress and Hey

The nature of the limited exceptions above are one reason Apple is at pains to emphasize that the App Store rules have been the same from the beginning; this is mostly correct, although the company has certainly tightened the limits around in-app purchasing over the years, to the extent that companies with cross-platform offerings can’t even tell users that they can subscribe on the web. It also seems that the App Store is going further than that; consider last weekend’s kerfuffle with the WordPress app:

  • Automattic CEO Matt Mullenweg tweeted that Apple was refusing to allow updates to the WordPress app until it implemented in-app purchase for WordPress.com.
  • The problem for Automattic is that the WordPress app is designed for not only WordPress.com, but also all open source WordPress sites (the app itself is distributed with the non-App-Store-compatible General Public License; Automattic has a special license from the WordPress Foundation, which owns the WordPress copyrights, to submit a version compatible with the App Store). This meant that Apple was demanding that an app meant to service all WordPress sites, including those on WordPress.com, add in-app purchases for just one of those sites.
  • After 24 hours of confusion and outcry (including from me), Apple reversed its decision and “apologized for any confusion that [they] caused”.

It seems likely that the dual nature of the WordPress app — both adjunct to the for-profit WordPress.com and tool for the open-source WordPress.org project — was the reason Apple reversed its decision (that or bad press); said reasoning, though, means that Apple very much intended to make Automattic add in-app purchase functionality because it felt entitled to the company’s revenue.

This certainly appeared to be the case for Hey.com; while Apple’s official position in its written communication to Basecamp was that the app had to add in-app purchase if it did not have free functionality, the final paragraph suggested the company felt it deserved a cut:

Thank you for being an iOS app developer. We understand that Basecamp has developed a number of apps and many subsequent versions for the App Store for many years, and that the App Store has distributed millions of these apps to iOS users. These apps do not offer in-app purchase — and, consequently, have not contributed any revenue to the App Store over the last eight years. We are happy to continue to support you in your app business and offer you the solutions to provide your services for free — so long as you follow and respect the same App Store Review Guidelines and terms that all developers must follow.

Ultimately Basecamp added free functionality (an email address that is only good for two weeks) and didn’t add in-app purchase, and Apple approved the app; like the WordPress case, though, the question remained: how much did the massive amount of publicity around the case, particularly given the fact this blew up right before Apple’s annual developer conference, matter?

App Store Anecdotes

From what I have seen, quite a bit. When the Hey.com rejection happened, I wondered on Twitter if Apple was blocking other developers from updating their apps unless they added in-app purchase, and was surprised at the response: twenty-one app developers who contacted me had added in-app purchase in the last twelve months, and all of the developers in that list with regular update schedules had significant gaps in their history of updates (for example, one app updated every two weeks, with a four-month interruption in the middle of 2019). Nine more had either committed to adding in-app purchase, still had their app in limbo, or had simply given up on the App Store.

What was striking about all of these apps is that only three of them functioned primarily on an iPhone; in the vast majority of cases Apple was demanding in-app purchase offerings for functionality that was largely not dependent on an iPhone:

  • 14 of the apps were “Companion Apps”, many of them in the business-to-business category. Imagine, for example, there was a service that allowed you to track inventory, and that service had a mobile app that let you look up your inventory numbers from your phone; Apple held up updates until the iPhone app had an in-app purchase option for the entire service (this is a fake example, but is representative). There were also some apps that looked a lot like the WordPress app: easier access to a web service (like a blog) that could just as easily have used a web page.
  • 6 of the apps were “Cross-platform Web Services”; in this case iPhone access was certainly essential, but only because said service had to work everywhere. Think Hey’s email service, but, well, other email services, none of whom appear to have achieved Hey’s favorable outcome.
  • 4 of the apps offered marketplace-type of functionality for things like classes, coaching, therapists, etc. Two examples are Airbnb and ClassPass, which the New York Times wrote about last month.
  • 3 of the apps were purely digital goods, 1 was a niche streaming video app (that for whatever reason did not fall under the “reader” exemption), and 1 was a hardware app.

I have sat on these anecdotes for several months now, in part because this is all I can say: none of the developers were willing to go on the record for fear of angering Apple. What I think the WordPress and Hey episodes show, though, is that these are the exact sort of apps where Apple is getting things wrong, at least as far as popular opinion is concerned. Epic, what with its costumes and emotes that have zero marginal costs and only ever exist within the virtual world that Fornite created, is in many respects the worst possible agent for App Store change.

Organizing Principles

Here is what I believe the App Store has fundamentally wrong: its current organizing principle is digital versus analog; anything that is digital has to have in-app purchase, while anything that is analog — i.e. connected to the real world — can monetize however it pleases. That is why Amazon or Uber can ask for your credit card, and Airbnb can do the same for rooms but not for digital experiences (according to Apple).

The problem with this organizing principle is found in “Reader” app exception; from the App Store Guidelines:

3.1.3(a) “Reader” Apps: Apps may allow a user to access previously purchased content or content subscriptions (specifically: magazines, newspapers, books, audio, music, video, access to professional databases, VoIP, cloud storage, and approved services such as classroom management apps), provided that you agree not to directly or indirectly target iOS users to use a purchasing method other than in-app purchase, and your general communications about other purchasing methods are not designed to discourage use of in-app purchase.

This is how you end up with Netflix or Spotify or Kindle having apps that open to a login screen with zero indication about how to sign up for an account; most users probably figure out to go to their websites, but it is hardly a good experience from anyone’s perspective, and lesser known apps are likely to simply lose potential customers. At the same time, though, you can understand why “Reader” apps don’t really have a choice: Kindle has to pay publishers for books, and Spotify music labels; layering on 30% simply isn’t feasible.

The better organizing principle is whether or not the app developer has marginal costs. If every incremental sale costs the developer money, then Apple should not only not charge 30%, but should in fact compete for that purchase. Consider, for example, the ClassPass example in that New York Times article:

ClassPass built its business on helping people book exercise classes at local gyms. So when the pandemic forced gyms across the United States to close, the company shifted to virtual classes. Then ClassPass received a concerning message from Apple. Because the classes it sold on its iPhone app were now virtual, Apple said it was entitled to 30 percent of the sales, up from no fee previously, according to a person close to ClassPass who spoke on the condition of anonymity for fear of upsetting Apple. The iPhone maker said it was merely enforcing a decade-old rule…

With gyms shut down, ClassPass dropped its typical commission on virtual classes, passing along 100 percent of sales to gyms, the person close to the company said. That meant Apple would have taken its cut from hundreds of struggling independent fitness centers, yoga studios and boxing gyms.

In this case, Apple should both allow ClassPass to sell its classes via a webview (i.e. loading a webpage within its app), and also offer in-app purchases for, say, 10%; yes, that’s more expensive than credit card processing fees (which are ~$0.30+2.5%~2.9%, or around 6% of a $10 purchase), but the superiority of the user experience may convert enough customers that ClassPass would consider it worth the expense. This should also apply to all of the apps in the “Reader” category.

Fortnite, on the other hand, like most games, is selling purely virtual goods that have zero marginal cost; a costume or emote are bits in a database. Epic may be right that Apple’s 30% take is higher than it would be if the App Store had competition, but ultimately the cost of Fortnite’s V-Bucks is a completely arbitrary one (that is why, for example, Fortnite was willing to cut the price of V-Bucks on consoles to make their App Store point, even though they were still paying 30% to Sony, Microsoft, and Nintendo). To the extent that the App Store tax must exist — and to be clear, this is all predicated on the assumption that it isn’t going anywhere — purely digital goods, particularly those that are only usable on Apple’s platform, are the least objectionable.

This does, I should note, apply to more categories of apps than games. Many productivity apps are zero marginal cost — they are simply infinitely replicable software — and Apple’s take is reducing profitability, as opposed to making individual sales unviable. Indeed, I have always been less concerned about the 30% take for productivity apps and more focused on the lack of traditional trials and paid updates.

There is also a distinction worth drawing between experiences that primarily happen on an iPhone, and those that are primarily on the web, or cross-platform. The latter should be allowed the current “Reader” exception: simply present a login, because, by definition, the user is already using the application in question elsewhere. It is absolutely bizarre that Apple is going after these apps to demand in-app purchase; the fact these developers bothered to make an iPhone app as an add-on is the real win, and punishing them is counter-productive.

Distinguishing apps according to their iPhone-centricity and marginal costs results in a landscape that looks like this:

A new App Store framework

iPhone-focused experiences with zero marginal cost goods pay the full in-app purchase tax, while cross-platform experiences are allowed only a login. Apps with marginal costs, meanwhile, can either offer their own payment solution via a webview, or take advantage of the App Store’s superior in-app purchase experience at a competitive rate.

A New App Store Approach

I know this Article has been wide-ranging, but there is a reason:

  • First, while I recognize there are good reasons for Apple’s approach to the App Store, in a vacuum I would prefer far more openness and freedom, primarily for the sake of increased innovation.
  • Second, under current law, I expect Apple to retain total control of the App Store.
  • Third, I believe that Apple’s current approach to the App Store is bad for developers, bad for innovation, and ultimately bad for Apple.

All of these points are important; it is tempting to write a screed about the App Store that ignores point two, for example, which means the screed doesn’t matter; at the same time, I am concerned that Apple itself will ignore point three, and miss an opportunity to rethink its approach.

That, then, is the spirit of my proposals: if we accept the fact that Apple is determined to make a significant amount of money off of the App Store, and that they have the right to do so, what is a better approach? For this I will incorporate all of the above, and also draw on the distinctions I made to discrete App Store functionality last week (and again, let me be very clear: this isn’t my preferred outcome, but rather one that I hope is plausible).

App Installation: Apple should stop using App Installation to stifle new business models like Google Stadia or Xbox Game Pass. This is, admittedly, one of my weaker arguments in terms of getting Apple’s buy-in: I believe Apple should allow these because innovation is important, and cloud gaming is exactly that. At the same time, cloud gaming is a direct challenge to Apple’s App Store control, so I understand why 30% is not enough from Apple’s perspective.

Payment Processing: This is where the marginal cost/cross-platform distinction comes into play:

  • If your app experience is contained to the iPhone and has zero marginal costs, you can only use in-app purchase at Apple’s rate (30% currently).
  • If your app experience is cross-platform and has zero marginal costs, your app can simply be a login page at launch, with the assumption you are paying elsewhere; if you wish to offer payments, you have to offer in-app purchase at Apple’s rate.
  • If your app experience has marginal costs, then you can offer either a webview for purchase or an in-app purchase at a new Apple rate (~10%) (keep in mind that marginal costs means something discrete; simply needing some indeterminate amount of more server capacity doesn’t suffice).

There will still be edge cases here, particularly when it comes to determining what is an iPhone-only experience, as opposed to a cross-platform one; Fortnite, for example, can be played cross-platform, but I would still classify it as an iPhone-only experience (I would be okay with simply assuming that all games are iPhone-only experiences). What makes these edge cases far more tolerable, though, is that they are arguing about who gets what share of zero marginal cost goods, as opposed to driving folks who need to pay for what they provide out of business.

In addition, I will never rest in my call for traditional trials and upgrade pricing (and go ahead Apple, take your 30%); it’s a better model for productivity apps than subscriptions, particularly small-scale apps, and it genuinely bums me out that this doesn’t yet exist. Indeed, this is the strongest possible argument as to why one company having a monopoly over payment processing is such a terrible idea.

Customer Management: Here Apple both gives and takes. The taking is clear: by virtue of controlling payment, Apple controls the customer relationship. That is a reason for a developer to try and consummate the payment on their own.

At the same time, the App Store is itself a marketing channel. I do believe that Apple massively overstates its importance — sure, it is nice to for an app to be featured, but you can’t build a business model around that like you can targeted advertising — but it is a potential value-add. What Apple should do is make discovery in the App Store contingent on using in-app purchase. If you want to be featured or show up in charts use in-app purchase; if you don’t, then customers have to search for your app directly.


The odds are that Apple isn’t going to change anything; the App Store is extremely profitable, and Apple is probably going to win its court case. Why give up a single dime? At the same time, the constant wave of controversies have to be wearing on the company, from a morale perspective if nothing else. Apple can be legitimately accused of profiteering off of COVID-19!

To that end, I hope the company will at least consider the possibility that this isn’t the 1990s, they’re not about to go out of business, and that being perceived as an asset to developers and not a tax opens up the possibility of growing the pie, not simply taking their slice. If that is the outcome of this summer of App Store turmoil, it will be a win for everyone: developers, Apple, and the users that want both security and innovation.

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

  1. Fortnite still works if you have previously downloaded it; the judge’s order does suggest that Apple could render Fortnite (and only Fortnite) completely unplayable if it chose to []
  2. See Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP. []
  3. See Pacific Bell Telephone Co. v. linkLine Communications, Inc.. []
  4. See Aspen Skiing v. Aspen Highlands Skiing; this case may apply to Apple’s removal of parental control apps that leveraged mobile device management capabilities. []
  5. See Eastman Kodak Co. v. Image Technical Services, Inc., of which the dissent is the de facto controlling precedent. []

Apple, Epic, and the App Store

Circuit Judge Consuelo M. Callahan, in last week’s decision by the Court of Appeals for the Ninth Circuit, reversing the District Court’s ruling that Qualcomm was guilty of antitrust violations, opened her opinion thusly:

This case asks us to draw the line between anticompetitive behavior, which is illegal under federal antitrust law, and hypercompetitive behavior, which is not.

This is, admittedly, a distinction I have not seen before, but it is perhaps a useful one, for the simple reason that being a successful business by definition means being anticompetitive: without some sort of differentiation and/or superior cost structure any sort of margin a business has will be competed away, and so preserving that differentiation and/or cost structure — being anticompetitive — should be the goal of any business. The distinction Callahan was drawing, though, is necessary if you interpret “anticompetitive” as being “illegal”: businesses should compete, but they should not break the law along the way.

What makes this distinction particularly challenging is that the question as to what is anticompetitive and what is simply good business changes as a business scales. A small business can generally be as anticompetitive as it wants to be, while a much larger business is much more constrained in how anticompetitively it can act (as a quick aside, for the first part of this essay I am painting in broad strokes as far as questions of specific legality go). The specific case of Apple and the iPhone raises an additional angle: should the importance of the market in the question make a difference as well?

Apple’s Vertical Integration

Apple’s business model, which uses software to differentiate hardware, is designed to be anticompetitive. The company has traditionally made its money by selling physical devices which run Apple’s proprietary operating systems; its device-manufacturing competitors, meanwhile, have had to rely on an operating system that they could license, primarily Windows for PCs, and Android for mobile devices. They cannot license macOS or iOS.

What is funny about calling this strategy “anticompetitive” is that it wasn’t that long ago that most pundits were sure Apple was anti-competing themselves into the ground. When Stratechery started in 2013, the media was filled with predictions of the iPhone’s imminent demise at the hands of Android: there were simply too many other manufacturers making too many smartphones at too many price points that Apple could not or would not match, which would inevitably lead to developers fleeing iOS and Apple fighting for its life.

The problem with these predictions, as I wrote in What Clayton Christensen Got Wrong, is that they drastically undervalued the experience of using Apple’s integrated products.

