Vacation Break: Week of June 17

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Tech and Antitrust

Four years ago I wrote Aggregation Theory, which argued that technology companies, uniquely enabled by zero marginal costs, were dominant by virtue of user preference driving suppliers onto their platforms, creating a virtuous cycle. Then, one month later, I predicted that the end state of Aggregation Theory would be increased demands for antitrust action. From Aggregation and the New Regulation:

This last point is key: under Aggregation Theory the winning aggregators have strong winner-take-all characteristics. In other words, they tend towards monopolies. Google is perhaps the best Aggregation Theory example of all — the company modularized individual pages from the publications that housed them even as it became the gateway to said pages for the vast majority of people — and so, given their success, perhaps it shouldn’t be a surprise that the company is under formal investigation by the European Union.

There was a second more subtle point in that article, though:

In other words, the regulation situation for these massive winner-take-all companies is not hopeless, but it has changed: their strength derives from the customer relationships they own, which means quiet backroom deals and straight-up arm wrestling of the Google and Uber varieties are liable to backfire in the face of overwhelming public opinion; it is in shaping that public opinion that the real battle will be fought. And while it’s true that the direct relationship aggregation companies have with their users is an advantage in this fight, the overwhelming power of social media is the new counterweight: it is easier than ever to reach said users with a report or column that resonates deeply. Your average writer or reporter has more (potential) power, not less.

This seems like the best explanation for how we have arrived at the current moment; Reuters reported last week that the U.S. Department of Justice and the Federal Trade Commission were divvying up tech companies for potential antitrust investigations — Google and Apple to the former, and Facebook and Amazon to the latter — a seemingly natural endpoint to what has been a mounting drumbeat for regulatory action against tech.

There’s just one problem: it’s not clear what there is to investigate.

I should state an obligatory caveat: I am not a lawyer or economist, which is relevant given that U.S. antitrust cases are adjudicated in court and largely driven by expert testimony. That reality, though, only underscores the point: any case against these four companies (with possibly one exception, which I will get to momentarily), will be extremely difficult to win.1 To explain why, it is worth examining all four companies with regards to:

  • Whether or not they have a durable monopoly
  • What anticompetitive behavior they are engaging in
  • What remedies are available
  • What will happen in the future with and without regulator intervention

In addition, for comparison’s sake, I will evaluate late 1990’s Microsoft, the last major tech antitrust case in the United States, along the same dimensions.

Durable Monopolies

The FTC defines monopolization as follows:

Courts do not require a literal monopoly before applying rules for single firm conduct; that term is used as shorthand for a firm with significant and durable market power — that is, the long term ability to raise price or exclude competitors. That is how that term is used here: a “monopolist” is a firm with significant and durable market power. Courts look at the firm’s market share, but typically do not find monopoly power if the firm (or a group of firms acting in concert) has less than 50 percent of the sales of a particular product or service within a certain geographic area. Some courts have required much higher percentages. In addition, that leading position must be sustainable over time: if competitive forces or the entry of new firms could discipline the conduct of the leading firm, courts are unlikely to find that the firm has lasting market power.

There are (at least) two major questions that arise from this: how is the relevant market defined, and what does it mean for market power to be sustainable over time?

1990s Microsoft: Microsoft was found to have a monopoly on operating systems for personal computers, and that advantage was found to be durable because of the lock-in created by the network effects between developers using the Windows API and users. Both conclusions were reasonable.

Google: Google certainly has a dominant position in search, but the real question is around durability. Google has long argued that “Competition is only a click away”, which has the welcome benefit of being true.

The European Commission handled this objection by arguing that Google also enjoys network effects:

There are also high barriers to entry in these markets, in part because of network effects: the more consumers use a search engine, the more attractive it becomes to advertisers. The profits generated can then be used to attract even more consumers. Similarly, the data a search engine gathers about consumers can in turn be used to improve results.

This is certainly a much more tenuous lock-in than the Windows API, but I think it is a plausible one.

Apple: There is no company for which the question of market definition matters more than Apple. The company is eager to point out that the iPhone has a minority smartphone share in every market in which it competes; even in the U.S., Apple’s best market, the iPhone has 45% share, less than the 50 percent of sales the FTC suggests as a cut-off.

In Europe, Apple is likely in trouble when it comes to the European Commission’s investigation of Apple about Spotify’s complaints about the App Store. In the Google Android case the European Commission determined that “Google is dominant in the markets for general internet search services, licensable smart mobile operating systems and app stores for the Android mobile operating system.” That last clause leaves room for Apple to be found dominant in app store for the iOS mobile operating system, at which point taking 30% of Spotify’s revenue (or else forbidding Spotify to even link to a web page with a sign-up form) will almost certainly be ruled illegal.

I strongly suspect the Department of Justice will have a much more difficult time convincing a federal court that such a narrow definition is appropriate, but at the same time, I’m not certain that “smartphones” are the correct market definition either. Suggesting that users changing ecosystems is a sufficient antidote to Apple’s behavior is like suggesting that users subject to a hospital monopoly in their city should simply move elsewhere; asking a third party to remedy anticompetitive behavior by incurring massive inconvenience with zero immediate gain is just as problematic as making up market definitions to achieve a desired result.

Facebook: Here again market definitions are very fuzzy. Most people have multiple social media accounts across both Facebook and non-Facebook services, which means any sort of workable market share definition would have to rely on “time-spent” or some other zero-sum metric. Moreover, it’s not clear what is or is not a social network: does iMessage count? What about text messaging generally? What about email?

There certainly is an argument that Google and Facebook are a duopoly when it comes to digital advertising, but it is not as if either has the power to foreclose supply: there is effectively infinite advertising inventory on the Internet, which suggests that Google and Facebook earn more advertising dollars because they are better at advertising, not because they foreclose competition.

Amazon: There really is no plausible argument that Amazon has a monopoly. Yes, the company has around 37% of e-commerce sales, but (1) that is obviously less than 50% and (2) the competition is only a click away! Moreover, it’s not clear why “e-commerce” is the relevant market, and in terms of retail Amazon has low single-digits market share.

Anticompetitive Behavior

But for a few exceptions, everything that follows is moot if the company in question is not found to have a durable monopoly. After all, “anticompetitive behavior” is simply another name for “driving differentiation”, which no one should want to be illegal for any company that is not in a dominant position; it is the potential to make outsized profits that drives innovation.

Still, it is worth examining what, if anything, these companies do that might be considered problematic.

1990s Microsoft: Microsoft was found guilty of illegally bundling Internet Explorer with Windows and unfairly restricting OEMs from shipping computers with alternative browsers (or alternative operating systems). The first objection is particularly interesting in 2019, given that it is unimaginable that any operating system would ship without web browser functionality (which, at a minimum, would obviate an essential distribution channel for 3rd-party software). The second is much more problematic: as I wrote in Where Warren’s Wrong, competition-constraining contracts from dominant players should be viewed with extreme skepticism, as their purpose is almost always to extend dominance, not increase consumer welfare.

Google: Again — and note a developing theme here — Google’s anticompetitive behavior is relatively clear. First, the company consistently favors its own properties in search results, particularly “above-the-fold” — that is, results that are not actually search results but which seek to answer the user’s query directly. A partial list:

  • Google by-and-large removed video segments from competing properties in favor of YouTube videos
  • Google offers local results from Google Maps above search results that tend to favor Yelp, TripAdvisor, etc.
  • Google offers hotel and flight listings above search results that tend to favor Booking, Expedia, etc.
  • Google displays AMP-enabled websites (a Google technology) above search results that are agnostic about how a web page is displayed.
  • Google displays tweets for individuals (thanks to a beneficial relationship with Twitter) above search results that tend to favor LinkedIn, Facebook, etc.

Of these local is probably the most open-and-shut case (although Google’s efforts around travel and hospitality are on the same track): Google Maps results were worse, got better when Google scraped data from competitors (which it stopped doing after an FTC investigation), and now is somewhat competitive by sheer force of exposure to customers defaulting to Google search.

Then, of course, there is Android, where Google leveraged the Play Store to force Android OEMs to feature Search and Chrome, and further forbade said OEMs from shipping any phones with open-source Android alternatives (a la Microsoft). This is one case the European Commission got exactly right.

Apple: As I argued in Antitrust, the App Store, and Apple, Apple is leveraging its position in the smartphone market to earn rents in the market for digital goods:

To put it another way, Apple profits handsomely from having a monopoly on iOS: if you want the Apple software experience, you have no choice but to buy Apple hardware. That is perfectly legitimate. The company, though, is leveraging that monopoly into an adjacent market — the digital content market — and rent-seeking. Apple does nothing to increase the value of Netflix shows or Spotify music or Amazon books or any number of digital services from any number of app providers; they simply skim off 30% because they can.

For this to be illegal does not necessarily require that Apple have a monopoly: tying (i.e. iOS users must use the App Store) is per se illegal in theory, but in practice the Supreme Court has dramatically constricted the definition of tying to include a requirement that the tie-er have market dominance; the Supreme Court also declined to review the Court of Appeals decision in the Microsoft case, which held that courts should use a rule of reason test for software specifically that also considers the benefits of tying, not simply the downsides.

I would certainly argue that the requirement that digital content use Apple’s payment processor (and thus give up 30%) has downsides that outweigh the benefits, but the truth is that this is a case that, under U.S. antitrust law, is harder to make than it was 20 years ago.

Facebook: There are certainly plenty of reasons to be upset with Facebook when it comes to issues of privacy, but the company has not done anything illegal from an antitrust perspective.

I am, to be clear, distinguishing anti-competitive behavior from anti-competitive mergers. I have made the case as to why Facebook’s acquisition of Instagram was so problematic, and this is the area that needs the most urgent attention from anyone who cares about competition. The single best way to maintain a dominant position in a market as dynamic as technology is to use the outsized profits that come from winning in one market to buy the winner in another; it follows, then, that the best way to spur competition in the long run is to force companies to compete with new entrants, not buy them out.

Amazon: Make no mistake, Amazon drives a very hard bargain with its suppliers. Those suppliers, though, have a whole host of alternatives through which to sell their product. Meanwhile, those hard bargains accrue to consumers’ benefit.

Similarly, it is very hard to see why Amazon can’t offer its own branded goods; this practice is widespread in retail, and for good reason: consumers get a better price, not only on the store-branded goods, but also on 3rd-party goods that can be priced more competitively since the retailer is making its margin on its own goods.

In short, more than any company on this list, the arguments against Amazon fall apart on the first point: Amazon simply isn’t a monopoly.


Remedies by definition come last: there has to be something worth remedying! Still, it is interesting to consider what the appropriate remedy for each company would be if they were indeed found to be a monopoly engaged in illegal anticompetitive behavior.

1990s Microsoft: Microsoft was originally ordered to be broken-up, although this remedy was overruled on appeal. The idea was that Windows would better serve all 3rd-party software suppliers if it weren’t incentivized to favor its own offerings. Ultimately, though, the company agreed to open up its API, although critics argued that the specifics simply cemented Windows’ dominance, instead of making it possible to build a Windows alternative that could run 3rd-party Windows applications.

The European Commission went further both in terms of requiring interoperability and also presenting users with choice in terms of both browsers and media players. In both cases 3rd-party competitors actually won in the long run — but they won because they were clearly better (first Firefox and then Chrome, and iTunes).

Google: An effective Google remedy would likely be more about constraining Google behavior than it would be about restructuring Google itself. Google might be forbidden from offering its own results for things like local search, or be forced to feature results from competitors according to an algorithm overseen by a court observer. There would also likely be a large fine.

Apple: The obvious remedy for Apple would be allowing 3rd-party payment processors for apps; frankly, I think this might go too far, as there are real benefits to Apple controlling everything API-related on the iOS platform. I would be satisfied with Apple allowing apps to launch web views for payment processing that is clearly handled on the app’s own webpage.

Alternatively, Apple could be forced to significantly reduces its App Store take rate, but I would prefer that Apple be forced to compete for payment processing business, which would achieve a similar result.

Facebook: Facebook, fascinatingly enough, given its lack of anticompetitive behavior, has the most obvious remedy: break apart Facebook, Instagram, and WhatsApp. I do believe this would be beneficial for competition: Instagram being an independent company would not only add another competitor for digital advertising, but would also make other companies like Snapchat more competitive by virtue of forcing advertisers to diversify. Again, though, this is more about a failure in merger review.

Amazon: Amazon has made anti-competitive acquisitions of its own, like Zappos and Those platforms are gone though, making any sort of breakup unrealistic (this is likely at least one factor in Facebook’s plans to integrate messaging across its platforms — that will make a breakup that much more difficult). And as far as selling its own products goes, not only is that probably not a problem, but there is little evidence 3rd-party sellers are being hurt by Amazon’s policies, and plenty of evidence that they are helped by having access to Amazon’s customers. Moreover, highly differentiated suppliers have found success prioritizing other retailers if Amazon squeezes too hard.

The Future

Ideally, an antitrust action is not simply about punishing bad behavior in the past, but also about ensuring competition going forward. To that end, it is worth considering whether the upheaval that would result from any sort of investigation would actually make a long-term difference.

1990s Microsoft: Here the Microsoft case is particularly pressing. It is my contention that Microsoft failed to compete on the Internet and in mobile because the company was fundamentally unsuited to do so, both in terms of culture and capability.

The implication of this conclusion is that the antitrust case against Microsoft was largely a waste of time: the company would have been surpassed by Google and Apple regardless (and that the company only returned to prominence when it embraced a market that suited its capabilities and transformed its culture).

Many disagree to be sure, arguing that the antitrust case prevented Microsoft from foreclosing Google, although it is never clear as to how Microsoft would have done so (nor any explanation as to why Microsoft failed in mobile, where they were not constrained). A better argument is IBM: the government may have ultimately failed in its antitrust case against the mainframe behemoth, but IBM did voluntarily separate its software sales from its hardware sales, setting the stage for its own disruption; then again, the bigger factor was that IBM simply didn’t care enough about PCs to lock them down effectively.

Google: I wrote that we had reached Peak Google in 2014; clearly I was wrong, at least as far as the company’s results and stock price were concerned, but notably the company is ever more dependent on search advertising. One of my biggest mistakes was underestimating the degree to which Google could monetize mobile, not simply through increased adoption but also stuffing results with ever more ads (which, in the limited viewport of smartphones, are even easier to tap on).

That, though, is also an argument that my mistake was one of timing, not thesis (still a mistake, to be clear). For all of Google’s seeming advantages in machine learning, the company has yet to come up with a true second act in terms of driving revenue and profits (with the notable exception of YouTube, an acquisition).

Frankly, I suspect this is why Google is the most at-risk in this analysis: when a company is growing, it has no need to engage in anti-competitive behavior; it is only when the low-hanging fruit is gone that the risk of leveraging one market into another becomes worth it.

Apple: That analysis applies to Apple as well: the company introduced the “Services Narrative” in the 6S cycle, which in retrospect was when iPhone growth plateaued. Suddenly the rent Apple collected from apps was not simply an added bonus to a thriving iPhone business but a core driver of the company’s stock price.

At the same time, it is not as if iPhones are disappearing: there is still an argument to act for the sake of all of the businesses that will be hurt in the meantime. The same argument applies to Google: just because antitrust action isn’t necessarily causal when it comes to a company being eclipsed doesn’t mean it can’t be an important tool to maintain competition in the meantime.

Facebook: As I noted above, Instagram bought Facebook another five-to-ten years of dominance. That, though, is itself evidence that social networks are not forever. Each generation has its own preferences, and as long as acquisition rules around network-based companies are significantly beefed up, the best solution for Facebook, at least from an antitrust perspective, is simply time.

Amazon: This probably deserves a longer article at some point, but I think there is reason to believe that Amazon’s consumer business has also slowed considerably. The company is pushing more into ads, squeezing its suppliers, and driving customers to 3rd-party merchants with their attendant higher margins (for Amazon). This makes sense: there are certain categories of products that make sense for e-commerce, and Amazon does very well there, but will — and perhaps has — hit a ceiling as far as overall retail share is concerned.

Indeed, a mistake many tech company critics make is assuming that graphs that are up-and-to-the-right continue indefinitely; nearly all of those graphs are S-curves that will flatten out, and it is dangerous making regulatory decisions without some sort of insight as to when that flattening will occur.