The business buyer, famously, does not care about the user experience. They are not the user, and so items that change how a product feels or that eliminate small annoyances simply don’t make it into their rational decision making process. Again, though, Christensen’s research is tilted towards business buyers. Critically, this includes the PC. For the most of its history, the vast majority of PC purchasers have been businesses, who have bought PCs on speeds, feeds, and ultimately, price…

I attributed Apple’s ability to eliminate many of those small annoyances to its vertical integration, which had long been out of fashion:

The traditional business theory about vertical integration rests on the costs and controls…The issue I have with this analysis of vertical integration…is that the only considered costs are financial. But there are other, more difficult to quantify costs. Modularization incurs costs in the design and experience of using products that cannot be overcome, yet cannot be measured. Business buyers — and the analysts who study them — simply ignore them, but consumers don’t. Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.

One thing that is worth noting is that Apple has only ever integrated part of its value chain, particularly once it started manufacturing in China. A Mac, for example, looks something like this:

Apple's integration of software and hardware

In this view Apple integrates hardware made with industry-standard components and macOS, providing a platform for even more app developers. Of course, this view of the Mac will soon be obsolete: Apple computers will soon come with Apple’s own chips, which is to say that the company is backward-integrating into one of its most important components. This is, as far as I can tell, seen as a good thing: Apple has both demonstrated its ability to build fast chips and to integrate those chips with its operating system; no one feels especially bad for Intel, particularly since the company had its own near-monopoly for decades.

App Store Integration

Of course iPhones have already been using Apple’s own chips for a decade; what has always made the iPhone different than the Mac, though, is the degree to which Apple has forward-integrated into the app ecosystem. What is critical to understand is that this integration proceeded in parts, and that those parts build on each other.

App Store Part One: Installation

Start with app installation: because Apple controls the operating system, it controls what apps can or cannot be installed on the device. iOS will only run apps that have permission from Apple (this permission is ultimately enforced by Apple’s hardware), and Apple grants this permission via the App Store. To put it in the context of the value chain, Apple leverages its integration of hardware and software to control app installation:

iOS integrated app installation

It is essential to note that this forward integration has had huge benefits for everyone involved. While Apple pretends like the Internet never existed as a distribution channel, the truth is it was a channel that wasn’t great for a lot of users: people were scared to install apps, convinced they would mess up their computers, get ripped off, or accidentally install a virus.

The App Store changed all of that: Apple effectively extended the trust it had earned with users over the years to all developers in the App Store. Users could install whatever they wanted, confident the app would not mess up their phone, rip them off, or be a virus. This by extension meant that the addressable market was far larger for app developers than the PC was, even though it would be several years before smartphones had a larger installed base than PCs. And this, of course, brought benefits to Apple:

This was the combination of integration and modularity at its absolute best: Apple leveraged its control to create a better market that benefited everyone.

App Store Part Two: Payment Processing

Given the fact that Apple controlled app installation, it was a natural extension into payment processing, particularly since the App Store was built on the same infrastructure as iTunes.

App installation integrated payment processing

Unsurprisingly, like iTunes at the time, payment processing functionality was limited to up-front purchases. Suppose you wanted Super Monkey Ball: you had to pay $9.99 to even download the app; there were no trials or in-app purchases:

The original App Store

From the beginning Apple kept 30% of every purchase; that was similar to the rate the company kept for iTunes purchases, and perhaps more pertinently, just barely covered credit card processing fees for a $0.99 app.1

This gets at why this was another great deal for everyone involved: most users had already trusted Apple with their credit card information, and again, Apple was extending that trust to every developer in its App Store, making it far more likely that developers would earn money on their apps than if they had to drive downloads and purchases on their own. And once again, this circled back to Apple’s benefit, both in terms of the ecosystem broadly and, as the App Store reached scale (and added in-app purchasing), real profits.

App Store Part Three: Customer Management

That Apple has controlled app installation and payment processing from the beginning is an obvious point; what is less appreciated is that Apple leveraged its control of payment processing, which was based on its control of app installation, which was based on its control of the operating system, into complete ownership of the customer relationship.

Payment processing integrated the customer relationship

Users didn’t pay developers, they paid Apple, who paid developers. Users didn’t get receipts from developers, they got receipts from Apple, who kept their email addresses for themselves. This did have some user benefits, particularly in terms of ensuring their data was not sold to unscrupulous data brokers, but the benefit to developers was much less clear cut. There remains no means to offer refunds, for example, and for many years developers could not respond to negative reviews in the App Store.

What was most frustrating for developers, though, was that the lack of a customer relationship, in conjunction with the lack of functionality for upgrade pricing, made it difficult to build sustainable businesses in product spaces that did not have an obvious service component (which might require a subscription) or consumables (which could be bought with in-app purchases). The App Store was about transactions, not relationships, and Apple liked it that way.


These three distinct integrations, each of which built on the previous, were present in the App Store from Day One — and Steve Jobs knew it. He articulated what just took me 700 words in a crisp five minutes and seven seconds:2

Everything about this video was exceptional at the time, and just as critically, nothing was objectionable. After all, the iPhone was still a small business; from a developer perspective, the App Store was (almost) all upside. It would be users who would vote with their wallets in favor of Apple’s approach.

App Store Problems

There is a bit of a running joke in tech that the mainstream media believes that every tech company is ridiculously over-valued right up until the day that the exact same company is a juggernaut that is killing industries; in the case of Apple, the company’s strategy was doomed right up until it was illegal, or so it seems with the App Store.

In truth, though, while many of the issues surrounding the App Store are about Apple being a whole lot bigger than they were in 2008, the company has, particularly over the last few years, extended its control further and further away from the core integration that undergirds its business.

Last year, for example, the company required that apps that utilize third-party login services also utilize “Sign in with Apple”.3 This, by extension, meant that cross-platform apps and services had to integrate “Sign in with Apple” into their Android and web apps. This was in part a further assumption of customer management, and also an extension of control beyond the iPhone.

Apple’s control of the customer relationship has also helped sustain its control of payment processing; after Amazon advertised that Kindle books were available on all platforms Apple forced the bookseller to stop selling books in its app. Moreover, Amazon couldn’t even tell users to visit Amazon.com, much less offer a link or, as Android allows, a webview of the store.

What is troubling about this example, which also applies to Netflix, Spotify, and other so-called “Reader” apps, is that Apple’s aggressive integration up the stack isn’t really helping anyone. Users are confused, these big developers get fewer customers than they might have otherwise, while Apple’s overall iPhone experience is degraded. The ones that really lose out, though, are smaller developers whose cost structures cannot support Apple’s 30% cut, yet don’t have the brand awareness to enable customers to find their websites. In this way Apple is actually making dominant companies even stronger (much like they are Facebook).

Apple also appears to be making an effort to limit this exception; while Basecamp managed to drive Apple to a face-saving retreat from its insistence on in-app purchase for its Hey email service, I heard from many developers that App Store review had started rejecting apps that had been in the store for years because they only allowed users to subscribe on the web.

What was particularly disappointing about these shakedowns, though, is that Apple itself admitted in a press release that it had been holding up bug fixes in App Review “over guideline violations”, many of which were about driving usage of its own payment processor. This is truly an inversion of the win-win-win dynamic that characterized the company’s previous integration efforts: now users were being put at risk for bugs developers were liable for because of arbitrary reasons related to Apple’s drive for Services revenue.

Of course Apple had long put users at risk in other ways; the company had turned a blind eye to the search for digital whales who would spend huge amounts of money on games they could never win. This was, in retrospect, the canary in the coal mine about the corrupting power of the App Store: Apple had started out bragging how they would protect users, but the company seemed far more concerned about protecting its bottom line.

And worst of all, while this was happening, App Store functionality, particularly around payments, was being left in the dust by companies like Stripe, Square, Shopify, and even PayPal. While these companies were making it radically easier for developers to accept payments, offer subscriptions, even get loans and manage their finances, Apple’s payment solution took years to even support subscriptions (never mind that that solution is so difficult to use that a startup just raised $15 million to provide basic tracking functionality); in-app purchase still doesn’t support traditional trials4 or upgrades, the importance of which I’ve been writing about for years.

For me this is the biggest disappointment. I have long believed that the Internet is going to fundamentally remake all aspects of society, including the economy, and that one area of immense promise is small-scale entrepreneurship. The App Store was, at least at the beginning, a wonderful example of this promise; as Jobs noted even the smallest developer could reach every iPhone on earth. Unfortunately, without even a whiff of competition, the App Store has now become a burden for most small developers, who instead of relying on the end-to-end functionality offered by, say, Stripe, have to support at least two payment solutions, the combined functionality of which is limited to the lowest common denominator, i.e. the App Store.

All that noted, what does remain valuable is Apple’s total control of the installation process. The iPhone is probably the most valuable target on earth for scams and hackers, and while vulnerabilities have been exploited, there is no denying the fact that users are safer on iOS than they are on other platforms, and that is valuable to everyone involved.

The Epic Lawsuit

All of this explains why I find Epic’s lawsuit against Apple, which was filed last Thursday after the company updated Fortnite to include an alternate payment system, and was promptly kicked out of the store by Apple, such a bummer.

Epic is attacking every level of the iPhone stack: the company doesn’t just want a direct relationship with customers, and it doesn’t just want to use its own payment processor; it is also demanding the right to run its own App Store. There is precedent on the PC: there Epic has built a rival to Steam that has benefited gamers most of all; at the same time, the PC has always been completely open, for better and for worse.

My preferred outcome would see Apple maintaining its control of app installation. I treasure and depend on the openness of PCs and Macs, but I am also relieved that the iPhone is so dependable for those less technically savvy than me. What would be a far better outcome, at least from my perspective, would be Apple remembering that those same users that benefit from the iPhone being locked down should be the focus everywhere.

That means, for example, allowing purchases via webviews, particularly for products and experiences that do not have zero marginal costs. Sure, that could mean less App Store revenue in the short run, but Apple would be well-served having to build more and better products to win developers over. At the end of the day, squeezing businesses that can stomach the cost of Apple development, both in terms of implementing in-app purchase and that 30%, by definition has less ultimate upside than growing the pie for everyone.

This lawsuit is also a reminder that Apple has a lot to lose. While the most likely outcome is an Apple victory — the Supreme Court has been pretty consistent in holding that companies do not have a “duty to deal” — every decision the company makes that favors only itself, and not society generally, is an invitation to examine just how important the iPhone is to, well, everything.

Indeed, this is the most frustrating aspect of this debate: Apple consistently acts like a company peeved it is not getting its fair share, somehow ignoring the fact it is worth nearly $2 trillion precisely because the iPhone matters more than anything. This is not a console you play on to entertain yourself, or even a PC for work: it is the foundation of modern life, which makes it all the more disappointing that Apple seems to care more about its short term bottom line than it does about the users and developers that used to share in its integration upside; if Apple doesn’t change course, hyperessential will at some point trump hypercompetitive.

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

  1. Credit card processing fees generally consist of a fixed fee between $0.25 and $0.30 per transaction, plus 1.5%~3.0%; Apple of course would have had a significant volume discount. []
  2. Although I can’t help but note that 2:30 mark has a very rare Apple presentation error: the Backgammon game should be on the iPhone screen []
  3. This previously stated that “Sign in with Apple” had to be at the top of the list, which as of the current version of the rules is not the case. []
  4. You can trial a subscription only []

Antitrust Politics

The only thing more predictable than members of Congress using hearings to make statements instead of ask questions, and when they do ask questions, usually of the “gotcha” variety, refusing to allow witnesses to answer (even as those witnesses seek to run out the clock), is people watching said hearings and griping about how worthless the whole exercise is.

There was, needless to say, all of the above last Wednesday, when the House Subcommittee on Antitrust, Commercial, and Administrative Law held a hearing featuring Tim Cook, CEO of Apple, Jeff Bezos, CEO of Amazon, Sundar Pichai, CEO of Google, and Mark Zuckerberg, CEO of Facebook. Statements were made, gotcha questions were asked, answers were interrupted, clocks were run out, and there was a whole lot of griping about what a waste of time it all was.

To be sure, it does seem like there must be a better way to hold these hearings, particularly if the goal is to learn something new, but the reality is that genuine inquiry is much more likely to happen without the glare of the media spotlight that inevitably accompanies such a high profile hearing; what that glare will highlight is the politics of the topic in question: what do various politicians and parties actually care about, what do they think that their constituents care about, and how should those affected by said hearings respond.

In that regard last Wednesday’s hearing was a success: partisan priorities were made clear on the politician side, tech’s collective position and impact on society came into view, even as each of the companies at the hearing revealed different strengths and vulnerabilities. This article will examine all of these points, but first a caveat: this post, even more than most on Stratechery, is meant as an analysis of the politics of this hearing in particular, not a statement of values; unless I say so explicitly, I am not necessarily endorsing or condemning any particular line of argument, simply pointing it out.

The Political Effects of Monopoly

Lina Khan, who rose to prominence with her 2017 law review article Amazon’s Antitrust Paradox, and who served as counsel for the antitrust subcommittee over the course of the investigation that culminated in Wednesday’s hearings, summarized the New Brandeis Movement of antitrust in 2018:

As the name suggests, this new movement traces its intellectual roots to Justice Louis Brandeis, who served on the Supreme Court between 1916 and 1939. Brandeis was a strong proponent of America’s Madisonian traditions—which aim at a democratic distribution of power and opportunity in the political economy. Early in the twentieth century, Brandeis successfully updated America’s antimonopoly regime, along Madisonian lines, for the industrial era, and his philosophy held sway well into the 1970s. As the ‘New Brandeis School’ gains prominence — even prompting two floor speeches by Senator Orrin Hatch (a Republican from Utah) — it’s worth understanding what this vision of antimonopoly does and does not represent.

While the article is worth reading in full, it is no accident that Khan started with “democracy”:

Brandeis and many of his contemporaries feared that concentration of economic power aids the concentration of political power, and that such private power can itself undermine and overwhelm public government. Dominant corporations wield outsized influence over political processes and outcomes, be it through lobbying, financing elections, staffing government, funding research, or establishing systemic importance that they can leverage. They use these strategies to win favorable policies, further entrenching their dominance.

Brandeis also believed that the structure of our markets and of our economy can determine how much real liberty individuals experiences in their daily lives. Most people’s day-to-day experience of power comes not from interacting with public officials, but through relationships in their economic lives — negotiating pay with an employer, for example, or wrangling the terms of business with a trading partner. Brandeis feared that autocratic structures in the commercial sphere — such as when one or a few private corporations call all the shots — can preclude the experience of liberty, threatening democracy in our civic sphere.

Chairman David Cicilline, in the conclusion to his opening statement, made a clear gesture to the New Brandeis Movement:1

Because concentrated economic power also leads to concentrated political power, this investigation also goes to the heart of whether we as a people govern ourselves, or whether we let ourselves be governed by private monopolies. American democracy has always been at war against monopoly power. Throughout our history, we’ve recognized that concentrated markets and concentrated political control are incompatible with democratic ideals. When the American people confronted monopolies in the past, be it the railroads or the oil tycoons or AT&T and Microsoft, we took action to ensure no private corporation controls our economy or our democracy.