Ultimately, when it comes to antitrust actions against tech companies in the U.S., there really isn’t nearly as much there as all of the attendant fervor would suggest. Google is absolutely vulnerable, Apple somewhat less so, and it is very hard to see any sort of case against Facebook or Amazon.

And again, this is probably a trailing indicator: Google and Apple have maximized their gains from their most important products, while Facebook and Amazon (particularly AWS) still have growth potential. I don’t think this alignment is a coincidence.

That is not to say that tech deserves no regulation: questions of privacy, for example, are something else entirely. Nor, for that matter, is antitrust irrelevant in the United States generally: concentration has increased dramatically throughout the economy.

What is driving that concentration matters, though: at the end of the day tech companies are powerful because consumers like them, not because they are the only option. Consumer welfare still matters, both in a court of law and in the court of public opinion.

  1. I will mention the European Commission’s different standards in passing; I addressed the differences between U.S. and European approaches more fully in 2016’s Antitrust and Aggregation []

Apple’s Audacity

It is the nature of hardware that a computer the vast majority of Apple’s customers will never own was the headline from the company’s keynote at its annual Worldwide Developer’s Conference (WWDC). The Mac Pro starts at $6,000, and will be configurable to a number many times that. If you think that is absurd, or would simply rather buy a new car, well, you’re not the target customer.

At the same time, here I am, leading with the Mac Pro, just like those headline writers, and I’m not incentivized by hardware driving clicks: it was fun seeing what Apple came up with in its attempt to build the most powerful Mac ever, in the same way it is fun to read about supercars. More importantly, I thought that sense of “going for it” that characterized the Mac Pro permeated the entire keynote: Apple seemed more sure of itself and, consequentially, more audacious than it has in several years.

The iPhone Plateau

In retrospect, the previous malaise around Apple should have been expected. When a product like the iPhone comes along — and make no mistake, there are very few products like the iPhone! — the goal is simply to hold on to a rocket ship. Growth was trivial: simply add a new country or a new carrier, and predict iPhone sales with eerie accuracy. That all culminated with the iPhone 6, when Apple’s forecasts were finally wrong — there was far more pent-up demand for larger screens than anyone anticipated.

It turned out that was the peak: Apple would again miss forecasts with the iPhone 6S, but this time their mistake was expecting growth that never materialized, eventually resulting in a $2 billion inventory draw-down. The forecasts did get better, but as I explained last year, unit growth never returned:

The 6S was the new normal: iPhone unit sales have been basically flat ever since:

iPhone unit sales over time

What has changed is Apple’s pricing: the iPhone 7 Plus cost $20 more than the iPhone 6S Plus. Then, last year, came the big jump: both the iPhones 8 and 8 Plus cost more than their predecessors ($50 and $30 respectively); more importantly, they were no longer the flagship. That appellation belonged to the $999 iPhone X, and given how many Apple fans will only buy the best, average selling price skyrocketed:

iPhone average selling price over time

From a financial perspective, it didn’t much matter where the growth came from — more units or more revenue per unit. The iPhone, though, was no longer a rocket ship scaling to new heights; it was an institution, something with roots, and something that could be exploited.

This changes a company: instead of looking outwards for opportunity, the gaze turns inwards. In 2018 I called it Apple’s Middle Age:

Apple’s growth is almost entirely inwardly-focused when it comes to its user-base: higher prices, more services, and more devices…The high-end smartphone market — that is, the iPhone market — is saturated. Apple still has the advantage in loyalty, which means switchers will on balance move from Android to iPhone, but that advantage is counter-weighted by clearly elongating upgrade cycles. To that end, if Apple wants growth, its existing customer base is by far the most obvious place to turn.

In short, it just doesn’t make much sense to act like a young person with nothing to lose: one gets older, one’s circumstances and priorities change, and one settles down. It’s all rather inevitable…The fact of the matter is that Apple under Cook is as strategically sound a company as there is; it makes sense to settle down. What that means for the long run — stability-driven growth, or stagnation — remains to be seen.

The long-run came quickly: one year later CEO Tim Cook had to issue a revenue warning thanks to slumping iPhone sales; after four years of accounting for between 68-70% of Apple’s revenue in the company’s fiscal first quarter, the iPhone suddenly only accounted for 62%.

It might have been the best thing that could have happened to Apple.

Three Announcements

There were three announcements in yesterday’s keynote that, particularly when taken together, spoke to a company moving forward.

The first was the end of iTunes, which will be split into separate Music, Podcasts, and TV apps; device syncing will be handed by the Finder. This is both straightforward and overdue, but still meaningful: while iTunes didn’t save Apple, the application is the connective thread of one of the greatest growth stories in business history. There is a direct line from the introduction of iTunes in January 2001 to the introduction of the iPod later that year, then the iTunes Music Store in 2003 (upon which the App Store was built), and ultimately the iPhone in 2007. iTunes provided the foundation for everything that followed, and it seems appropriate that the application is going away at the same time that growth story is coming to a close.

The second was the introduction of iPadOS. This is, to be clear, mostly a marketing move: iPadOS is very much the same iOS it was two days ago. Marketing moves can matter, though: in this case — much like the Mac Pro — it is a statement from Apple that the non-iPhone parts of its business still matter. While the company was on the iPhone plateau it wasn’t so clear that management cared about either — both the iPad and Mac languished, the former in terms of software, and the latter in terms of hardware — but now there is real evidence the company is fully back in. That management no longer had a choice is besides the point.

The third announcement was the App Store on Apple Watch. While there was not any news about the Apple Watch being completely untethered from the iPhone — non-cellular models have no choice — it is a clear step towards making the Watch independent.1 That, by extension, completely changes the Watch’s addressable market from iPhone users to everyone. This was likely Apple’s endgame all along, but there is more urgency than there may have been even six months ago, and that is a great thing: better urgency than complacency.

Privacy and Purpose

Last fall Cook gave a remarkable speech at the 40th International Conference of Data Protection and Privacy Commissioners in Europe. This was certainly not the first time Cook has spoken about privacy, but the clarity, purpose, and passion with which Cook spoke was striking. I wrote about the speech in a Daily Update, so I will not break it down in full here, but this portion is worth highlighting again:

Now there are many people who would prefer I never said all of that. Some oppose any form of privacy legislation; others will endorse reform in public and then resist and undermine it behind closed doors. They may say to you, “Our companies can never achieve technology’s true potential if they are constrained with privacy regulation.” But this notion isn’t just wrong: it is destructive. Technology’s potential is, and always must be, rooted in the faith people have in it, in the optimism and the creativity that it stirs in the hearts of individuals, and in its promise and capacity to make the world a better place. It’s time to face facts: we will never achieve technology’s true potential without the full faith and confidence of the people who use it.

It was only a month ago that Google made a very different pitch, making the case that the services it created with all of the data it collected was a tradeoff worth making. Unsurprisingly, the two different visions aligned with the company’s two different business models: data collection is obviously integral to advertising, and privacy a differentiating factor for Apple’s high-end hardware.

What I appreciated about both company’s events, though, was the commitment. Google did not try to obfuscate or hide how its products worked, but rather embraced and dwelled on the centrality of user data to its offerings. Apple, similarly, emphasized privacy at every turn, and did so with passion: it felt like the fight for privacy has given the entire company a new sense of purpose, and that is invaluable.

In short, it is clear that privacy has become more than a Strategy Credit for Apple. It is a driving force behind the company’s decisions, both in terms of product features and also strategy. This is particularly apparent in perhaps the most important announcement yesterday, Sign In with Apple.

Sign In with Apple

It’s important to note that the question of privacy goes far beyond Google and Facebook — it predates the Internet. Starting in the 1960s companies began collecting all of the personal information on individual consumers they could get; Lester Wunderman gave it the sanitized name of “direct marketing”. Everything from reward programs to store loyalty discounts to credit cards were created and mined to better understand and market to those individual consumers.

The Internet plugged into this existing infrastructure: it was that much easier to track what users were interested in, particularly on the desktop, and there were far more places to put advertisements in front of them. Mobile actually tamped this down, for a bit: there was no longer one browser that accepted cookies from anyone and everyone, which made it harder to track. That, though, was a boon for Facebook in particular: its walled-garden both collected data and displayed advertisements all in one place.

Over time Facebook extended its data collection far beyond the Facebook app: both it and Google have a presence on most websites, and offering login services for apps not only relieves developers from having to manage identities but also give both companies a view into what their users are doing. The alternative is for users to use their email address to create accounts, but that is hardly better: your email address is to data collectors as your house address was fifty years ago — a unique identifier that connects you to the all-encompassing profiles that have been built without your knowledge.

This is the context for Sign In with Apple: developers can now let Apple handle identity instead of Facebook or Google. Furthermore, users creating accounts with Sign In with Apple have the option of using a unique email address per service, breaking that key link to their data profiles, wherever they are housed.

This was certainly an interesting announcement in its own right: identity management is one of the single most powerful tools in technology. Owning identity was and is a critical part of Microsoft’s dominance in enterprise, and the same could be said of Facebook in particular in the consumer space. Apple making a similar push — or even simply weakening the position of others — is noteworthy.

Privacy and Power

Still, Sign In with Apple is a hard sell for most developers who have already aligned themselves with Facebook or Google or have rolled their own solution. And, given that developers want to make money, is it really worth adding on an identity manager that would likely interfere with that?

Then came the bombshell in Apple’s Updates to the App Store Guidelines:

Sign In with Apple will be available for beta testing this summer. It will be required as an option for users in apps that support third-party sign-in when it is commercially available later this year.

Apple is going to leverage its monopoly position as app provider on the iPhone to force developers (who use 3rd party solutions)2 to use Sign In with Apple. Keep in mind, that also means building Sign In with Apple into related websites, and even Android apps, at least if you want users to be able to login anywhere other than their iPhones. It was quite the announcement, particularly on a day where it became clear that Apple was a potential target of U.S. antitrust investigators.

It is also the starkest example yet of how the push for privacy and the push for competition are, as I wrote a year ago often at odds. Apple is without question proposing an identity solution that is better for privacy, and they are going to ensure that solution gets traction by leveraging their control of the App Store.

Note, though, that even this fits in the broader theme of Apple regaining its mojo: complaints about the App Store have been in part about data but mostly about Apple’s commission and refusal to allow alternative payment methods. It is a tactic that very much fits into the “get more revenue from existing customers” approach that characterized the last few years.

Sign In with Apple, though, is much more aggressive and strategic in nature: it is a new capability, that could both hurt competitors and attract new users. It is the move of a company looking outwards for opportunity, and motivated by something more intrinsic than revenue. It is very Apple-like, and while there will be a lot of debate about whether leveraging the App Store in this way is illegal or not, it is a lot more interesting for the industry to have Apple off the iPhone plateau.

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

  1. The Watch will now be able to update itself as well []
  2. One unanswered question: what about enterprise single sign-on offerings like Okta? []

China, Leverage, and Values

Tim Culpan declared at Bloomberg that The Tech Cold War Has Begun after the Trump administration barred companies viewed as national security threats from selling to the U.S., and blocked U.S. companies from selling to Huawei specifically without explicit permission. Culpan writes:

The prospect that the U.S. government would cut off the supply of components to Huawei was precisely what management had been anticipating for close to a year, Bloomberg News reported Friday. Huawei has at least three months of supplies stockpiled. That’s not a lot, but it speaks to the seriousness with which the Shenzhen-based company took the threat.

There’s hope that this latest escalation is just part of the U.S.’s trade-war posturing and will be resolved as part of broader negotiations. Huawei, or Chinese leaders, are unlikely to be so naive as to share that. Even the briefest of bans will be proof to them that China can no long rely on outsiders.

We can now expect China to redouble efforts to roll out a homegrown smartphone operating system, design its own chips, develop its own semiconductor technology (including design tools and manufacturing equipment), and implement its own technology standards. This can only accelerate the process of creating a digital iron curtain that separates the world into two distinct, mutually exclusive technological spheres.

I agree with Culpan’s overall conclusions, and dived into some of the short and medium-term implications of the Trump administration’s action in yesterday’s Daily Update. However, to the extent that a “tech Cold War has begun”, that is only because a war takes two.

The ZTE Ban

Huawei’s preparation for this moment likely started last year when a similar ban was placed on the sale of American components to ZTE; as I explained at the time:

Obviously the United States government cannot tell a Chinese company what to do. However, the U.S. government can tell American companies what to do, and that includes determining what technology can be exported, and to whom. To that end, countries like Iran and North Korea have long been subject to U.S. sanctions, which means that it is illegal for U.S. companies in many sectors, particularly technology-related ones, to export products to those countries (including digital products like licensed software). And, by extension, U.S. companies cannot knowingly export embargoed products to companies that then sell those products to countries covered by those sanctions.

That ZTE was flouting those sanctions was well-known, and the company settled with the U.S. government in 2017. The action last year, then, was in response to ZTE allegedly violating that settlement; at the same time, it was hard not to wonder if there was any relation to the ongoing trade dispute with China?

Similar questions surround this Huawei action: the Trump administration ultimately made a deal to spare ZTE, and a waiver has already been granted allowing Huawei to service existing networks and phones in the U.S.

Still, if you’re looking for the start of this “tech cold war”, the move against ZTE was arguably the bigger deal: for the first time the extreme vulnerability China’s tech giants have to U.S. action was laid bare.

The U.S. Advantage

While tech devices like iPhones are “Made in China”, it is important to note that little of the technology originates there — less than $10 worth, in fact. Much more goes to component suppliers in the United States, South Korea, Taiwan, and Japan1 (and obviously, even more goes to Apple itself).

The reality is that China is still relatively far behind when it comes to the manufacture of most advanced components, and very far behind when it comes to both advanced processing chips and also the equipment that goes into designing and fabricating them. Yes, Huawei has its own system-on-a-chip, but it is a relatively bog-standard ARM design that even then relies heavily on U.S. software. China may very well be committed to becoming technologically independent, but that is an effort that will take years.

That is why the best that Huawei could do over the last year was stockpile supplies: the U.S. retains a significant upper-hand in this “war”. At the same time, cutting off Chinese customers like Huawei will cost U.S. suppliers dearly: high-value components by definition entail very large research and development costs and significant capital outlays for their manufacture; that means that profit comes from volume, and losing a massive customer like Huawei would be costly.

China has one other card to play: rare earth elements. These 17 elements2 are essential for electronic components, and China dominates their production, accounting for over 90% of the world’s supply. The country flexed its power in 2010, imposing export quotas (which were later ruled illegal by the WTO) that caused prices to skyrocket, at least for non-Chinese companies, giving Chinese companies an advantage. To that end, it is certainly not a coincidence that Chinese President Xi Jinping toured a rare earth mining and processing center yesterday, accompanied by China’s top trade negotiator.

China’s Protectionism

China’s 2010 rare earth export reduction wasn’t the only shot the country has taken: in January of that year Google announced that its network had been hacked by China, resulting in the theft of intellectual property, and that the company was reevaluating its approach to the Chinese market. Soon after Google closed down its China operations and directed users to its Hong Kong site, which was summarily blocked by the Great Firewall.

Google was hardly alone in this regard: YouTube, Twitter, and Facebook were all blocked in 2009, and since Google’s block sites like Instagram, Dropbox, Pinterest, Reddit, and Discord have been as well, along with a whole host of media sites like the Wall Street Journal, New York Times, and Wikipedia.

Indeed, this is where I take the biggest issue with Culpan 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).3

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.

Not that the U.S. investor class cared: for U.S. component suppliers China provided not only revenue but scale; for hardware manufacturers like Apple China provided low labor costs and an increasingly sophisticated base of manufacturing expertise, and full-on design services for more commoditized OEM’s like PC makers. And while U.S. services may not have been allowed in China, U.S. venture capital money was certainly allowed to invest in Chinese startups.

The truth is that the U.S. China relationship has been extremely one-sided for a very long time now: China buys the hardware it needs, and keeps all of the software opportunities for itself — and, of course, pursues software opportunities abroad. At the same time, U.S. acquiescence to this state of affairs has denied China the necessary motivation to actually make the investments necessary to replace U.S. hardware completely, leading to this specific moment in time.