What was notable to me is that in the hearing Cicilline and the other Democrats never really focused on this point; the rest of Cicilline’s opening statement, and much of the Democratic questioning, focused on what they perceived as illegal activities that caused economic harm, without necessarily tying that to political harm. Again, that’s not to say they were ignoring the linkage, but it wasn’t a priority.

What made this stand out was that Republicans were focused almost entirely on the politics of monopoly, specifically their contention that large platforms, particularly Google and Facebook (and Twitter), were censoring conservative viewpoints and working to elect Democratic candidates to office, particularly the presidency, and that this was a problem because of their dominance. Leave aside, if you can, your opinion about the veracity of these complaints (and remember my note at the beginning about focusing on analysis): while the Republicans were certainly not endorsing the “New Brandeis School” — Ranking Member James Sensenbrenner in particular took care to highlight support for the consumer welfare standard, also known as the “Chicago School” — their concern with the size of tech companies had nothing to do with economic effects and everything to do with political effects. It was a striking contrast.

Begging the Question

One of the more humorous lines of questioning, at least for language nerds, came courtesy of Republican Representative Matt Gaetz:

I want to talk about Search because that’s an area where I know Google has real market dominance. On December 11th, you testified to the Judiciary Committee, and in response to a question from my colleague Zoe Lofgren about Search, you said, “We don’t manually intervene on any particular search result.” But leaked memos obtained by The Daily Caller show that that isn’t true. In fact, those memos were altered December 3rd, just a week before your testimony. And they describe a deceptive news blacklist and a process for developing that blacklist approved by Ben Gomes, who leads Search with your company. And also something called a fringe ranking, which seems to beg the question, who gets to decide what’s fringe?

And in your answer, you said to Ms. Lofgren that there is no manual intervention of search. That was your testimony, but … And now I’m going to cite specifically from this memo from The Daily Caller. It says that the … I’m sorry, that The Daily Caller obtained from your company. It says, “The beginning of the workflow starts when a website is placed on a watch list.” It continues, “This watch list is maintained and stored by Ares with access restricted to policy and enforcement specialists.” Sort of does beg the question who these enforcement specialists are?

First off, note that this is an example of Republicans linking dominance to concerns about censorship. The point about language, though, is that Gaetz is using the phrase “begs the question” incorrectly; I know this, because I used to make the same mistake, until a reader graciously corrected me a couple of years ago. What Gaetz meant to say was “raises the question”; “begs the question”, on the other hand, to use Wikipedia’s definition, is:

An informal fallacy that occurs when an argument’s premises assume the truth of the conclusion, instead of supporting it. It is a type of circular reasoning: an argument that requires that the desired conclusion be true. This often occurs in an indirect way such that the fallacy’s presence is hidden, or at least not easily apparent.

For an example of this logical fallacy at work, look no further than this antitrust hearing, and Cicilline’s concluding statement:

Today, we had the opportunity to hear from the decision makers at four of the most powerful companies in the world. This hearing has made one fact clear to me. These companies, as exist today, have monopoly power. Some need to be broken up, all need to be properly regulated and held accountable.

If I may nitpick, this is obviously not true — Cicilline had decided well before this hearing that these companies have monopoly power. The problem is that a huge number of questions in the hearing took it as a given that these companies were monopolies, and proceeded to find rather common business practices as being major crimes. In other words, they begged the question.

One of the most striking examples of this fallacy — where it is assumed that a company is a monopoly, and therefore its actions are illegal, and because its actions are illegal it is a monopoly — was this exchange between Representative Jamie Raskin and Bezos:

Start with the HBO Max-on-Fire TV question. One of the first things you learn about conducting effective negotiations is that you want to negotiate about more things, not fewer. The reasoning is straightforward: if you are only negotiating about a single variable — in this example, Raskin believes that Amazon and HBO should only negotiate on price — the outcome is zero sum: every cent that Amazon wins is a cent that HBO loses. However, if you are able to introduce more variables, then you might find out that one company cares a lot about price, while the other company cares a lot about promotion (just to make up an example); in that case one company can get a better price and give up a lot of promotional opportunities, while the other can get a worse price and gain a lot of promotional opportunities, and thanks to their differing priorities, both feel like winners. That’s good negotiating!

It also appears to be, at least according to Raskin, illegal, because Amazon is “us[ing its] gatekeeper status role in the streaming device market to promote [its] position as a competitor in the video streaming market with respect to content.” That’s the problem though: there was zero evidence provided that Amazon has a monopolistic position in either streaming devices or video streaming; it was simply taken as fact, which made basic negotiating practices suspect, and evidence that Amazon was a monopoly. Begging the question.

Raskin’s question about Amazon’s acquisition of Ring was an even better example of the fallacy at work; while I don’t really understand why multivariate negotiations would be illegal even if you are a monopoly, there are clear antitrust issues raised by a monopolist acquiring a company for market share. Crucially, though, acquiring a company for market share if you are not a monopolist is not a crime.

It follows, then, that if Amazon had a monopoly in the home automation market, and acquired Ring for market share reasons, that could very well be an antitrust violation, but if they weren’t a monopoly, it would not be. What is critical to note is that you have to establish that Amazon has a monopoly first; only then can you decide if the acquisition was anticompetitive. Raskin, though, begs the question: the fact that Amazon acquired Ring for market share reasons is taken as evidence that Amazon has a monopoly, which then makes the acquisition illegal.

The same problem applied to Raskin’s final two complaints: Alexa defaulting to Amazon Prime Music, and recommending Amazon Basics. Those may be a problem if you first establish that Amazon has a monopoly in the relevant product areas, but it is not itself evidence that Amazon is a monopoly.

I’m focusing on this specific exchange, but the truth is that a combination of vilifying common business practices and begging the question was a consistent theme. Things like market research or copying competitor features or improving products were held up as obvious crimes and evidence of monopoly, when they were often not crimes at all, or only crimes if a monopoly in the relevant market had first been established. That is not to say that the committee’s investigation didn’t produce evidence of illegal anticompetitive actions, but rather that said evidence, such that there was, too often begged the question.

The GOP Bargain

The combination of the Republicans’ focus on the political aspects of antitrust and the tendency of the Democrats to see antitrust crimes even in normal business proceedings produced what was, I think, the most obvious political takeaway for tech companies: the Democrats have made up their minds (that tech is guilty), while the Republicans are willing to cut a deal.

The outline of that deal could not have been more obvious: Republicans are fine with the consumer welfare standard (which, as I noted back in 2016, inherently favors Aggregators) and tech’s business practices, as long as tech companies don’t “censor”; the alternating format of Congressional hearings placed these demands in direct contrast to Democratic assumptions of guilt. To put it in explicit terms: “We, Republicans, are your friends in Washington, but if you want us to defend you from the Democrats, you need to stop censoring conservatives.”

Again, it doesn’t matter that conservative websites tend to do particularly well on social media, or that the destruction of the media business model helped lay the groundwork for President Trump’s rise; Republicans expect that tech companies — by which they mostly mean Google and Facebook (and Twitter) — err on the side of not censoring or checking conservative content if they want help in Washington, because that help is not coming from the Democrats.

Tech’s United Front

Something that stood out from the four CEOs’ opening statements, and the general tenor of their defenses, was their insistence that they supported small-and-medium sized businesses.

Bezos:

20 years ago, we made the decision to invite other sellers to sell in our store, to share the same valuable real estate we’ve spent billions to build, market, and maintain. We believe that combining the strengths of Amazon Store with the vast selection of products offered by third parties would be a better experience for customers, and that the growing pie of revenue and profits would be big enough for all. We were betting that it was not a zero sum game. Fortunately, we were right. There are now, 1.7 million small-and-medium-sized businesses selling on Amazon.

Pichai:

One way we contribute is by building helpful products. Research found that free services like search, Gmail, maps, and photos provide thousands of dollars a year in value to the average American. And many are small businesses using our digital tools to grow. Stone Dimensions, a family owned stone company in Pewaukee, Wisconsin uses Google My Business to draw more customers. Gil’s appliances, a family owned appliance store in Bristol, Rhode Island credits Google analytics with helping them reach customers online during the pandemic. Nearly one third of small business owners say that without digital tools, they would have had to close all or part of their business during COVID.

Cook:

What does motivate us is that timeless drive to build new things that we’re proud to show our users. We focus relentlessly on those innovations, on deepening core principles like privacy and security and on creating new features. In 2008, we introduced a new feature of the iPhone called the App Store launched with 500 apps, which seemed like a lot at the time, the App Store provided a safe and trusted way for users to get more out of their phone. We knew the distribution options for software developers at the time didn’t work well, brick-and-mortar stores charged high fees and have limited reach, physical media like CDs had to be shipped and were hard to update. From the beginning, the App Store was a revolutionary alternative. App Store developers set prices for their apps and never pay for shelf space.2

Zuckerberg:

We’ve built services that billions of people find useful. I’m proud that we’ve given people who’ve never had a voice before the opportunity to be heard, and given small businesses access to tools that only the largest players used to have.

This shared focus was notable for two reasons, one specific to these hearings, and one that tells a broader story about how the Internet is changing the world.

First off, probably the most obvious connective thread in the hearing was concern about these companies creating platforms and then favoring themselves unfairly. Amazon, for example, is accused of using data about third party sellers to inform its private-label goods strategy (and data from AWS); Google is accused of using data about search to keep users on its pages; Apple is accused of using its control of the App Store to favor its own apps; and Facebook is accused of using data about app usage to drive its acquisition strategy. What each of these companies is arguing is that focusing on a couple of disgruntled companies is to miss the larger picture, wherein these companies created those opportunities in the first place, and for exponentially more companies than those the Committee may have heard from.

What is particularly interesting, though, is that to the extent these companies are right it foretells both a new kind of economy and a new kind of political alignment. Zuckerberg’s summary was the shortest yet most explicit, perhaps because Facebook is the best example of this phenomenon; I wrote in Apple and Facebook:

This explains why the news about large CPG companies boycotting Facebook is, from a financial perspective, simply not a big deal. Unilever’s $11.8 million in U.S. ad spend, to take one example, is replaced with the same automated efficiency that Facebook’s timeline ensures you never run out of content. Moreover, while Facebook loses some top-line revenue — in an auction-based system, less demand corresponds to lower prices — the companies that are the most likely to take advantage of those lower prices are those that would not exist without Facebook, like the direct-to-consumer companies trying to steal customers from massive conglomerates like Unilever.

The Internet is best illustrated by the smiling curve, in which value flows to large Aggregators and Platforms on one side, and small businesses built with Internet assumptions about addressable markets (and Internet cost structures) on the other side, while the folks in the middle that built their businesses on owning distribution in a world of scarcity are increasingly obsolete.

That is why you regularly see strange political bedfellows, like Uber and drivers and riders versus taxi companies and politicians, or Airbnb and hosts versus hotels and, well, politicians, or these companies and their small business bases against newspapers, retailers, cross-platform software businesses, vertical aggregators and yes, politicians. Zuckerberg made this point on behalf of the tech industry as a whole:

We’re here to talk about online platforms, but I think the true nature of competition is much broader. When Google bought YouTube, they could compete against the dominant player in video, which was the cable industry. When Amazon bought Whole Foods, they could compete against Kroger’s and Walmart. When Facebook bought WhatsApp, we could compete against telcos who used to charge 10 cents a text message, but not anymore. Now people can watch video, get groceries delivered, and send private messages for free. That’s competition. New companies are created all the time, all over the world. And history shows that if we don’t keep innovating, someone will replace every company here today.

Companies that used to be big, at least before the big tech companies came along, have the most to lose from tech, but just because they are ill-equipped to compete does not mean they are representative of all businesses, particularly companies that only exist because these platforms and Aggregators exist.3

Tech’s Differing Prospects

That noted, just because there were similarities in their messaging does not mean that each tech company has similar prospects as far as potential regulation is concerned. From the companies that should be the least concerned to the most:

Apple: It was obvious that the committee only invited Apple because they wanted to say that they invited all of the large consumer tech CEOs. The questions for Cook were hilariously uninformed about the App Store, making it easy for Apple’s CEO to run out the clock (often without any interruption). This was certainly disappointing given that many of Apple’s policies are clearly anticompetitive (which, as I noted above, is different than being illegal), but for now the takeaway is that Congress doesn’t know and doesn’t care.

Facebook: Facebook was probably the biggest beneficiary of Democrats not focusing on political harm relative to economic harm; as I noted last year in Tech and Antitrust, there really isn’t much about the company’s business practices (post acquisitions) that are anticompetitive. There was an interesting back-and-forth about Facebook’s discriminatory willingness to deal as far as access to their friend graph is concerned, but for that to be illegal you have to first establish that Facebook is a monopoly.

On this point I thought the Committee’s questioning was frequently unfair: the fact that social networks that existed when Facebook was founded no longer do (MySpace, Friendster, etc.) was taken as evidence that Facebook is a monopoly, with zero acknowledgment of the rise of Snapchat, TikTok, iMessage, etc. Similarly, Facebook’s acquisition of Instagram was discussed as if it happened today, when Instagram has over a billion users, as opposed to 2012, when it had 30 million. To be sure, some saw the anticompetitive angle of that purchase at the time, but many more mocked the price; at a minimum we can all agree that judging decisions made in 2012 according to the facts of 2020 isn’t necessarily just.

Amazon: Amazon seemed to attract the most in-depth scrutiny from the committee (perhaps because of Kahn), and while the biggest focus was on the 3rd-party marketplace and Amazon’s private-label strategy, there was a clear attempt across multiple questioners to make the case that Amazon creates “innovation kill zones”, as Representative Joe Neguse put it, across all of its product lines. There was clearly a target on Bezos.

At the same time, as Bezos regularly noted, it is not clear in what markets Amazon has a monopoly, and if it is not a monopoly, a lot of the behavior lawmakers were objecting to is not illegal (and, as I noted above, may not be illegal regardless). Bezos also made the point that only the military has a higher approval rating than Amazon, and when it comes to politics, that still matters.

Google: I think that Google is in trouble. The company received the second greatest amount of specificity in its questions as far as competition topics go — Representative Pramila Jayapal’s questions about ad exchanges was particularly well-done, especially given the constraints of the format — but more importantly, at least far as the politics of this hearing is concerned, was revealed to have no friends.

Specifically, the price of the company pulling out of Project Maven and the Pentagon’s JEDI project because of concerns about collaborating with the U.S. military4 is that the GOP deal I detailed above is not on the table: Republicans pushed Pichai on not just censorship and election interference but also its refusal to support the military repeatedly, and it seems clear than if and when an antitrust case is brought against the company, it will have few defenders. That is a particularly big problem for Google because the antitrust case against the company is by far the most straightforward.


As I wrote last week before the hearing, I am glad that it occurred. Figuring out how to regulate tech companies — particularly Aggregators, that base their power on consumer welfare — will require new approaches, and probably new laws. Moreover, any such regulations will necessitate difficult trade-offs between competition, privacy, national security, etc. (I was grateful that Representative Kelly Armstrong highlighted how GDPR made big tech companies stronger), which again means that Congress is best situated to decide what tradeoffs we should make.

To that end, I think the hearing was more successful than the format made it seem: there is more clarity about both Democratic and Republican priorities, as well as potential new divisions driven by technology generally, and a finer-grained understanding of how individual companies raise different concerns specifically. No, this wasn’t “Mr. Smith Goes to Washington”, but then again that movie was made by a studio about to be convicted of acting anti-competitively.