A Question of Leverage

To that end, and leaving aside broader questions about the Trump administration’s approach to trade with China, when it comes to a “tech cold war” I think the U.S. has the most leverage it ever will have: the U.S. advantage in advanced components, particularly processors and their fabrication, is massive, and will only grow if the U.S. is able to gain the support of countries like South Korea, Japan, and Taiwan. Yes, China will spend whatever is necessary to catch up, but it will take a lot of time.

The primary potential pain points for the U.S., meanwhile, are those same component manufacturers that China needs, whose revenue and profits will be hurt, rare earths, and Apple. The latter is more exposed to China than anyone, on two fronts: first, the company’s massive manufacturing facilities in China, and second, the importance of the Chinese consumer market to the iPhone in particular.

This does not guarantee that Apple will be retaliated against: Apple employs millions of Chinese, both directly in manufacturing and also component suppliers, and the Chinese leadership will be loath to leave any of them unemployed. And, on the flipside, Chinese consumers, particularly those in influential first-tier cities, like Apple products. I do think the latter is more likely to be impacted than the former: China can do a lot to disrupt Apple’s consumer-facing operations in China, as they already have in both services and iPhone sales.

The other big question is if the Trump administration will levy tariffs on iPhones for U.S. consumers: to date Apple has been largely spared, but the U.S. is running out of goods to slap tariffs on; again the company benefits from its popularity with end users, who would be much more sensitive to a rise in iPhone prices than just about anything else.

A Question of Values

For obvious reasons, I think most people in tech are opposed to the Trump administration’s approach: not only is Trump unpopular in Silicon Valley generally (which means his policies are), but the near-term damage to U.S. tech companies could be significant.

At the same time, as someone who has argued that technology is an amoral force, China gives me significant pause. On one hand, while the shift of manufacturing to China has hurt the industrial heartlands of both the U.S. and Europe, nothing in history has had a greater impact on the alleviation of poverty and suffering of humanity generally than China’s embrace of capitalism and globalization, protectionist though it may have been. Technology, particularly improvements in global communication and transportation capabilities, played a major role in that.

On the other hand, for all of the praise that is heaped on Chinese service companies like Tencent for their innovation, the fact that everything on Tencent is monitored and censored is chilling, particularly when people disappear. The possibilities of a central government creating the conditions for, say, self-driving cars or some other top-down application of technology is appealing, but turning a city into a prison through surveillance is terrifying. And while it is tempting to fantasize about removing “fake news” and hateful content with an iron fist, it is a step down the road to removing everything that is objectionable to an unaccountable authority with little more than an adjustment to a configuration file.

This is the true war when it comes to technology: censorship versus openness, control versus creativity, and centralization versus competition. These are, of course, connected: China’s censorship is about control facilitated by centralization. That, though, should not only give Western tech companies and investors pause about China generally, but should also lead to serious introspection about the appropriate policies towards our own tech industry. Openness, creativity, and competition are just as related as their counterparts, and infringement on any one of them should be taken as a threat to all three.

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

  1. The relative order varies based on the iPhone model; the iPhones XS, for example, gets its very expensive OLED screen from Samsung in South Korea, and its processor from TSMC in Taiwan. Previous iPhone models sources screens from Japan and processors from Samsung. []
  2. The elements are cerium (Ce), dysprosium (Dy), erbium (Er), europium (Eu), gadolinium (Gd), holmium (Ho), lanthanum (La), lutetium (Lu), neodymium (Nd), praseodymium (Pr), promethium (Pm), samarium (Sm), scandium (Sc), terbium (Tb), thulium (Tm), ytterbium (Yb), and yttrium (Y) []
  3. This doesn’t even address rampant piracy in China: the country was one of Microsoft’s largest markets by usage, but drove revenue equivalent to the Netherlands. []

Google Fights Back

For a company famed for its engineering culture, you wouldn’t expect a video at Google’s annual I/O developer conference to have such emotional resonance. And yet, just watch (I have included the context around the video in question, which starts at the 2:33 mark):

“I liked that very much.”

"I liked that very much"

This was the most direct statement of what was a clear theme from Google’s entire keynote:
“Technology, particularly Google’s technology, is a good thing, and we are going to remind you why you like it.”

Google’s Mission

As he opened the keynote, CEO Sundar Pichai, as he always does, repeated Google’s mission statements:

Google's Mission

It all begins with our mission to organize the world’s information and make it universally accessible and useful, and today, our mission feels as relevant as ever.

Pichai, though, quickly pivoted to something rather different than simply organizing and presenting information:

The way we approach it is constantly evolving. We are moving from a company that helps you find answers to a company that helps you get things done…We want our products to work harder for you in the context of your job, your home, and your life, and they all share a single goal: to be helpful, so we can be there for you in moments big and small over the course of your day.

In short, the mission statement may be the same, but what that means for Google and its products has shifted:

Google's goal

Our goal is to build a more helpful Google for everyone. And when we say helpful, we mean giving you the tools to increase your knowledge, success, health, and happiness. We feel so privileged to be developing products for billions of users, and with that scale comes a deep sense of responsibility to create things that improve people’s lives. By focusing on these fundamental attributes, we can empower individuals and benefit society as a whole.

This set the stage for the rest of the keynote, including the video above: Google spent most of the keynote demonstrating — both with actual products, and a whole bunch of vaporware — how Google could take a much more proactive role in its users’ lives in ways they ought appreciate.

Google’s Data Collection

To be sure, not all of the demos were of unassailably positive use cases like helping an illiterate person navigate the world; take, for example, this demonstration of Duplex for the Web:

With the caveat that this is one of the pieces of vaporware I referenced earlier (Duplex, it should be noted, did finally launch several months after last year’s Google I/O), the demonstration is very impressive. What is worth noting, though, is the degree to which the demo relies on Google’s having access to your data; to that end, perhaps the most striking takeaway is that Google didn’t bother hiding this fact:

Duplex on Web uses your data

The implicit message was clear: “Yes, we have all of your data, but the fact we have all of your data is a good thing, because it allows us to make your life easier.”

Notice that Aparna Chennapragada, the Vice President of Google’s AR, VR, and Vision-based Products whose video I opened with, makes the same point:

What you are seeing here is text-to-speech, computer vision, the power of translate, and 20 years of language understanding from search, all coming together.

To put it more succinctly: “Yes, we collect a lot of data. But that data makes amazing things possible.”

Google’s Strategy Credits

There was one more thing Chennapragada said at the end of her presentation:

The power to read is the power to buy a train ticket, to shop in a store, to follow the news. It’s the power to get things done, so we want to make this feature accessible to as many people as possible.

This is another feather in Google’s cap: it really does serve everyone in the way a company like Apple does not. Pichai made this point as well:

So far, we have talked about building a more helpful Google. It is equally important to us it for everyone. “For everyone” is a core philosophy for us at Google. That’s why from the earliest days Search works the same whether you’re a professor at Stanford or a student in rural Indonesia. It’s why we build affordable laptops for classrooms everywhere. And it’s why we care about the experience on low-cost phones in countries where users are just starting to come on-line, with the same passion as we do with premium phones.

What was unmentioned is that this is very much a Strategy Credit. Google spends billions of dollars on research and development and global-scaling infrastructure in order to deliver superior products to, first and foremost, users on premium phones (who have a huge amount of overlap with the set of customers most attractive to advertisers). That expenditure, though, is a fixed cost, while serving a marginal user is effectively free; it follows, then, that the best way to leverage those costs is to serve as many people as possible, even if the revenue from doing so is quite meager, at least for now.

To be clear, to say that something is a Strategy Credit is not a bad thing: it is simply an observation that doing the “right thing” requires no trade-offs when it comes to a company’s core business model; I originally created the term to explain why Apple could commit to not collecting data in a way that a company like Google could not.

Even so, it is striking how Google leaned into its core business model during the keynote: while Facebook likes to talk about connecting everyone, the company mostly tries to have its privacy cake and eat it too, that is, talk a lot about privacy and major moves it claims it is making in that direction, while actually changing nothing about its core business (or acknowledging that those moves are for competitive reasons).