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

  1. That is Khan sitting behind Cicilline []
  2. Yes, Cook is pretending like the Internet never existed as a distribution channel []
  3. Again, this is not to say that regulation isn’t necessary — see A Framework for Regulating Competition on the Internet []
  4. Incidentally, I think the real reason that Google pulled out of the JEDI project is that Google Cloud was not competitive with Azure and AWS; citing ethical concerns was a misguided attempt to claim a strategy credit that is coming back to bite the company in a major way []

India, Jio, and the Four Internets

One of the more pernicious mistruths surrounding the debate about TikTok is that this will potentially lead to the splintering of the Internet; this completely erases the history of China’s Great Firewall, started 23 years ago, which effectively cut China off from most Western services. That the U.S. may finally respond in kind is a reflection of reality, not the creation of a new one.

What is new is the increased splintering in the non-China Internet: the U.S. model is still the default for most of the world, but the European Union and India are increasingly pursuing their own paths.

The U.S. Model

The U.S. Internet model is a laissez-faire one, and it is hard to argue against its effectiveness. Not only is the technology sector the biggest driver of U.S. economic growth for many years now, but U.S. Internet companies have come to dominate most of the world, conveying U.S. soft power like McDonald’s and Hollywood on steroids. There are obvious downsides to this approach: the Internet’s lack of friction both leads to Aggregators dominating markets and creates communities both good and bad.

This article, though, is primarily focused on economics and politics, and in that regard the winners and losers of the U.S.’s approach are as follows:

Winners:

  • Large U.S. tech companies operate freely in the U.S., giving them a large and profitable user base to fund expansion abroad.
  • New U.S. tech companies face relatively few barriers to entry, particularly in terms of regulation of content or data collection.
  • The U.S. government collects the vast majority of taxes from these U.S. companies, including from revenue generated abroad, and also sees the overall U.S. view of the world exported via U.S. tech companies, while also having access to the data of non-U.S. citizens.
  • U.S. citizens operate with a high degree of freedom online, although there are minimal restrictions on the collection of the data generated from doing so by private companies.
  • Non-U.S. citizens operate with a high degree of freedom online, although there are minimal restrictions on the collection of the data generated from doing so by private companies or the U.S. government.
  • Non-U.S. companies are free to operate in the United States without restriction, and in other countries that follow the U.S.’s approach.

Losers:

  • Non-U.S. governments have limited control over U.S. tech companies, limited access to their revenues, and limited control over the spread of information.

My biases should be obvious: I definitely believe that the U.S. approach is the best one. Certainly many will quibble with the effect on new companies, given how Aggregators tend to dominate their markets, while others are focused on the collection of data; I am concerned that proposed solutions are worse than the harms, particularly given the consumer benefit of data factories. Still, as I noted yesterday, I believe the European Union Court of Justice makes a compelling case that the ability of the U.S. government to collect data from non-U.S. citizens is a serious privacy issue.

Those quibbles, though, serve to highlight a point we can all agree on: non-U.S. governments have a lot of legitimate complaints about the hegemony of U.S. tech companies.

The China Model

The driving impetus of the China model is, first and foremost, control over information. This is evidenced by the fact that not only does China control access to Western services at the network level, but also employs huge numbers of censors for the Internet within China, and expects Chinese Internet companies like Tencent or ByteDance to have thousands of censors of their own.

At the same time, the economic benefit of China’s approach for China can not be denied. China is the only country to rival the U.S. for the sheer size and breadth of its Internet companies, thanks to the combination of a massive market and the lack of competition. Moreover, this led to all sorts of innovation, as China’s leapfrog to mobile avoided the baggage of PC-assumptions that still limits many U.S. companies.

That noted, it is fair to wonder just how replicable the China model is. Smaller countries like Iran have instituted similar controls on U.S. tech companies, but without a market like China it is far more difficult to capture the economic upside of the Great Firewall. And, it should be noted, there are a lot of losers with the China model, including Chinese citizens.

The European Model

Europe, through regulations like GDPR and the Copyright Directive, along with last week’s court decision striking down the Privacy Shield framework negotiated by the European Commission and the U.S. International Trade Administration (and a previous decision striking down the Safe Harbor Privacy Principles framework), is splintering off into an Internet of its own.

This Internet, though, feels like the worst of all possible outcomes. On one hand, large U.S. tech companies are winners, at least relative to everyone else: yes, all of the regulatory red tape increases costs (and, for targeted advertising, may reduce revenue), but the impact is far greater on would-be competitors. To put it in allegorical terms, the E.U. is restricting the size of the castle even as it dramatically increases the moat.

E.U. citizens, meanwhile, are likely to see their data increasingly protected from the U.S. government, which is a win; other protections, meanwhile, seem unlikely to be particularly effective or outweigh the general annoyance and loss of relevance that comes from endless permission dialogs and non-targeted content. Moreover, per the previous point, the number of alternatives to established incumbents are likely to decrease, particularly relative to the U.S.

It also seems unlikely that European competitors will fill in the gap. Any company that wishes to achieve scale needs to do so in its home market first, before going abroad, but it seems far more likely that Europe will make the most sense as a secondary market for companies that have done the messy work of iterating on data and achieving product-market fit in markets that are more open to experimentation and impose less of a regulatory burden. Higher costs mean you need a greater expectation of success, which means a proven model, not a speculative one.

Worst of all, at least from the E.U.’s perspective, is that this approach doesn’t really have any upside for European governments. That’s the thing with rule by regulation: without a focus on growth it is harder to create win-win situations.

The Indian Model

The India market has always been a bit unique: while foreign companies have usually been unencumbered when it comes to digital goods, leading to a huge number of users for U.S. companies like Google and Facebook, and Chinese companies like TikTok, India has kept a much tighter leash when it comes to the physical layer of tech. This ranges from strong tariffs on electronics to a ban on foreign direct investment in things like e-commerce. Moreover, India has always been one of the most challenging markets in terms of Internet access and logistics.

At the same time, the Indian market is the most enticing in the world for both U.S. and Chinese tech companies, which have largely saturated their home markets. This has led to a regular number of collisions between foreign tech companies and India regulators, whether it be Facebook’s attempts to introduce Free Basics or WhatsApp payments, increasing restrictions on Amazon and Flipkart’s e-commerce operations, or most recently, the outright banning of TikTok on national security concerns.

Over the last few months, though, a way to square this circle has become apparent to U.S. tech companies in particular, and it portends a fourth Internet: invest in Jio Platforms.

The Jio Bet

Jio, the dominant telecoms network in India, is one of the all-time greatest examples of the power of building, and the outsized returns that come from betting on technology-enabled disruption. I described the economics of the bet by Mukesh Ambani, India’s richest man, in an April Daily Update:

The key to understanding Ambani’s bet is that while all of the incumbent mobile operators in India were, like mobile operators around the world, companies built on voice calls that layered on data, Jio was built to be a data network — specifically 4G — from the beginning.

  • 4G, unlike 2G and 3G, does not support traditional circuit-switched telephony services; voice calls are instead handled the same as any other data.
  • Because everything is data, 4G networks can be built with commodity hardware in a way that 2G and 3G networks cannot.
  • Because Jio was offering a data network, voice calls, which are relatively low bandwidth, were the cheapest services to offer, and capacity was effectively infinite.

To put it another way, Jio was a bet on zero marginal costs — or, at a minimum, drastically lower marginal costs than its competitors. This meant that the optimal strategy was — you know what is coming! — to spend a massive amount of money up front and then seek to serve the greatest number of consumers in order to get maximum leverage on that up-front investment.

That is exactly what Jio did: it spent that $32 billion building a network that covered all of India, launched with an offer for three months of free data and free voice, and once that was up, kept the free voice offering permanently while charging only a couple of bucks for data by the gigabyte. It was the classic Silicon Valley bet: spend money up front, then make it up on volume because of a superior cost structure enabled by the zero-marginal nature of technology.

What makes this story so compelling is the contrast to Facebook’s argument for Free Basics:

The end result is what Zuckerberg said must be done: hundreds of millions of Indians, a huge portion of them from the country’s poorest regions, were connected to the Internet. Unlike Free Basics, though, it was all of the Internet.

That actually undersells just how much better Jio is for Indians than Free Basics would have ever been: Zuckerberg had no plan for upending India’s old mobile order, where operators focused most of their investment on India’s largest cities and competed for the richest parts of society, charging so much that Andreessen could declare, with a straight face, that to not offer Free Basics was “morally wrong.” In that world, India’s poor may have had access to Facebook, but little more, since there would have been no reason for non-Free Basics companies to invest. Instead they not only have the whole Internet but companies from India to China to the United States competing to serve them.

I wrote that Daily Update on the occasion of Facebook investing $5.7 billion for a 10% stake into Jio Platforms; it turned out that was the first of many investments into Jio:

  • In May, Silver Lake Partners invested $790 million for a 1.15% stake, General Atlantic invested $930 million for a 1.34% stake, and KKR invested $1.6 billion for a 2.32% stake.
  • In June, the Mubadala and Adia UAE sovereign funds and Saudi Arabia sovereign fund invested $1.3 billion for a 1.85% stake, $800 million for a 1.16% stake, and $1.6 billion for a 2.32% stake, respectively; Silver Lake Partners invested an additional $640 million to up its stake to 2.08%, TPG invested $640 million for a 0.93% stake, and Catterton invested $270 million for a 0.39% stake. In addition, Intel invested $253 million for a 0.39% stake.
  • In July, Qualcomm invested $97 million for a 0.15% stake, and Google invested $4.7 billion for a 7.7% stake.

With that flurry of fundraising Reliance completely paid off the billions of dollars it had borrowed to build out Jio. What is increasingly clear, though, is that the company’s ambitions extend far beyond being a mere telecoms provider.

Jio’s Vision

Last Wednesday, after announcing Google’s investment in Jio Platforms at Reliance Industries’ Annual General Meeting, Ambani said:

I would like to first share with you the philosophy that animates Jio’s current and future initiatives. The digital revolution marks the greatest disruptive transformation in the history of mankind, comparable only to the appearance of human beings with intelligence capability on our planet about 50,000 years ago. It is comparable because man is now beginning to infuse almost limitless intelligence into the world around him.

We are today at the initial stages of the evolution of an intelligent planet. Unlike in the past this evolution will proceed with a revolutionary speed. Our world will change more unrecognizably in just eight remaining decades of the 21st century, than today’s world has changed from what it was 20 centuries ago. For the first time in history mankind has an opportunity to solve big problems inherited from the past. This will create a world of prosperity, beauty, and happiness for all. India must lead this change to create a better world. For this all our people and all our enterprises have to be enabled and empowered with the necessary technology infrastructure and capabilities. This is Jio’s purpose. This is Jio’s ambition.

The "Two Pillars of Jio" slide from Reliance's Annual Global Meeting

Friends, Jio is now the undisputed leader in India with the largest customer base, the largest share of data and voice traffic, and a world-class next-generation broadband network that covers the length and the breadth of our country…Jio’s vision stands on two solid pillars. One is digital connectivity and the other is digital platforms.

In short, Jio is determined to achieve the dream that has long eluded telecom providers in other countries: moving up the stack from fixed-cost infrastructure to high-margin services. Ambani’s vision is comprehensive:

Jio's vision slides from Reliance's Annual Global Meeting

What gives Jio a chance are three important differences from telecom efforts in other markets:

  • First, Jio has created a huge portion of its addressable market; whereas a Verizon in the U.S., or a NTT DoCoMo in Japan was seeking to offer services on top of a competitive telecom market, Jio is the only option for a huge number of Indians (and for those that have options, Jio is so much cheaper because of its IP-based network that it can afford the extra costs).
  • Second, instead of seeking to usurp companies like Facebook or Google that already have major marketshare in India, Jio is partnering with them.
  • Third, Jio is positioning itself as an Indian champion, and the lynchpin of the Indian model.

Notice how Ambani introduced Jio’s 5G plans:

Jio’s global scale 4G and fiber network is powered by several core software technologies and components that have been developed by the young Jio engineers right here in India. This capability and know-how that Jio has developed positions Jio on the cutting edge of another exciting frontier: 5G.

Today friends, I have great pride in announcing that Jio has designed and developed a complete 5G solution from scratch. This will enable us to launch a world-class 5G service in India using 100% homegrown technology and solution. This made in India 5G solution will be ready for trials as soon as 5G spectrum is available, and can be ready for field deployment next year. And because of Jio’s converged all-IP network architecture we can easily upgrade our 4G network to 5G.

Once Jio’s 5G solution is proven at India-scale, Jio platforms would be well-positioned to be an exporter of 5G solutions to other telecom operators globally as a complete managed service. I dedicate Jio’s 5G solution to our Prime Minister Shri Narendra Modi’s highly motivating vision of ‘Atmanirhbhar Bharat’.

The "Motivations" slide from Reliance's Annual Global Meeting

Friends, Jio Platform is conceived with this vision of developing original captive intellectual property using which we can demonstrate the transformative power of technology across multiple industry ecosystems, first in India, and then confidently offering these Made-in-India solutions to the rest of the world.

Make no mistake: Jio’s network and its work on 5G, which takes years, was by definition not motivated by a phrase Prime Minister Modi first deployed two months ago. Rather, Ambani’s dedication hinted at the role Jio investors like Facebook and Google are anticipating Jio will play:

  • Jio leverages its investment to become the monopoly provider of telecom services in India.
  • Jio is now a single point of leverage for the government to both exert control over the Internet, and to collect its share of revenue.
  • Jio becomes a reliable interface for foreign companies to invest in the Indian market; yes, they will have to share revenue with Jio, but Jio will smooth over the regulatory and infrastructure hurdles that have stymied so many

What is fascinating about this approach is that the list of winners and losers gets pretty muddled pretty quickly. On one hand, Jio brought the Internet to hundreds of millions of Indians that would never have had access, and the benefits of that investment are only going to increase as Jio’s services and partnerships come on line. On the other hand, locking in a monopolistic player, particularly in the context of a government that has shown a desire for more control over the flow of information is a real downside.

The economic outcomes are just as muddled. Monopolies always have deadweight loss; then again, if an efficient market means that all of the profits flow to Silicon Valley, why should India particularly care about efficiency? In a Jio-mediated market it is U.S. tech companies that make less than they would have, and not only does India collect more taxes along the way, Jio’s vision of being a national champion abroad could be a huge win for India in the long run.

The Indian Counterweight

It is increasingly impossible — or at least irresponsible — to evaluate the tech industry, in particular the largest players, without considering the geopolitical concerns at stake. With that in mind, I welcome Jio’s ambition. Not only is it unreasonable and disrespectful for the U.S. to expect India to be some sort of vassal state technologically speaking, it is actually a good thing to not only have a counterweight to China geographically, but also a counterweight amongst developing countries specifically. Jio is considering problem-spaces that U.S. tech companies are all too often ignorant of, which matters not simply for India but also for much of the rest of the world.

Still, Facebook, Google, Intel, Qualcomm, et al should proceed with their eyes wide-open: they are very much a means to an end for a company and a country that is on its own path. That is not to say these investments are not a good idea — I think they are — but India’s path is perhaps a more populist and nationalistic one than many Americans would prefer. Still, it is less antagonistic to Western liberalism than the Chinese Communist Party, and again, an important counterweight.