Google, on the other hand, didn’t just admit it collects data, it highlighted how that collection makes Google more helpful. Google didn’t just admit that its goal is to be the Aggregator of information for every customer on earth, it bragged about that fact. And Google certainly didn’t engage in any self-effacing comments about how technology could be used for both good and bad: the entire keynote was arguing that technology is not only good, it is going to get better, and Google will lead the way.

Google’s Opportunities

There should be, to be sure, concerns about Google believing their own hype: many of the problems with YouTube, for example, stem from The Pollyannish Assumption that treats technology as an inherent good instead of an amoral force that makes everything — both positive outcomes and negative ones — easier and more efficient to achieve.

At the same time, from a purely strategic perspective, the positive message makes sense. Presuming that everything about technology is bad is just as mistaken as the opposite perspective, and the fact of the matter is that lots of people like Google products, and reminding them of that fact is to Google’s long-term benefit.

Moreover, a world of assistants and machine-learning based products is very much to Google’s advantage: the argument to not simply tolerate Google’s collection of data, but to actually give them more, is less about some lame case about better-targeted ads but about making actually useful products better. The better-targeted ads are a Strategy Credit!

It certainly appears that Google is pressing its advantage: after several years of including iPhones in Google I/O demos and/or alluding to products coming out on iOS — a welcome correction to The Android Detour — the only mention of iPhones was in a camera comparison to Google’s Pixel phone.1 Notably, Pixel’s headline feature — its camera — is very Google-like; Sabrina Ellis, Vice President of Product Management, said while introducing the $399 Pixel 3a:

Delivering premium features with high performance on a phone at this price point has been a huge engineering challenge, and I’m really proud of what our team has been able to accomplish with Pixel 3a…What Pixel is really known for is its incredible camera. With software optimizations we found a way to bring our exclusive camera features and our industry-leading image quality into Pixel 3a. So photos look stunning in any light. What other smartphone cameras try to do with expensive hardware, we can deliver with software and AI, including high-end computational photography.

While phones are certainly not a zero marginal cost item, the point is that Google applies overwhelming computer resources that can be leveraged through software instead of premium hardware, lowering the price of a phone, thus allowing it to be sold more broadly (better leveraging Google’s investment).

Google’s Challenges

At the same time, while many of today’s trends are in Google’s favor, the Pixel is a reminder that the company still has significant challenges: Google has struggled to sell Pixels not because it hasn’t invested in a quality phone, but because it hasn’t invested in marketing and distribution. To that end, what was even more notable than the Pixel 3a price point is the fact it will be available on more than one U.S. carrier for the first time; unfortunately for Google, that is only one country, and there remain the massive investments in marketing necessary to become a major smartphone player.

More importantly, while Google Assistant continues to impress — putting everything on device promises a major breakthrough in speed, a major limiting factor for Assistants today — it is not at all clear what Google’s business model is. It is hard to imagine anything as profitable as search ads, which benefit not only from precise targeting — the user explicitly says what they want! — but also an auction format that leverages the user to pick winners, and incentivizes those winners to overpay for the chance of forming an ongoing relationship with that user.

Indeed, this was both the promise and pitfall of Google’s overall presentation: organizing the world’s information was (relatively) easy when that information was widely available, and it was easy to monetize. Everything was aligned. The future, though, is a lot messier: getting information is more difficult, presenting that information is more challenging, and making money is very much an open question. Just because Google is better positioned in this race than anyone else doesn’t matter quite as much when the race is harder, even as the prize is less lucrative, while an increasing number of spectators are cheering for failure. Might as well bring cheerleaders!

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

  1. It was pretty lame that Google used an iPhone X instead of an iPhone XS for the comparison, though []

Microsoft, Slack, Zoom, and the SaaS Opportunity

It is difficult to discuss enterprise software without at least mentioning Microsoft, and there is no better time than now: last week the company (briefly) became the third U.S. company, after Apple and Amazon, to achieve a market capitalization of over $1 trillion, and is currently the most valuable publicly-listed company in the world.

It is a remarkable turnaround, and, thanks to the fact that I started Stratechery just months before the exit of former CEO Steve Ballmer, it is one that I have been able to document stage-by-stage. The critical breakthrough was three-fold, and, as is so often the case, the three breakthroughs were really about the same existential question — whither Windows:

The most important factor that made all of this possible, though, is that for all of the disruption that the enterprise market has faced thanks to the rise of Software-as-a-Service (Saas), Microsoft was remarkably well-placed to take advantage of this new paradigm, if only they could get out of their own way.

At least in part.

The SaaS Business Model

There are three parts of any new paradigm in technology: doing current use cases better, coming up with a new business model, and creating entirely new use cases. Microsoft, to Ballmer’s credit, was actually very early to the new business model aspect of SaaS.

Previously, enterprise software was sold on a license basis: companies bought software on a per-seat basis (or per-server or per-core basis in the case of back-end software), and when new versions of the software came out, they would potentially update — or not. Or not wasn’t great for anyone: companies would be running on out-of-date software, and vendors would not make new revenue.

What Microsoft figured out is that it made far more sense for both Microsoft and their customers to pay on a subscription basis: companies would pay a set price on a monthly or annual basis, and receive access to the latest-and-greatest software. This wasn’t a complete panacea — updating software was still a significant undertaking — but at least the incentive to avoid upgrades was removed.

There were also subtle advantages from a balance sheet perspective: now companies were paying for software in a rough approximation to their usage over time — an operational expense — as opposed to a fixed-cost basis. This improved their return-on-invested-capital (ROIC) measurements, if nothing else. And, for Microsoft, revenue became much more predictable.

SaaS and Current Use Cases

A more profound implication of SaaS, though — and to be clear, I mean software accessed over the Internet, not datacenter software paid for on a subscription basis — is how it makes current use cases more efficient for existing enterprise customers on one hand, and accessible for completely new customers on the other.

Start with enterprise customers: the reality for many industries is that their needs are variable. Sometimes they need more seats for a particular piece of software, and sometimes they need less; this is particularly pronounced in the case of Infrastructure-as-a-Service (IaaS), where computing needs may change seasonally. The brilliance of paying on a subscription basis is that a company can buy exactly what it needs, when it needs it, and no more. Microsoft, again in credit to Ballmer, was moving this way with Office 365: seats could be provisioned on a monthly basis, with no major upfront expenditure required.

That lack of upfront expenditure, though, also expanded the market: buying an
Exchange seat on Office 365 means hiring Microsoft to run your email server, something that previously needed to be done internally. Now all kinds of small-and-medium sized companies could use enterprise level software without needing their own IT departments.

Microsoft’s SaaS Challenge

This was also a challenge for Microsoft, to be sure: “hiring” SaaS providers meant it was easier to find providers that actually cared about modern use cases, particularly mobile. I wrote about this in 2015 in Redmond and Reality, in the context of cloud storage:

Once you remove the burden of support and maintenance — that’s handled by the service provider — it suddenly doesn’t necessarily make sense to buy from only one vendor simply because they are integrated. There is more freedom to evaluate a particular product on different characteristics, like, say, how easy it is to use, or how well it supports mobile. And it’s here that Microsoft products, particularly the hated SharePoint, were found to be lacking.

This is where Nadella made the biggest difference. It was notable, from a symbolic perspective, if nothing else, that his first public event was unveiling Office for iPad:

This is the power CEOs have. They cannot do all the work, and they cannot impact industry trends beyond their control. But they can choose whether or not to accept reality, and in so doing, impact the worldview of all those they lead. This is why it matters that the first public event Satya Nadella appeared at was Office for iPad. This is why it matters that Microsoft released it even though the Windows Touch version wasn’t finished. This is why it matters that Microsoft gave up the pretense of Windows Phone license payments that were already effectively zero and simply made it free.

This is the only possible route for a SaaS provider: the entire point is to host all of the infrastructure in one place, which means the greatest possible gains come from increasing the addressable market, which further means serving all devices, not simply the ones owned by one’s company. That, though, is the burden of incumbency: what is obviously right from the outside is often counter to what is obviously right when it comes to company cash flows and especially company culture.

Zoom and Being Better

Redmond and Reality was about file-sharing software, but the broader idea — that SaaS changes the plane of competition from ease-of-integration to ease-of-use — is perhaps best exemplified by the rise of Zoom. It turns out that video-conferencing software is an exceptionally difficult technical problem, and Zoom has done a better job than anyone in solving those technical challenges. It is simply better than the alternatives.