The only question left, then, is whither Europe, and frankly, the picture is not pretty:

The Four Internets

What differs Europe’s Internet from the U.S., Chinese, or Indian visions is, well, the lack of vision. Doing nothing more than continually saying “no” leads to a pale imitation of the status quo, where money matters more than innovation.

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

The TikTok War

Over the last week, as the idea of banning TikTok in the U.S. has shifted from a fringe idea to a seeming inevitability (thanks in no small part to India’s decision to do just that), those opposed to the idea and those in support seem to be talking past each other. The reasons for this disconnect go beyond the usual divisions in tech, culture, and national security: what makes TikTok so unique is that it is the culmination of two trends: one about humans and the Internet, and the other about China and ideology.

The Analog World

It is always tricky to look at the analog world if you are trying to understand the digital one. When it comes to designing products, a pattern you see repeatedly is copying what came before, poorly, and only later creating something native to the medium.

Consider text: given that newspapers monetized by placing advertisements next to news stories, the first websites tried to monetize by — you guessed it — placing advertisements next to news stories. This worked, but not particularly well; publishers talked about print dollars and digital dimes, and later mobile pennies. Sure, the Internet drew attention, but it just didn’t monetize well.

What changed was the feed, something uniquely enabled by digital. Whereas a newspaper had to be defined up-front, such that it could be printed and distributed at scale, a feed is tailored to the individual in real-time — and so are the advertisements. Suddenly it was print that was worth pennies, while the Internet generally and mobile especially were worth more than newspapers ever were.

At the same time, while mediums change, humans remain the same, and here analog history is helpful; last month I pointed out that while newspaper revenue grew throughout the latter half of the 20th century, circulation actually fell. It’s the same story when it comes to newspapers’ overall share of advertising:

Newspapers' declining share of advertising to TV

Assuming that advertising revenue is a reasonable proxy for attention, it turns out that humans like pictures more than text, and moving pictures most of all; so it has gone on the Internet. Once Facebook introduced the news feed the company quickly figured out that photos drove much more engagement; that meant that Instagram, a fledgling social network made of nothing but photos, was a tremendous threat and, once acquired, a tremendous opportunity.

Four years later, it was Instagram that Facebook used to counter Snapchat’s Stories feature, an even more immersive way of interacting with content than the feed. The point was not to win users back from Snapchat, but to prevent Instagram users from even trying Snapchat out; the gambit succeeded beautifully.

The Rise of TikTok

The rise of TikTok, though, suggests that Facebook didn’t learn the correct lesson from the Snapchat threat: while part of Snapchat’s allure was the possibility of creating a new network in an app predicated on chat and disappearing media, what made Stories particularly compelling is that the experience was closer to video. That meant there was an opportunity to focus on specifically that.

Of course Facebook had spent plenty of time trying to get video to work in its feed; flush with money from its targeted feed-based advertising the company lurched from initiative to initiative predicated on encouraging professional video makers to focus on Facebook instead of YouTube. The error the company made is obvious in retrospect: what has always made Facebook powerful is that its most valuable content is generated by its own users, yet the company was counting on 3rd-parties to make compelling videos.

You can understand Facebook’s thinking: while it is easy for users to create text updates, and, with the rise of smartphones, even easier to create pictures, producing video is difficult. Until recently, phone cameras were even worse at video than they were photos, but more importantly, compelling video takes some degree of planning and skill. The chances of your typical Facebook user having a network full of accomplished videographers is slim, and remember, when it comes to showing user-generated content, Facebook is constrained by who your friends are (the company got busted by the FTC for trying to switch posts from private to public).

All of this explains what makes TikTok such a breakthrough product. First, humans like video. Second, TikTok’s video creation tools were far more accessible and inspiring for non-professional videographers. The crucial missing piece, though, is that TikTok isn’t really a social network.

ByteDance and the Algorithm

This is where it is important to understand the history of ByteDance, TikTok’s Chinese owner. ByteDance’s breakthrough product was a news app called TouTiao; whereas Facebook evolved from being primarily a social network to an algorithmic feed, TouTiao was about the feed and the algorithm from the beginning. The first time a user opened TouTiao, the news might be rather generic, but every scroll, every linger over a story, every click, was fed into a feedback loop that refined what it was the user saw.

Meanwhile all of that data fed back into TouTiao’s larger machine learning processes, which effectively ran billions of A/B tests a day on content of all types, cross-referenced against all of the user data it could collect. Soon the app was indispensable to its users, able to anticipate the news they cared about with nary a friend recommendation in sight. That was definitely more of a feature than a bug in China, where any information service was subject to not just overt government censorship, but also an expectation of self-censorship; all the better to control everything that end users saw, without the messiness of users explicitly recommending content themselves (although that didn’t prevent ByteDance CEO Zhang Yiming from having to give a groveling apology for giving users too much low-brow content).

ByteDance’s 2016 launch of Douyin — the Chinese version of TikTok — revealed another, even more important benefit to relying purely on the algorithm: by expanding the library of available video from those made by your network to any video made by anyone on the service, Douyin/TikTok leverages the sheer scale of user-generated content to generate far more compelling content than professionals could ever generate, and relies on its algorithms to ensure that users are only seeing the cream of the crop. I noted while explaining what Quibi got wrong:

The single most important fact about both movies and television is that they were defined by scarcity: there were only so many movies that would ever be made to fill only so many theater slots, and in the case of TV, there were only 24 hours in a day. That meant that there was significant value in being someone who could figure out what was going to be a hit before it was ever created, and then investing to make it so. That sort of selection and production is what Katzenberg and the rest of Hollywood have been doing for decades, and it’s understandable that Katzenberg thought he could apply the same formula to mobile.

Mobile, though, is defined by the Internet, which is to say it is defined by abundance…So it is on TikTok, or any other app with user-generated content. The goal is not to pick out the hits, but rather to attract as much content as possible, and then algorithmically boost whatever turns out to be good…The truth is that Katzenberg got a lot right: YouTube did have a vulnerability in terms of video content on mobile, in part because it was a product built for the desktop; TikTok, like Quibi, is unequivocally a mobile application. Unlike Quibi, though, it is also an entertainment entity predicated on Internet assumptions about abundance, not Hollywood assumptions about scarcity.

To summarize:

  • Humans prefer video to photos to text
  • TikTok makes it easy to create videos, ensuring a massive supply of content (even if most of the supply is low quality)
  • TikTok relies on the algorithm to surface compelling content, and is not constrained by your social network

This both explains why TikTok succeeds, and why it is an app the United States ought to be concerned about.

China’s War

It was just over a year ago, after the U.S. government placed restrictions on selling components to Huawei, that I pushed back on declarations that tech was entering a cold war:

This is where I take the biggest issue with labeling this past week’s actions as the start of a tech cold war: China took the first shots, and they took them a long time ago. For over a decade U.S. services companies have been unilaterally shut out of the China market, even as Chinese alternatives had full reign, running on servers built with U.S. components (and likely using U.S. intellectual property).

To be sure, China’s motivation was not necessarily protectionism, at least in the economic sense: what mattered most to the country’s ruling Communist Party was control of the flow of information. At the same time, from a narrow economic perspective, the truth is that China has been limiting the economic upside of U.S. companies far longer than the U.S. has tried to limit China’s.

I can’t emphasize this point enough: one of the gravest errors made by far too many people in the U.S. is taking an exceptionally self-centered view of U.S.-China relations, where everything is about what the U.S. says and does, while China is treated like an NPC. Indeed, it is quite insulting to China, a great nation with a history far longer than that of the United States.

To that end, this long history looms large in how China thinks about its relationship to the U.S. specifically, and the West generally. China is driven to reverse its “century of humiliation”, and to retake what it sees as its rightful place as a dominant force in the world. What few in the West seem to realize, though, is that the Chinese Communist Party very much believes that Marxism is the means by which that must be accomplished, and that Western liberal values are actively hostile to that goal. Tanner Greer wrote in Tablet:

Xi Jinping endorsed this explanation for the Soviet collapse in a 2013 address to party cadres. “Why did the Soviet Union disintegrate?” he asked his audience. “An important reason is that in the ideological domain, competition is fierce!” The party leadership is determined to avoid the Soviet mistake. A leaked internal party directive from 2013 describes “the very real threat of Western anti-China forces and their attempt at carrying out westernization” within China. The directive describes the party as being in the midst of an “intense, ideological struggle” for survival. According to the directive, the ideas that threaten China with “major disorder” include concepts such as “separation of powers,” “independent judiciaries,” “universal human rights,” “Western freedom,” “civil society,” “economic liberalism,” “total privatization,” “freedom of the press,” and “free flow of information on the internet.” To allow the Chinese people to contemplate these concepts would “dismantle [our] party’s social foundation” and jeopardize the party’s aim to build a modern, socialist future.

Westerners asked to think about competition with China — a minority until fairly recently, as many envisioned a China liberalized by economic integration — tend to see it through a geopolitical or military lens. But Chinese communists believe that the greatest threat to the security of their party, the stability of their country, and China’s return to its rightful place at the center of human civilization, is ideological. They are not fond of the military machines United States Pacific Command has arrayed against them, but what spooks them more than American weapons and soldiers are ideas—hostile ideas they believe America has embedded in the discourse and institutions of the existing global order. “International hostile forces [seek to] westernize and divide China” warned former CPC General Secretary Jiang Zemin more than a decade ago, and that means that, as Jiang argued in a second speech, the “old international political and economic order” created by these forces “has to be changed fundamentally” to safeguard China’s rejuvenation. Xi Jinping has endorsed this view, arguing that “since the end of the Cold War countries affected by Western values have been torn apart by war or afflicted with chaos. If we tailor our practices to Western values … The consequences will be devastating.”

This is why it was not enough for China to have blocked Western social networks like Facebook or Twitter within China, but to also demand that Western entities like the NBA police Twitter content in the United States; I wrote at the time:

The problem from a Western perspective is that the links Clinton was so sure would push in only one direction — towards political freedom — turned out to be two-way streets: China is not simply resisting Western ideals of freedom, but seeking to impose their own.

This understanding of China’s belief that it is fighting an ideological war explains why the severe curtailing of freedom that happened in Hong Kong this month was inevitable; if the Party’s ideology is ultimately opposed to liberalism anywhere, “one country-two systems” were always empty words in service of China’s rejuvenation, and Marxism’s triumph. To see that reality, though, means taking China seriously, and believing what they say.

TikTok and Data

In that light, the latest TikTok news missed the mark, and ultimately, missed the point; from the New York Times:

Amazon on Friday asked its employees to delete the Chinese-owned video app TikTok from their cellphones, putting the tech giant at the center of growing suspicion and paranoia about the app. Almost five hours later, Amazon reversed course, saying the email to workers was sent in error.

In the initial email, which was obtained by The New York Times, Amazon officials said that because of “security risks,” employees must delete the app from any devices that “access Amazon email.” Employees had to remove the app by Friday to remain able to obtain mobile access to their Amazon email, the note said.

While traditional applications on Macs or PCs had full access to your computer — including your email — on modern smartphones apps exist in “sandboxes”, which, as John Gruber and I discussed on Dithering, are much more akin to a vault or a prison; apps can only access their own data, and a limited set of external data to which they are explicitly granted permission. In other words, banning TikTok because it is surreptitiously stealing your email doesn’t make technical sense.

That is not to say that TikTok is not capturing data: it is vacuuming up as much as it can, from your usage to your IP address to your contacts and location (if you gave the app permission). This, as many TikTok advocates note, is similar to what Facebook does.

This, to be clear, is absolutely true. It is also at this point where important differences emerge. First, Facebook is a U.S. company, and while TikTok claims that it is independent from ByteDance and stores data in the U.S. and Singapore, its privacy policy is clear:

We may share your information with a parent, subsidiary, or other affiliate of our corporate group.

That means that TikTok data absolutely can be sent to China, and, it is important to note, this would be the case even if the privacy policy were not so honest. All Chinese Internet companies are compelled by the country’s National Intelligence Law to turn over any and all data that the government demands, and that power is not limited by China’s borders. Moreover, this requisition of data is not subject to warrants or courts, as is the case with U.S. government requests for data from Facebook or any other entity; the Chinese government absolutely could be running a learning algorithms in parallel to ByteDance’s on all TikTok data.

If anything it would be a something of a surprise were it not; an important piece of China’s thousands of years of history is the presence of a bureaucracy focused on collecting data on, well, everyone and everything. I see examples of it here in Taiwan, where my household is registered, cameras are everywhere (and routinely accessed), and cellphone data is a pandemic fighting tool, and this is a democratic country based on liberal values. China, which combines this tradition with a totalitarian government, takes data collection to the max. Facial recognition is omnipresent, nearly all transactions, even in the real world, are digital, and social networks like WeChat are completely open to censors, both from Tencent and the government; the government even hacks your computers as a matter of policy. Given this reality it is completely reasonable to be concerned about TikTok data!

That, though, is not the primary risk: what should truly concern Americans is the algorithm.

TikTok’s Algorithm

Last month, after President Trump held a rally in Tulsa with a far-smaller crowd than he anticipated, the New York Times suggested that TikTok might be responsible:

President Trump’s campaign promised huge crowds at his rally in Tulsa, Okla., on Saturday, but it failed to deliver. Hundreds of teenage TikTok users and K-pop fans say they’re at least partially responsible…

TikTok users and fans of Korean pop music groups claimed to have registered potentially hundreds of thousands of tickets for Mr. Trump’s campaign rally as a prank. After the Trump campaign’s official account @TeamTrump posted a tweet asking supporters to register for free tickets using their phones on June 11, K-pop fan accounts began sharing the information with followers, encouraging them to register for the rally — and then not show.

Leaving aside whether or not the TikTok campaign or coronavirus concerns were responsible for the low turnout, I actually am inclined to believe that this movement on the video service was genuine. It is important to note, though, that there is no way we can know for sure, and, to the extent that TikTok actually did have an impact on the rally, that should frighten people of all political persuasions.

After all, this certainly wasn’t the first time that TikTok has seemed to act politically: the service censored #BlackLivesMatter and #GeorgeFloyd, blocked a teenager discussing China’s genocide in Xinjiang, and blocked a video of Tank Man. The Guardian published TikTok guidelines that censored Tiananmen Square, Tibetan independence, and the Falun Gong, and I myself demonstrated that TikTok appeared to be censoring the Hong Kong protests and Houston Rockets basketball team.

The point, though, is not just censorship, but its inverse: propaganda. TikTok’s algorithm, unmoored from the constraints of your social network or professional content creators, is free to promote whatever videos it likes, without anyone knowing the difference. TikTok could promote a particular candidate or a particular issue in a particular geography, without anyone — except perhaps the candidate, now indebted to a Chinese company — knowing. You may be skeptical this might happen, but again, China has already demonstrated a willingness to censor speech on a platform banned in China; how much of a leap is it to think that a Party committed to ideological dominance will forever leave a route directly into the hearts and minds of millions of Americans untouched?