Even so, if said video-conferencing software had to be delivered via an on-premises software installation, it is doubtful that Zoom would be as successful as it has been: just as important is that signing up for Zoom requires nothing more than an email address; a paid plan takes only a credit card. This reduction in friction means that quality matters more than it ever did previously, which is why Zoom is such a success.

The challenge for incumbents, including Microsoft and also other competitors like Citrix, Cisco, etc., is that years of building their business on leveraging their existing relationships with enterprises left them vulnerable to a company like Zoom singularly focused on delivering a superior product, at least once a SaaS architecture made distribution so much easier. Make no mistake, enterprise software still requires a sales force, but it is far easier to start with customers that have already discovered and tried the product on their own than it is to sell something without any sort of pre-existing relationship.

Slack and New Use Cases

There remains, though, one final implication of a new paradigm, and this one is the most profound: completely new use cases. This was something Slack sought to highlight in their S-1, which was made public last week.

First, the company argued that Slack transforms internal communications:

The most helpful explanation of Slack is often that it replaces the use of email inside the organization. Like email (or the Internet or electricity), Slack has very general and broad applicability. It is not aimed at any one specific purpose, but nearly anything that people do together at work.

Unlike email, however, most of this activity happens in team-based channels, rather than in individual inboxes. Channels offer a persistent record of the conversations, data, documents, and application workflows relevant to a project or a topic. Membership of a channel can change over time as people join or leave a project or organization, and users benefit from the accumulated historical information in a way an employee never could when starting with an empty email inbox. Depending on the size of the organization, this might provide tens, hundreds or even thousands of times more access to information than is available to individuals working in environments where email is the primary means of communication.

Secondly, Slack argues that it changes what it means to integrate software:

Also unlike email, Slack was designed from the ground up to integrate with external software systems. Slack provides an easy way for users to share and aggregate information from other software, take action on notifications, and advance workflows in a multitude of third-party applications, over 1,500 of which are listed in the Slack App Directory. Further, Slack’s platform capabilities extend beyond integrations with third-party applications and allow for easy integrations with an organization’s internally-developed software. During the three months ended January 31, 2019, our more than 10 million daily active users included more than 500,000 registered developers. Developers have collectively created more than 450,000 third-party applications or custom integrations that were used in a typical week during the three months ended January 31, 2019. Additionally, we are currently developing low-code solutions to create integrations and workflows entirely in Slack, suitable for all users and based on a simple, non-technical user interface.

There is a two-part challenge when it comes to introducing a completely new way to work: first, you have to convince companies that the new way to work is better, and second, you have to actually help them implement it. It is here that the Internet’s impact on enterprise software is the most profound:

  • First, the Internet is inherently viral, thanks to the fact that information can be transmitted with zero marginal cost. In the case of Slack, telling others about its benefits required little more than a post on social media, and over time, an invitation to a Slack team.
  • Second, and related to the prior point, it is actually cost-effective for Slack to provide a free product: there is no need for a customer installation, simply a few entries in a database.
  • Third, implementation is a matter of paying — and that’s it. There are no qualms about using scarce IT resources, simply a question about costs, and this decision is usually based on an originally-free implementation.

This gets at why I believe Slack is the poster child for the impact of the Internet on the enterprise software market: Zoom is in some respects a more impressive business, but its use-case was a pre-existing one. Slack, on the other hand, introduced an entirely new way to work, and based on its S-1, did so in a way that will produce a very profitable company over time (Slack is losing money, but at a far lower rate than it is growing revenue; this is a company that has leverage on its costs and will be very profitable in the future).

What Microsoft is Missing

Make no mistake: the Microsoft optimism that is driving a (near) trillion dollar valuation is justified. Azure is the biggest reason, of course, but Office 365 benefits from all of the dynamics I described above: as I noted last week, its market is increasing both in terms of current customers, new users at companies it already serves, and upselling all of those users to new functionality.

At the same time, the reason to use Microsoft is very much grounded in the past: Office documents are familiar, and Exchange remains the standard for enterprise email. The advantage of going with Microsoft is that everything works mostly as it has previously. That, though, raises an existential question that Nadella’s Microsoft has yet to answer: why would a new company, without any attachment to Microsoft-based workflows, choose Office 365?

Note that this is a separate question as to whether Teams, Office 365’s answers to Slack, is viable: distribution still matters in enterprise software, and Teams has valuable strengths that derive from its integration with Microsoft’s other products.

At the same time, even the bullish case for Teams is that it captures a segment of Microsoft’s existing userbase:

Teams will only ever capture a portion of Office 365s userbase

This is precisely what you would expect from a product leveraging an existing use case and an existing customer relationship. Contrast this first to Zoom, which addresses an existing use case with the need to acquire new customer relationships: Zoom had a challenge building their initial customer base, but from that base they have growth opportunities both in terms of new use cases and also deepening their engagement with their customers.

Slack’s opportunity is even more striking: by virtue of starting with both new customers and a new use case, the opportunity to absorb both existing use cases (always easier than creating new ones) and also deepening utility with existing customers is significant. That is how you get IPO graphs that look like this:

Slack's cohort growth

Slack is not only growing users, it is also growing its monetization of those users over time, and it is fair to expect both to continue. This is exactly what Microsoft is lacking: at best the company is transitioning existing Microsoft users to a SaaS model, and keeping them away from companies like Zoom or Slack. That, though, is not a recipe for growth in the very long run.

The Enterprise Growth Framework

You can chart these three products on those two vectors — the pre-existence of a customer relationship, and the pre-existence of a customer use case:

Use case versus existing customer relationships in enterprise software

This is where Nadella’s Microsoft has fallen short. The company has done well to leverage its pre-existing strengths into more valuable relationships with its existing customers and a viable option for new ones, and, as I noted above, has indeed moved into new use cases; Teams clearly goes in the lower-right part of the above graph:

Teams expands the use cases within Microsoft's existing userbase

The problem is that to the extent Teams is successful it is because it is exploiting Microsoft’s existing customer base, not necessarily winning customers who would have never considered Microsoft in the first place. There is not nearly enough industry-leading technology (as is the case with Zoom) or innovation in new use cases (as was the case with Slack) to engender confidence that the company can grow beyond its existing customer relationships in the very long run. This is why companies like Zoom and especially Slack are so valuable: they create new customers who are primed for growth; Microsoft, meanwhile, is mostly keeping its existing customers in-house.

This, then, is Nadella’s new challenge: the company could have acquired Slack early in Nadella’s tenure, and considered Zoom, but waited too long on both. Microsoft has figured out how to leverage its existing userbase: how to increase it remains an open question.

Uber Questions

Over the course of Uber’s remarkable rise — very significant stumbles along the way notwithstanding — it has been more prudent to defend the company’s valuation than to question it. Look no further than the first Stratechery article about the ride-sharing “personal mobility” company, written in response to a 2014 Wall Street Journal column questioning Uber’s latest valuation. The title — Why Uber is Worth $18.2 Billion — holds up well given that Uber is expected to be worth around $100 billion when it prices its stock.

At the same time, to argue you were right based on a company’s private valuation is problematic: that valuation is a proxy for data about the business that simply isn’t available publicly. How much of the valuation is good money chasing bad? How much of the business is dependent on artificially low prices that are subsidized by those private investments? What parts — if any — of the company are leverageable?

Those questions are supposed to be answered by a company’s S-1. Uber’s, not so much.

The Personal Mobility Question

The promise of Uber — the biggest reason to believe that Uber was worth more than a taxi company — is, appropriately enough, how the company leads off its S-1.

We believe that Personal Mobility represents a vast, rapidly growing, and underpenetrated market opportunity. We operate our Personal Mobility offering in 63 countries with an aggregate population of 4.1 billion people. Through our Personal Mobility offering, we estimate that our platform served 2% of the population in these countries based on MAPCs in the quarter ended December 31, 2018. We estimate that people traveled 4.7 trillion vehicle miles in trips under 30 miles in these countries in 2018, of which the approximately 26 billion miles traveled on our platform represent less than 1% penetration.