Again, this is where it is worth taking China seriously: the Party has shown through its actions, particularly building and maintaining the Great Firewall at tremendous expense, that it believes in the power of information and ideas. Countless speeches, from Chairman Xi and others, have stated that the Party believes it is in an ideological war with liberalism generally and the U.S. specifically. If we are to give China’s leaders the respect of believing what they say, instead of projecting our own beliefs for no reason other than our own solipsism, how can we take that chance?

A Reluctant Prescription

I am not a China absolutist; to give one timely example, while I mourn the end of a free and vibrant Hong Kong that I have had the pleasure of visiting on multiple occasions, I am unmoved by complaints about China’s promised adherence to the Basic Law; it has become clear that was a means to the end of reclaiming Hong Kong from a colonial power,1 and Hong Kong is unquestionably a Chinese city, ultimately subject to Chinese law. Similarly, I abhor and condemn and encourage all to speak out about what is happening to Uighur’s in Xinjiang, but I am not counseling U.S. intervention.

What is increasingly clear, though, is that China’s insistence that the West ignore the country’s “internal affairs” is a sentiment that is not reciprocated; the list of Western companies bullied by China for Western content is long and growing, the country is flooding Twitter and Facebook with coronavirus propaganda, and is leveraging WeChat to spread misinformation and to surveil the Chinese diaspora.

In short, I believe it is time to take China seriously and literally: the Communist Party is not only ideologically opposed to liberalism, it believes that only one of liberalism or Marxism can prevail. To that end it has been taking action for over 20 years to control information within its borders and, over the last several years, to control information outside of its borders. It is time for the U.S. to respond, both on the government level and corporate level, and it should do so in a multi-faceted fashion.

First, data security is absolutely a concern. To that end all companies that deal with valuable intellectual property or national security-related information should ban the use of WeChat by any of their employees, as should the government; it is simply too easy to pass information, even by accident. In addition, that same group of companies and governments should not use Zoom until the (American) company has shifted the bulk of its engineering out of China and demonstrated vastly improved corporate controls.

What matters more in an ideological war, though, is influence, and that is why I do believe that ByteDance’s continued ownership of TikTok is unacceptable. My strong preference would be for ByteDance to sell TikTok to non-Chinese investors or a non-Chinese company, by which I mean not-Facebook. TikTok is not only a brilliant app that figured out video on mobile, it is also shaping up to be a major challenge to Facebook’s hold on attention and thus, in the long run, advertising. This would be a very good thing, and I fear that simply banning TikTok will simply leave the market to Instagram Reels, Facebook’s TikTok clone.

However, if ByteDance is unwilling to sell, then the U.S. government should be willing to act. One possible route is a review of ByteDance’s acquisition of Musical.ly by the Committee on Foreign Investment in the United States (CFIUS), or invoking the International Emergency Economic Powers Act (IEEPA), which would require declaring a national emergency; I would prefer that Congress take the lead. What is notable is that because of the dominance of the iOS App Store and Google Play Store there is no need for an ISP-level firewall; Apple and Google can not only remove TikTok from the App Store, they could, if ordered, make already-installed apps unusable.

This is, without question, a prescription I don’t come to lightly. Perhaps the most powerful argument against taking any sort of action is that we aren’t China, and isn’t blocking TikTok something that China would do? Well yes, we know that is what they would do, because the Chinese government has blocked U.S. social networks for years. Wars, though, are fought not because we lust for battle, but because we pray for peace. If China is on the offensive against liberalism not only within its borders but within ours, it is in liberalism’s interest to cut off a vector that has taken root precisely because it is so brilliantly engineered to give humans exactly what they want.

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

  1. This originally said, “that was an agreement imposed on China by a colonial power” which is not technically correct; the point I was trying to make is that China promulgated the Basic Law as a response to British rule, not because it believed in it []

The Slack Social Network

On November 2, 2016, Microsoft announced Teams at a special event in New York City. Slack decided to mark the occasion:

The text of the ad was condescension cloaked in congratulations:

Dear Microsoft,

Wow. Big news! Congratulations on today’s announcements. We’re genuinely excited to have some competition.

We realized a few years ago that the value of switching to Slack was so obvious and the advantages so overwhelming that every business would be using Slack, or “something just like it,” within the decade. It’s validating to see you’ve come around to the same way of thinking. And even though — being honest here — it’s a little scary, we know it will bring a better future forward faster.

However, all this is harder than it looks. So, as you set out to build “something just like it,” we want to give you some friendly advice.

Slack’s “advice” was, naturally, self-serving, at least in terms of how the startup saw their advantages relative to Microsoft; to quote the ad:

  • It’s not the features that matter
  • An open platform is essential
  • You’ve got to do this with love

The advertisement added under that last point:

We love our work, and when we say our mission is to make people’s working lives simpler, more pleasant, and more productive, we’re not simply mouthing the words. If you want customers to switch to your product, you’re going to have to match our commitment to their success and take the same amount of delight in their happiness.

Two-and-a-half years later Teams passed Slack in daily active users (DAUs). On the company’s last earnings call CEO Satya Nadella revealed that Teams had 75 million daily active users; Slack hasn’t provided a post-pandemic-onset DAU number, but had 12 million last October (Microsoft’s pre-pandemic number was 32 million in early March). And while Slack’s ad may have welcomed Microsoft as a competitor, now CEO Stewart Butterfield is saying that Teams isn’t a competitor after all.

Fortunately for Slack, that is increasingly true.

Microsoft Strikes Back

I have long quipped that most of Silicon Valley has serially underestimated Facebook because it is the social network of friends and family, and many people in tech are trying to escape said friends and family. You can say the same thing about Microsoft: while the company was once the disruptive upstart, for decades it has been the default for all of those businesses that Silicon Valley is seeking to disrupt. Ergo, if those businesses are surely doomed, then so is Microsoft.

Moreover, just as Twitter is the social network of choice within the tech ecosystem, the vast majority of Silicon Valley companies host their email with Google and use Google’s productivity software, or one of the myriad of offerings seeking to usurp documents or spreadsheets or presentations. And even when it comes to the cloud, the choice for startups is usually between AWS and Google Cloud Platform. Microsoft is out-of-sight and out-of-mind.

And then something mysterious occurs; an enterprise SaaS company will grow like a weed, getting buzz amongst investors and the press that covers them, raise rounds for growth, perhaps even IPO, and then, well, Teams versus Slack happens:

Teams versus Slack growth

The obvious reason for Teams’ success relative to Slack is the oldest tactic in the book: Teams is free, and Slack isn’t. Well, technically, Teams requires an Office Microsoft 365 subscription (although yes, there are free versions of both Teams and Slack), but as Slack itself notes, a good portion of its addressable market has exactly that. In other words, the effective choice is exactly what I stated: “free” versus paid.

Moreover, while Slack concluded its advertisement by talking about how difficult it would be for Microsoft to convince Slack users to “switch” to Teams, switching was never the goal: just as Facebook created Instagram Stories to remove the impetus for new users to even try Snapchat, Teams is particularly effective as a way to prevent a Microsoft customer from even trying Slack. And, in that case, it doesn’t matter how much “love” Slack put into its product: said love was not simply unrequited, but unexperienced.

Still, it is not as if all of those Teams users started using the program because they were inspired by Slack: Microsoft has a huge sales team with relationships that go back years, and a massive partner network that serves companies that are too small to sell to directly; I wrote about the latter when Teams passed Slack:

I am sure it was not a coincidence that this announcement happened in the middle of Microsoft’s annual partner conference in Las Vegas. Most of the media pays much more attention to Microsoft’s Build developer conference in the spring, but that is because writing about products is much easier than writing about ecosystems, particularly when it comes to enterprise.

Microsoft’s partner network is a truly gargantuan moat. When it comes to enterprise, it is easy to focus on the biggest companies, where Microsoft will engage directly, and challengers like Slack can build up sales forces to compete. Underneath those companies, though, are tens of thousands of smaller businesses that, even if they have IT directors of their own, rely on outside vendors to build up their technical infrastructure. Here Microsoft has invested heavily in training and equipping these vendors; critically, the company also overhauled its incentive program such that it shares its subscription revenue for Azure and Office 365 with its partners, as opposed to one-off payments for acquiring customers.

The result is that these partners are heavily motivated to offer and implement Microsoft-centric solutions: not only does everything (generally) work together, they also make more money in the process. This, then, is the context of the Teams daily active users announcement: Microsoft wasn’t simply pounding its chest, it was sending a message to its partners that pushing Teams is a winning strategy.

The key is integration.

Microsoft’s Integration

Any discussion of integration and modularization in the context of technology inevitably casts Microsoft as the ultimate example of the latter, particularly relative to Apple. In truth, though, while Windows ran on whatever hardware you wished to throw at it, the company’s software products have always been designed to work together, particularly in the enterprise. Windows Server came with Active Directory, which undergirded Microsoft Exchange, which users accessed via Outlook on their Windows computers that, of course, ran the rest of the Office suite better than anything else. It was, frankly, a pain in the rear end to try and switch out any of the pieces, which Microsoft leveraged to not only lock in its position, but also drive continual upgrades, which it used to justify subscription pricing years before the rest of Silicon Valley discovered the SaaS business model.

The combination of cloud and mobile started to break this integration apart: Microsoft’s misguided Windows-centric strategy meant that Office wasn’t available on the dominant mobile platforms, which drove companies to search out cloud-based alternatives, which made them much easier to both trial and support. That is why it was so important that Satya Nadella’s first public appearance as CEO was announcing Office for iPad, and why his greatest triumph was The End of Windows.

The end of Windows as the center of Microsoft’s approach, and the shift to the cloud, though, did not mean the end of Microsoft’s focus on integration, or its attempt to be an operating system; the company simply changed its definition of what an operating system was; Satya Nadella said at a press briefing in 2019:

The other effort for us is what we describe as Microsoft 365. What we are trying to do is bring home that notion that it’s about the user, the user is going to have relationships with other users and other people, they’re going to have a bunch of artifacts, their schedules, their projects, their documents, many other things, their to-do’s, and they are going to use a variety of different devices. That’s what Microsoft 365 is all about.

Sometimes I think the new OS is not going to start from the hardware, because the classic OS definition, that Tanenbaum, one of the guys who wrote the book on Operating Systems that I read when I went to school was: “It does two things, it abstracts hardware, and it creates an app model”. Right now the abstraction of hardware has to start by abstracting all of the hardware in your life, so the notion that this is one device is interesting and important, it doesn’t mean the kernel that boots your device just goes away, it still exists, but the point of real relevance I think in our lives is “hey, what’s that abstraction of all the hardware in my life that I use?” – some of it is shared, some of it is personal. And then, what’s the app model for it? How do I write an experience that transcends all of that hardware? And that’s really what our pursuit of Microsoft 365 is all about.

This is where Teams thrives: if you fully commit to the Microsoft ecosystem, one app combines your contacts, conversations, phone calls, access to files, 3rd-party applications, in a way that “just works”; I explained my personal experience with Teams in a December 2018 Daily Update:

Here’s the thing, though: Dropbox absolutely is better than One Drive. Google Apps are better at collaboration than Microsoft’s Office apps. Asana is better than Planner. And, to be very clear, Slack is massively better than Teams at chat. Using all of them together, though, well, it sucks: the user experience that matters for me is not any one app but all of them at once, and for the way I want to work, having everything organized in one single place is simply better (and that’s even with the normal spate of maddening Microsoft UI oddities!). In this Teams is less a chat app than it is a file explorer for the cloud generally, and Stratechery LLC specifically.

This is what Slack — and Silicon Valley, generally — failed to understand about Microsoft’s competitive advantage: the company doesn’t win just because it bundles, or because it has a superior ground game. By virtue of doing everything, even if mediocrely, the company is providing a whole that is greater than the sum of its parts, particularly for the non-tech workers that are in fact most of the market. Slack may have infused its chat client with love, but chatting is a means to an end, and Microsoft often seems like the only enterprise company that understands that.

Slack Connect

This left Slack in a very vulnerable position: Teams was “free”, supported by Microsoft’s sales teams and partner network, and, from a certain perspective, was actually easier to use. Unless your job was to chat all day, why choose Slack? In fact, that was the solution: what Slack has done over the last few years is make chat itself into a moat, not just by being better at it, but by expanding who it is you can chat with.

The key piece is Shared Channels, which officially launched in 2019, after a seemingly interminable two-year beta period. From the announcement on Slack’s blog:

Millions of people use Slack every day as a better way to get work done: with faster and more effective collaboration, deeper connections with colleagues, and seamless integrations with the apps and programs we use every day. But what about all the work that happens outside our organizations—with vendors, partners, contractors? Why compromise there?

For that, there’s shared channels, a new feature that allows Slack teams in different organizations to use Slack to collaborate together as easily and productively as they do internally. It’s officially out of beta today and available for all paid plans.

A shared channel works just like a normal Slack channel, only now connecting organizations. This means a team from Company A is communicating in the same Slack channel as their partners at Company B. New people coming into a project can readily access a project’s archive, allowing them to ramp up swiftly. Teams can easily share updates and files, loop in the right people, and quickly make decisions—all from a single place in Slack.

Shared Channels are a far more compelling feature than Slack’s attempt at a platform, particularly when it comes to accentuating the ways in which Slack is better than Teams. First, chat is the point, not integrating with toolchains that are probably different on a company-by-company basis, which lets Slack’s strengths as a chat client come to the forefront. Second, because Slack is not deeply integrated with a bunch of other applications, it is actually easier for it to horizontally connect different companies. Third, being first actually matters.

Consider Slack Connect, which the company announced late last month:

For years, Slack has been changing the way millions of people work together within their organizations. By shifting internal communication out of inboxes and into channels, teams can work more transparently with each other and get more done. But we know the work doesn’t stop at a company’s walls. That’s why today, we’re taking the next step and bringing all the benefits of Slack to everyone you work with, both inside and outside your organization. Introducing Slack Connect: a more secure and productive way for organizations to communicate together.

More than four years in the making and developed with customers, Slack Connect is a secure communications environment that lets you move all the conversations with your external partners, clients, vendors and others into Slack, replacing email and taking business collaboration to the next level…Starting today, up to 20 organizations can come together in a single Slack channel, enabling customers to bring even more of their external ecosystem into Slack—such as their entire supply chain, corporate subsidiaries or industry peers.

Slack Connect is about more than chat: not only can you have multiple companies in one channel, you can also manage the flow of data between different organizations; to put it another way, while Microsoft is busy building an operating system in the cloud, Slack has decided to build the enterprise social network. Or, to put it in visual terms, Microsoft is a vertical company, and Slack has gone fully horizontal:

Slack is going horizontal; Microsoft is vertical

This doubles down on all of the advantages of shared channels. The user experience of chat specifically is what matters; the only reason this is even possible is because Slack is focused on one specific part of the stack, and the more companies that take advantage of Slack Connect the more of a moat Slack has. That’s the thing about social networks: their best feature is whether or not your friends are on it, or, in this case, whether or not the companies you are working with are using Slack.

I certainly find it compelling: it is hard to imagine how the Stratechery podcast service would have been built without shared channels, which means that yes, I pay for both Microsoft 365 and Slack, and happily so. Moreover, I can’t imagine ever not paying — Stratechery LLC is already tied into 4 other companies, and that number will only go up. It appears that Slack has learned the lesson all successful companies must learn: idealistic statements — or advertisements — about building with “love” are a lot less useful than actually understanding what solutions you can build that both solve customer problems and give your product a moat in the process.


Slack’s shift into being an enterprise social network is not necessarily bad news for Microsoft; if anything it removes a potential contender for the enterprise cloud OS. It does, though, raise the question of who will actually build the modular alternative to Microsoft?

The obvious answer is Google: the company has both the resources and, in the case of G Suite, the core products to do so. The biggest obstacle is that the search company is the exception that proves the rule: Google search won simply by being better, in a market that was both desperate for what the company built, and completely open. A better search engine really was just a click away.

The problem this presents to Google’s enterprise efforts is that the company has never learned how to listen to customers, how to sell, or how to build an ecosystem. Yes, Android has as many apps as you might want, but that is more a function of just how massive the mobile opportunity is (which is why Apple can be a rent-seeking platform for developers yet have a huge ecosystem). Creating a full stack alternative to Microsoft filled with best-of-breed apps will require capabilities that Google has never really demonstrated.

For that reason, while Microsoft still needs to learn how to capture new companies, its moat with most of the enterprise market appears as strong as ever; Slack deserves credit for carving out its own.

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

Apple and Facebook

When it comes to the big four consumer tech companies — Microsoft’s decision to close its retail stores was the culmination of a step-back from the consumer space five years in the making — Google and Amazon have always had moats that were easier to understand. Google has a huge advantage in data and infrastructure, augmented by its control of consumer touch points (by owning Android outright, and paying heavily for default placement on other platforms); Amazon has a huge advantage in infrastructure and data, augmented by its control of the number one consumer touch point for shopping (the Amazon search box). Building a competitor for either feels daunting at best, impossible at worst.

Apple’s Moat

Apple, though, faced questions about the sustainability of its business for years, even after the runaway success of the iPhone; one of the topics that helped Stratechery gain traction in its first year was arguing that the iPhone was actually not about to be disrupted as so many — including Professor Clayton Christensen himself — were sure was going to happen. I explained why Apple’s approach was sustainable in 2014’s Best:

Moreover, integrated solutions will just about always be superior when it comes to the user experience: if you make the whole thing, you can ensure everything works well together, avoiding the inevitable rough spots and lack of optimization that comes with standards and interconnects. The key, though, is that this integration and experience be valued by the user. That is why — and this was the crux of my criticism of Christensen’s development of the theory — the user experience angle only matters when the buyer of a product is also the user. Users care about the user experience (surprise), but an isolated buyer — as is the case for most business-to-business products, and all of Christensen’s examples — does not. I believe this was the root of Christensen’s blind spot about Apple, which persists. From an interview with Henry Blodget a month ago:

You can predict with perfect certainty that if Apple is having that extraordinary experience, the people with modularity are striving. You can predict that they are motivated to figure out how to emulate what they are offering, but with modularity. And so ultimately, unless there is no ceiling, at some point Apple hits the ceiling. So their options are hopefully they can come up with another product category or something that is proprietary because they really are good at developing products that are proprietary. Most companies have that insight into closed operating systems once, they hit the ceiling, and then they crash.

That’s the thing though: the quality of a user experience has no ceiling. As nearly every other consumer industry has shown, as long as there is a clear delineation between the top-of-the-line and everything else, some segment of the user base will pay a premium for the best. That’s the key to Apple’s future: they don’t need completely new products every other year (or half-decade); they just need to keep creating the best stuff in their categories. Easy, right?

It’s not easy, of course, and yet when it comes to hardware in particular, Apple’s lead is greater than it ever was, thanks in large part to its superior systems-on-a-chip; the headline news from WWDC was that Apple is extending that particular advantage to the Mac.

Of course having the best device is not enough either — this was the other reason why Apple was, according to many, eternally doomed; here is Blodget again in Business Insider, in 2013:1

If smartphones and tablets were not a platform — if the only thing that mattered to the value of the product and a customer’s purchase decision was the gadget itself — then Apple’s loss of market share would not make a difference. Apple zealots would be correct when they smugly assert that what matters is Apple’s “profit share” not “market share.”

But smartphones and tablets are a platform. Third-party companies are building apps and services to run on smartphone and tablet platforms. These apps and services, in turn, are making the platforms more valuable. Consumers are standardizing their lives around the apps and services that run on smartphone and tablet platforms. Because of these “network effects,” in platform markets, dominant market share is huge competitive advantage. In platform markets, as the often-hated but always insanely powerful Microsoft demonstrated for decades in the PC market, the vast majority of the power and profits eventually accrue to the market-share leader.

In fact, it turned out that Apple’s prioritization of the user experience wasn’t simply a moat, but also a point of leverage with developers, who need Apple much more than Apple needs them. Thus the second big story over the last two weeks, which has been Apple’s App Store policies: it appears that Apple has significantly tightened its unwritten rules over the last year as the company seeks to increase its Services revenue. Developers, from the smallest to the largest, have no choice but to accede to the iPhone maker’s demands because Apple has combined the loyalty of the most valuable users with App Review, an unavoidable gatekeeper in terms of getting apps onto those users’ iPhones.

The Bill Gates Line

Facebook, meanwhile, is often thought of as being the opposite of Apple: Apple sells products, and Facebook sells advertising. Apple minimizes data collection, and Facebook maximizes it. Apple is a platform, and Facebook is just an app.

What both share, though, is a sort of eternal skepticism from Silicon Valley in particular. Facebook, for its part, has been doubted from its formation to its decision to decline Yahoo’s acquisition offer to its post-IPO stock price slump; every hot new social app, from Twitter to Snapchat to TikTok, is framed as the service that will finally doom Facebook to being the next MySpace.

The truth, though, is that in many respects Facebook is more of a platform than Apple is. In 2018 I wrote about The Bill Gates Line, which was actually coined as criticism of Facebook:

Over the last few weeks I have been exploring what differences there are between platforms and aggregators, and was reminded of this anecdote from Chamath Palihapitiya in an interview with Semil Shah:

Semil Shah: Do you see any similarities from your time at Facebook with Facebook platform and connect, and how Uber may supercharge their platform?

Chamath Palihapitiya: Neither of them are platforms. They’re both kind of like these comical endeavors that do you as an Nth priority. I was in charge of Facebook Platform. We trumpeted it out like it was some hot shit big deal. And I remember when we raised money from Bill Gates, 3 or 4 months after — like our funding history was $5M, $83 M, $500M, and then $15B. When that 15B happened a few months after Facebook Platform and Gates said something along the lines of, “That’s a crock of shit. This isn’t a platform. A platform is when the economic value of everybody that uses it, exceeds the value of the company that creates it. Then it’s a platform.”

By this measure Windows was indeed the ultimate platform — the company used to brag about only capturing a minority of the total value of the Windows ecosystem — and the operating system’s clear successors are Amazon Web Services and Microsoft’s own Azure Cloud Services. In all three cases there are strong and durable businesses to be built on top.

A drawing of Platform Businesses Attract Customers by Third Parties

Once a platform dips under the Bill Gates Line, though, the long-term potential of a business built on a “platform” starts to decline. Apple’s App Store, for example, has all of the trappings of a platform, but Apple quite clearly captures the vast majority of the overall ecosystem, both because of the profitability of the iPhone and also because of its control of App Store economics; the paucity of strong and durable businesses on the App Store is a natural outgrowth of that.

A drawing of Apple's Control of the App Store Ecosystem

Note that Apple’s ability to control the economics of its developers comes from intermediating the relationship of those developers with customers.

What is missing in this story is how exactly all of those developers made money on the App Store. Yes, without question, a big part of it was the iPhone’s explosive growth and how the App Store made it easy and safe to install apps. Another very big part of it, though, was Facebook.

Facebook’s Platform

Facebook’s early stumbles on mobile are well-documented: the company bet on web-based apps that just didn’t work very well; the company completely rewrote its iOS app even as it was going public, which meant it had a stagnating app at the exact time mobile was exploding, threatening the desktop advertising product and platform that were the basis of the company’s S-1.

The re-write turned out to be not just a company-saving move — the native mobile app had the exact same user-facing features as the web-centric one, with the rather important detail that it actually worked — but in fact an industry-transformational one: one of the first new products enabled by the company’s new app were app install ads. From TechCrunch in 2012:

Facebook is making a big bet on the app economy, and wants to be the top source of discovery outside of the app stores. The mobile app install ads let developers buy tiles that promote their apps in the Facebook mobile news feed. When tapped, these instantly open the Apple App Store or Google Play market where users can download apps.

The ads are working already. One client TinyCo saw a 50% higher click through rate and higher conversion rates compared to other install channels. Facebook’s ads also brought in more engaged users. Ads tech startup Nanigans clients attained 8-10X more reach than traditional mobile ad buys when it purchased Facebook mobile app install ads. AdParlor racked up a consistent 1-2% click through rate.

Facebook’s App Install product quickly became the most important channel for acquiring users, particularly for games that monetized with Apple’s in-app purchase API: the combination of Facebook data with developer’s sophisticated understanding of expected value per app install led to an explosion in App Store revenue. And yet, even this was seen as a reason to doubt Facebook; in 2015 I wrote about a prominent venture capitalist’s Facebook skepticism:

Much of the criticism of app install ads rests on obsolete assumptions that view apps as fun baubles instead of the dominant interaction layer between companies and consumers. If you start with the premise that apps are more important than web pages or any other form of interaction when it comes to connecting with consumers, being the dominant channel for app installs seems downright safe.

Surely, though, at least some portion of Facebook’s revenue must come from app-install ads for games, no? Absolutely! But even that is less of a danger than critics think for three reasons:

  • It’s a mistake to assume that just because venture-backed companies have a tendency to be profligate with their money that app install ad spending is little more than “spray-and-pray”. In fact, app install ads are not just direct marketing, which is much easier to track, Facebook app install ads in particular are one of the most data rich ad formats around…
  • That said, were I a venture capitalist like Gurley, I would be gun-shy about mobile gaming; there are a whole host of examples of one-shot wonders that attract funding or even IPO on a hit game only to struggle to recreate their initial success. I think it’s a really hard area to invest in. Facebook, though, doesn’t need to care if a particular gaming company succeeds or fails, because they aren’t exposed to any one gaming company: they have exposure to the industry as a whole. And on that note:
  • Mobile gaming revenue is not a flash-in-the-pan. According to Newzoo, a video game research firm, global mobile game revenues is expected to surpass console revenue this year. Interestingly — and perhaps this makes the space a bit of a blind-spot for U.S.-based observers — console spending will still dominate in North America ($11.1 billion to $7.2 billion); it’s in the rest of the world — particularly in Asia — where mobile is absolutely dominant.

…Ultimately, if there is a bubble, everyone will suffer, including Facebook. But big picture I continue to consider the company the most underrated in the Valley (which is kind of amazing). Facebook has barely scratched the surface of their monetization capabilities, brand advertising has yet to migrate from TV, Instagram still isn’t monetized at all, and to cap it off Facebook usage is still increasing. This is a juggernaut that, if there is a downturn, is more likely to be the exception to industry doldrums than the rule.

While this excerpt is about mobile games, the analysis applies to a whole host of industries that have grown up on Facebook, like direct-to-consumer e-commerce companies:

  • Facebook’s targeting is a particularly potent combination for companies that convert on-line. Indeed, the biggest mistake I’ve made in evaluating the company is over-estimating the potential of brand advertising and under-appreciating just how large the direct response opportunity was.
  • Relatedly, the direct response opportunity is so large because Facebook has created the conditions for new direct response-based companies to be created. For apps, this opportunity was created in conjunction with Apple and Google (Android); for e-commerce this opportunity was created in conjunction with Shopify. What both examples have in common is that Facebook’s advertising was a critical factor in creating new businesses that were unique to the Internet.
  • It’s not just mobile gaming that is more than a flash-in-the-pain: the transformative impact of the Internet is only starting to be felt, which is to say that the long run will be less about traditional companies adopting digital than it will be about their entire way of doing business being rendered obsolete.

One of my favorite examples are CPG companies.

Facebook’s Anti-Fragility

In 2016’s TV Advertising’s Surprising Strength — And Inevitable Fall I observed:

The very institution of television advertising is intertwined with the kinds of advertisers that use it the most, the products they sell, and the way they are bought-and-sold. And what should be terrifying to television executives is that all of those pieces that make television advertising the gold mine that it has been are under the exact same threat that TV watching itself is: the threat of the Internet…

CPG is the perfect example: building a “house of brands” allows a company like Procter & Gamble to target demographic groups even as they leverage scale to invest in R&D, bring down the cost of products, and most importantly, dominate the distribution channel (i.e. retail shelf space). Said retailers, meanwhile, are huge in their own right, not only so they can match their massive suppliers at the bargaining table but also so they can scale logistics, inventory management, store development, etc. Automobile companies, meanwhile, are not unlike CPG companies: they operate a “house of brands” to serve different demographics while benefitting from scale in production and distribution; the primary difference is that they make money through one large purchase instead of over many smaller purchases over time.

Similar principles apply to the other companies on this list: all are looking to reach as many consumers as possible with blunt targeting at best, all benefit from scale, and all are looking to earn significant lifetime value from consumers. And, along those lines, all can afford the expense of TV. In fact, the top 200 advertisers in the U.S. love TV so much that they make up 80% of television advertising, despite accounting for only 51% of total advertising (and 41% of digital).

This is a very different picture from Facebook, where as of Q1 2019 the top 100 advertisers made up less than 20% of the company’s ad revenue; most of the $69.7 billion the company brought in last year came from its long tail of 8 million advertisers.

This focus on the long-tail, which is only possible because of Facebook’s fully automated ad-buying system, has turned out to be a tremendous asset during the coronavirus slow-down. I explained after Facebook’s Q1 2020 earnings:

That first bit gets at the other thing the Wall Street Journal article got wrong: it is not simply that direct response stayed strong while brand advertising declined, but rather that Facebook actually received more direct response advertising because brand advertising declined…

Notice, though, what happens in a situation like the coronavirus crisis, where a segment of advertisers competing for limited inventory stop buying ads: the mobile gaming company doesn’t reduce their budget — to do so would be to kill the company! — but in fact ends up getting more efficient spend. Suddenly the clearing price for the auction to show those app install ads is $0.75 per app install; now the mobile gaming company is getting 26,667 app installs for its $20,000 spend, which results in an expected profit of $6,667.

This does, obviously, entail downside for Facebook — that extra ~$6,000 in profit is out of Facebook’s pocket — but at the same time the loss is capped because not only is the mobile gaming company not reducing its spend, it is in fact incentivized to increase its spend given the reduced competition and thus increased profitability for its ads. And, of course, as that opportunity is seized on by more and more companies, Facebook’s profits, which in the end are gated by the amount of inventory it has, not only return to normal but arguably have more upside, given that usage of the platform is increasing.

This explains why the news about large CPG companies boycotting Facebook is, from a financial perspective, simply not a big deal. Unilever’s $11.8 million in U.S. ad spend, to take one example, is replaced with the same automated efficiency that Facebook’s timeline ensures you never run out of content. Moreover, while Facebook loses some top-line revenue — in an auction-based system, less demand corresponds to lower prices — the companies that are the most likely to take advantage of those lower prices are those that would not exist without Facebook, like the direct-to-consumer companies trying to steal customers from massive conglomerates like Unilever.

In this way Facebook has a degree of anti-fragility that even Google lacks: so much of its business comes from the long tail of Internet-native companies that are built around Facebook from first principles, that any disruption to traditional advertisers — like the coronavirus crisis or the current boycotts — actually serves to strengthen the Facebook ecosystem at the expense of the TV-centric ecosystem of which these CPG companies are a part.

The Apple Vulnerability

Facebook, though, has a vulnerability: Apple. From AdAge:

Apple announced new privacy changes to its upcoming iOS 14 software that will significantly hinder how media buyers and brands target, measure and find consumers. One change will make it harder for apps to track iOS users across different apps and websites. Another will make attribution — determining which tactics contribute to sales or conversions — harder for marketers.

The changes, announced Monday at Apple’s Worldwide Developers Conference, apply to the company’s Identifier for Advertisers (IDFA), which assigns a unique number to a user’s mobile device. Advertisers have access to the feature and use it in areas including ad targeting, building lookalike audiences, attribution and encouraging consumers to download apps.

IDFA is shared with app makers and advertisers by default, but that will change once iOS 14 rolls out this fall. Then, users must give explicit permission through a popup for app publishers to track them across different apps and websites, or to share that information with third parties.

Facebook was the king of the IDFA (and the Google Advertising ID equivalent on Android): it was the linchpin around which its app install business in particular was built. The company could understand when a user spent a certain amount in a game, for example, look for users that were similar, and then display an app install ad for that game, and measure how effective it was. In fact, over the last few years, Facebook has simply asked advertisers to specify what return on ad spend they are hoping to achieve, and Facebook does all of the work of figuring out how many ads to display to which users — the entire process is automated.

This part of the business is going to change a lot. Apple was quite clever in their approach: instead of killing the IDFA, which could be construed as anti-competitive, particularly given Apple’s expanding app install ad business (which is expanding beyond App Store search ads), Apple is simply asking users if they would like to be tracked, and letting them render the IDFA useless. Notably, Facebook has declined to even show app install advertisements to the 30% of U.S. iPhone users that turned off their IDFA of their own accord — and now it is opt-in, instead of opt-out.

Still, I wouldn’t count Facebook out: to the extent the company is hurt, it seems likely that the universe of 3rd-party ad tech companies that lack Facebook’s direct connection with users, both in terms of data collection and ad display, will be in far worse shape, and it is not as if the digital ecosystem — and its associated advertising — is going to disappear. Indeed, much like GDPR, the safe bet is the company with the wherewithal to make lemons out of lemonade. Notably, Apple’s alternative for app install ad campaigns, SKAdNetwork, is so limited that there is likely to be tremendous value in whatever company can create the exact sort of automated campaign creation that Facebook is already offering.

It’s also worth noting that Apple’s crackdown on web cookies has also helped Facebook, as I explained last month; by making it more difficult for 3rd-party payment providers to offer a seamless experience, Apple is opening the door to Facebook taking over payments for direct-to-consumer companies:

Facebook Shops is a perfect example: it is going to succeed because it is good for Shopify’s merchants, but the reason it is good for Shopify’s merchants is because Facebook and Apple effectively teamed up to make it impossible for Shopify to fix the payment problem on their own.

This is what makes the Apple-Facebook dynamic so fascinating: Facebook’s biggest opportunities come from filling in the holes in Apple’s platform proposition, even as Apple seems opposed to Facebook at every turn.

Shared Risk

What is particularly notable is how conflict between the two companies threatens their greatest assets.

Start with Apple: while its battle against cookies and effective obliteration of the IDFA are from one perspective deeply rooted in its focus on users, it is impossible to ignore the company’s focus on Services revenue. Making the web less useful makes apps more useful, from which Apple can take its share; similarly, it is notable that Apple is expanding its own app install product even as it is knee-capping the industry’s. The question is if these attempts to maximize services revenue are in service of the user experience, or Apple’s bottom line; the company should take care to remember that the latter follows the former.

Facebook, meanwhile, already sees promise in taking business from its best partners, as seen in the announcement of Facebook Shops; there may be a similar temptation when it comes to IDFA, given that the IDFV — Identifier for Vendor, which allows a vendor to get the device ID from its own apps — is still available. Might Facebook consider shifting its business model from being an advertising platform for other apps into a WeChat-like publishing model for the most popular games and services?2 The company should also take care: its service of the long tail has not only made it more of a Bill-Gates platform than Apple, but is also the foundation of the company’s strength in crisis.

Regardless, what seems clearer than ever is that it is these two companies, Apple and Facebook, that are driving the industry. That their approaches are so different is in fact why they are the pairing that matters most.

  1. I previously quoted this piece in Beachheads and Obstacles. []
  2. I do expect a lot of consolidation in the mobile gaming industry, particularly amongst hyper-casual game publishers, for exactly this reason []

The End of OS X

On May 6, 2002, Steve Jobs opened WWDC with a funeral for Classic Mac OS:

Yesterday, 18 years later, OS X finally reached its own end of the road: the next version of macOS is not 10.16, but 11.0.

macOS 11.0

There was no funeral.

The OS X Family Tree

OS X has one of the most fascinating family trees in technology; to understand its significance requires understanding each of its forebearers.

The OS X Family Tree

Unix: Unix does refer to a specific operating system that originated in AT&T’s Bell Labs (the copyrights of which are owned by Novell), but thanks to a settlement with the U.S. government (that was widely criticized for going easy on the telecoms giant), Unix was widely-licensed to universities in particular. One of the most popular variants that resulted was the Berkeley Software Distribution (BSD), developed at the University of California, Berkeley.

What all of the variations of Unix had in common was the Unix Philosophy; the Bell System Technical Journal explained in 1978:

A number of maxims have gained currency among the builders and users of the Unix system to explain and promote its characteristic style:

  1. Make each program do one thing well. To do a new job, build afresh rather than complicate old programs by adding new “features”.
  2. Expect the output of every program to become the input to another, as yet unknown, program. Don’t clutter output with extraneous information. Avoid stringently columnar or binary input formats. Don’t insist on interactive input.
  3. Design and build software, even operating systems, to be tried early, ideally within weeks. Don’t hesitate to throw away the clumsy parts and rebuild them.
  4. Use tools in preference to unskilled help to lighten a programming task, even if you have to detour to build the tools and expect to throw some of them out after you’ve finished using them.

[…]

The Unix operating system, the C programming language, and the many tools and techniques developed in this environment are finding extensive use within the Bell System and at universities, government laboratories, and other commercial installations. The style of computing encouraged by this environment is influencing a new generation of programmers and system designers. This, perhaps, is the most exciting part of the Unix story, for the increased productivity fostered by a friendly environment and quality tools is essential to meet every-increasing demands for software.

Today you can still run nearly any Unix program on macOS, but particularly with some of the security changes made in Catalina, you are liable to run into permissions issues, particularly when it comes to seamlessly linking programs together.

Mach: Mach was a microkernel developed at Carnegie Mellon University; the concept of a microkernel is to run the smallest amount of software necessary for the core functionality of an operating system in the most privileged mode, and put all other functionality into less privileged modes. OS X doesn’t have a true microkernel — the BSD subsystem runs in the same privileged mode, for performance reasons — but the modular structure of a microkernel-type design makes it easier to port to different processor architectures, or remove operating system functionality that is not needed for different types of devices (there is, of course, lots of other work that goes into a porting a modern operating system; this is a dramatic simplification).

More generally, the spirit of a microkernel — a small centralized piece of software passing messages between different components — is how modern computers, particularly mobile devices, are architected: multiple specialized chips doing discrete tasks under the direction of an operating system organizing it all.

Xerox: The story of Steve Jobs’ visiting Xerox is as mistaken as it is well-known; the Xerox Alto and its groundbreaking mouse-driven graphical user interface was well-known around Silicon Valley, thanks to the thousands of demos the Palo Alto Research Center (PARC) did and the papers it had published. PARC’s problem is that Xerox cared more about making money from copy machines than in figuring out how to bring the Alto to market.

That doesn’t change just how much of an inspiration the Alto was to Jobs in particular: after the visit he pushed the Lisa computer to have a graphical user interface, and it was why he took over the Macintosh project, determined to make an inexpensive computer that was far easier to use than anything that had come before it.

Apple: The Macintosh was not the first Apple computer: that was the Apple I, and then the iconic Apple II. What made the Apple II unique was its explicit focus on consumers, not businesses; interestingly, what made the Apple II successful was VisiCalc, the first spreadsheet application, which is to say that the Apple II sold primarily to businesses. Still, the truth is that Apple has been a consumer company from the very beginning.

This is why the Mac is best thought of as the child of Apple and Xerox: Apple understood consumers and wanted to sell products to them, and Xerox provided the inspiration for what those products should look like.

It was NeXTSTEP, meanwhile, that was the child of Unix and Mach: an extremely modular design, from its own architecture to its focus on object-oriented programming and its inclusion of different “kits” that were easy to fit together to create new programs.

And so we arrive at OS X, the child of the classic Macintosh OS and NeXTSTEP. The best way to think about OS X is that it took the consumer focus and interface paradigms of the Macintosh and layered them on top of NeXTSTEP’s technology. In other words, the Unix side of the family was the defining feature of OS X.

Return of the Mac

In 2005 Paul Graham wrote an essay entitled Return of the Mac explaining why it was that developers were returning to Apple for the first time since the 1980s:

All the best hackers I know are gradually switching to Macs. My friend Robert said his whole research group at MIT recently bought themselves Powerbooks. These guys are not the graphic designers and grandmas who were buying Macs at Apple’s low point in the mid 1990s. They’re about as hardcore OS hackers as you can get.

The reason, of course, is OS X. Powerbooks are beautifully designed and run FreeBSD. What more do you need to know?

Graham argued that hackers were a leading indicator, which is why he advised his dad to buy Apple stock:

If you want to know what ordinary people will be doing with computers in ten years, just walk around the CS department at a good university. Whatever they’re doing, you’ll be doing.

In the matter of “platforms” this tendency is even more pronounced, because novel software originates with great hackers, and they tend to write it first for whatever computer they personally use. And software sells hardware. Many if not most of the initial sales of the Apple II came from people who bought one to run VisiCalc. And why did Bricklin and Frankston write VisiCalc for the Apple II? Because they personally liked it. They could have chosen any machine to make into a star.

If you want to attract hackers to write software that will sell your hardware, you have to make it something that they themselves use. It’s not enough to make it “open.” It has to be open and good. And open and good is what Macs are again, finally.

What is interesting is that Graham’s stock call could not have been more prescient: Apple’s stock closed at $5.15 on March 31, 2005, and $358.87 yesterday;1 the primary driver of that increase, though, was not the Mac, but rather the iPhone.

The iOS Sibling

If one were to add iOS to the family tree I illustrated above, most would put it under Mac OS X; I think, though, iOS is best understood as another child of Classic Mac and NeXT, but this time the resemblance is to the Apple side of the family. Or to put it another way, while the Mac was the perfect machine for “hackers”, to use Graham’s term, the iPhone was one of the purest expressions of Apple’s focus on consumers.

The iPhone, as Steve Jobs declared at its unveiling in 2007, runs OS X, but it was certainly not Mac OS X: it ran the same XNU kernel, and most of the same subsystem (with some new additions to support things like cellular capability), but it had a completely new interface. That interface, notably, did not include a terminal; you could not run arbitrary Unix programs.2 That new interface, though, was far more accessible to regular users.

What is more notable is that the iPhone gave up parts of the Unix Philosophy as well: applications all ran in individual sandboxes, which meant that they could not access the data of other applications or of the operating system. This was great for security, and is the primary reason why iOS doesn’t suffer from malware and apps that drag the entire system into a morass, but one certainly couldn’t “expect the output of every program to become the input to another”; until sharing extensions were added in iOS 8 programs couldn’t share data with each other at all, and even now it is tightly regulated.

At the same time, the App Store made principle one — “make each program do one thing well” — accessible to normal consumers. Whatever possible use case you could imagine for a computer that was always with you, well, “There’s an App for That”:

Consumers didn’t care that these apps couldn’t talk to each other: they were simply happy they existed, and that they could download as many as they wanted without worrying about bad things happening to their phone — or to them. While sandboxing protected the operating system, the fact that every app was reviewed by Apple weeded out apps that didn’t work, or worse, tried to scam end users.

This ended up being good for developers, at least from a business point-of-view: sure, the degree to which the iPhone was locked down grated on many, but Apple’s approach created millions of new customers that never existed for the Mac; the fact it was closed and good was a benefit for everyone.

macOS 11.0

What is striking about macOS 11.0 is the degree to which is feels more like a son of iOS than the sibling that Mac OS X was:

  • macOS 11.0 runs on ARM, just like iOS; in fact the Developer Transition Kit that Apple is making available to developers has the same A12Z chip as the iPad Pro.
  • macOS 11.0 has a user interface overhaul that not only appears to be heavily inspired by iOS, but also seems geared for touch.
  • macOS 11.0 attempts to acquire developers not primarily by being open and good, but by being easy and good enough.

The seeds for this last point were planted last year with Catalyst, which made it easier to port iPad apps to the Mac; with macOS 11.0, at least the version which will run on ARM, Apple isn’t even requiring a recompile: iOS apps will simply run on macOS 11.0, and they will be in the Mac App Store by default (developers can opt-out).

In this way Apple is using their most powerful point of leverage — all of those iPhone consumers, which compel developers to build apps for the iPhone, Apple’s rules notwithstanding — to address what the company perceives as a weakness: the paucity of apps in the Mac App Store.

Is the lack of Mac App Store apps really a weakness, though? When I consider the apps that I use regularly on the Mac, a huge number of them are not available in the Mac App Store, not because the developers are protesting Apple’s 30% cut of sales, but simply because they would not work given the limitations Apple puts on apps in the Mac App Store.

The primary limitation, notably, is the same sandboxing technology that made iOS so trustworthy; that trustworthiness has always come with a cost, which is the ability to build tools that do things that “lighten a task”, to use the words from the Unix Philosophy, even if the means to do so opens the door to more nefarious ends.

Fortunately macOS 11.0 preserves its NeXTSTEP heritage: non-Mac App Store apps are still allowed, for better (new use cases constrained only by imagination and permissions dialogs) and worse (access to other apps and your files). What is notable is that this was even a concern: Apple’s recent moves on iOS, particularly around requiring in-app purchase for SaaS apps, feel like a drift towards Xerox, a company that was so obsessed with making money it ignored that it was giving demos of the future to its competitors; one wondered if the obsession would filter down to the Mac.

For now the answer is no, and that is a reason for optimism: an open platform on top of the tremendous hardware innovation being driven by the iPhone sounds amazing. Moreover, one can argue (hope?) it is a more reliable driver of future growth than squeezing every last penny out of the greenfield created by the iPhone. At a minimum, leaving open the possibility of entirely new things leaves far more future optionality than drawing the strings every more tightly as on iOS. OS X’s legacy lives, for now.

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

  1. Yes, this incorporates Apple’s 7:1 stock split []
  2. Unless you jailbroke your phone []