Uber went on to define its Total Addressable Market as “11.9 trillion miles per year, representing an estimated $5.7 trillion market opportunity in 175 countries.” That, needless to say, is not a small market: it’s about 7% of gross world product, and an even higher percentage if you only measure those 175 countries (Uber cannot enter an additional 20 countries after selling its operations in those countries to competitors). Uber was slightly more modest about its Serviceable Available Market, that is, the countries it is currently operating in (and is not regulatory encumbered): a mere $2.5 trillion market opportunity — $3 trillion if you include those six countries with regulatory restrictions.1 The company concluded:

We believe that we are just getting started: consumers only traveled approximately 26 billion miles on our platform in 2018, implying a less than 1% penetration rate of our near-term SAM.

Uber has often seemed to function as a parody of startup culture, and this line is no exception: “We only need to get a small share of this very large market” is the most cliché of startup pitches, but that appears to be exactly what Uber is promoting.

And yet, what an alluring pitch it remains! The fundamental idea of paying tens of thousands of dollars (more or less) for a large metal box that sits idle the vast majority of the time, doing nothing but depreciating in value, doesn’t really make much sense in a world where everyone carries Internet communicators that let you call up a ride when — and crucially, only when — you need one. Remember that other classic Silicon Valley cliché — the Wayne Gretzky quote about skating to where the puck will be, not where it is — and the sheer ambition starts to make sense.

The Lyft Question

Of course Uber isn’t the only company chasing this prize: U.S. & Canada competitor Lyft IPO’d a few weeks ago and, despite Lyft’s growth, particularly in the wake of Uber’s self-inflicted disaster that was 2017, Uber should in theory be in a stronger position: it has more share, and more share should mean both more leverage on costs and better liquidity for drivers and riders.

Here’s the problem, though: it’s impossible to tell if theory matches reality. Uber has two major problems in the way they presented data in their S-1:

  • First, data from developed and emerging markets are presented in aggregate
  • Second, data from Uber ride-sharing and its other businesses, particularly Uber Eats, are also presented in aggregate

Consider the question of how Uber is doing in the U.S. & Canada, the relevant markets for a Lyft comparison: Uber reported $6.148 billion in “Core Platform Revenue”. “Core Platform” means ride-sharing and Uber Eats, and “Core Platform Revenue” is “Core Platform Gross Bookings less (i) Driver and restaurant earnings, refunds, and discounts and (ii) Driver incentives.” Therefore, in order to get a direct comparison to Lyft, it is necessary to separate ride-sharing and Uber Eats.

Unfortunately this is impossible for two reasons: first, while Uber does report separate numbers for ride-sharing and Uber Eats, that number is “Core Platform Adjusted Net Revenue”, which equals “Core Platform revenue (i) less excess Driver incentives, (ii) less Driver referrals, (iii) excluding the impact of legal, tax, and regulatory reserves and settlements recorded as contra-revenue, and (iv) excluding the impact of our 2018 Divested Operations.” Secondly, those numbers are not split out geographically. In short, to understand Uber’s North American ride-sharing business, you need to not only compare apples to oranges, but have to somehow ascertain exactly how many apples and oranges you are talking about.2

The Scooter Question

Meanwhile, 46% of trips in the U.S. are under three miles, and here scooters, e-bikes, and other non-car solutions could impact Uber’s core ride-sharing product, which the company admits:

We believe that dockless e-bikes and e-scooters address many of these use cases and will replace a portion of these vehicle trips over time, particularly in urban environments that suffer from substantial traffic during peak commuting hours…

The introduction of New Mobility products such as dockless e-bikes and e-scooters, which have lower price points than our existing products and offerings, will lower the average Gross Bookings per Trip on our platform.

This is ok, again in theory: Uber’s leading position in ride-sharing should give the company the advantage when it comes to redefining the space from ride-sharing to transportation-as-a-service. The problem, though, is that the S-1 offers basically no details about how this transition is going: is New Mobility growing? What are the cost structures like? Are increased trips making up for cannibalized revenue from ride-sharing?

To be fair, these are very early days for e-bikes and scooters, so the lack of data is understandable. At the same time, a lack of data is turning into a theme.

The Self-Driving Question

One of the biggest existential questions surrounding Uber (and Lyft) is self-driving cars: what happens when drivers are no longer necessary? In fact, it was here that I thought Uber’s S-1 was strongest:

Along the way to a potential future autonomous vehicle world, we believe that there will be a long period of hybrid autonomy, in which autonomous vehicles will be deployed gradually against specific use cases while Drivers continue to serve most consumer demand. As we solve specific autonomous use cases, we will deploy autonomous vehicles against them. Such situations may include trips along a standard, well-mapped route in a predictable environment in good weather. In other situations, such as those that involve substantial traffic, complex routes, or unusual weather conditions, we will continue to rely on Drivers. Moreover, high-demand events, such as concerts or sporting events, will likely exceed the capacity of a highly utilized, fully autonomous vehicle fleet and require the dynamic addition of Drivers to the network in real time. Our regional on-the-ground operations teams will be critical to maintaining reliable supply for such high-demand events.

Deciding which trip receives a vehicle driven by a Driver and which receives an autonomous vehicle, and deploying both in real time while maintaining liquidity in all situations, is a dynamic that we believe is imperative for the success of an autonomous vehicle future. Accordingly, we believe that we will be uniquely suited for this dynamic during the expected long hybrid period of co-existence of Drivers and autonomous vehicles. Drivers are therefore a critical and differentiating advantage for us and will continue to be our valued partners for the long-term. We will continue to partner with original equipment manufacturers (“OEMs”) and other technology companies to determine how to most effectively leverage our network during the transition to autonomous vehicle technologies.

This fits my previous read on the situation: I think that the most likely go-to-market for autonomous cars is via the ride-sharing networks, not as a substitute, and that driver availability and liquidity will continue to be differentiating factors.

That, though, raises two points of concern for Uber. First, while Uber has mostly settled its intellectual property dispute with Google’s Waymo (although Uber may still have to make changes to its autonomous vehicle software), Google has become much more closely allied with Lyft. This is a huge problem for Uber in the long-run if Waymo’s approach ends up winning out (because presumably Google would partner with Lyft to go-to-market at scale), and just as big of an issue in the short-term. Lyft is one of the best ways for investors to bet on Waymo, and the more money that Lyft has, the more Uber will struggle for profitability in the markets in which they compete.

Second, self-driving cars may emerge in markets that Uber cannot enter, like Singapore or China, thanks both to significantly increased density (which is better for ride-sharing in general and for leveraging high cost capital assets in particular) as well as governments more likely to limit the use of personal vehicles. This isn’t a total loss — Uber owns a portion of both Didi in China and Grab in southeast Asia — but whatever financial benefits may result may pale in comparison to the data and experience, leaving Uber vulnerable (neither Didi nor Grab are restrained from entering Uber’s markets).

And, of course, it goes without saying that there is precious little data about how Uber’s self-driving efforts are progressing, or what partnerships it has formed.

The Profitability Question

Unsurprisingly, many folks have fastened onto this risk factor:

We have incurred significant losses since inception, including in the United States and other major markets. We expect our operating expenses to increase significantly in the foreseeable future, and we may not achieve profitability.

This is, of course, quite standard, but it does feel particularly pressing given that Uber measures its annual losses in the billions. Unfortunately, it is here that Uber’s S-1 is particularly lacking. We don’t know:

  • How much it costs Uber to acquire drivers
  • How much it costs Uber to acquire riders
  • How much it costs Uber Eats to acquire restaurants
  • How much it costs Uber Eats to acquire customers
  • What is Uber’s retention rate for drivers
  • What is Uber’s retention rate for riders
  • What is Uber Eats’ retention rate for restaurants
  • What is Uber Eats’ retention rate for customers
  • Any sort of cohort analysis of any of the above categories
  • Ride-sharing revenue and profitability by geography
  • Uber Eats revenue and profitability by geography
  • Ride-sharing’s take rate overall and in developed versus emerging markets
  • Uber Eats’ take rate overall and in developed versus emerging markets
  • Ride-sharing revenue and profitability by time-in-market
  • Uber Eats revenue and profitability by time-in-market
  • An understanding of driver incentives and how they affect top-line revenue, or how “excess driver incentives” have changed over time
  • How costs are allocated, particularly when it comes to rider marketing and incentives
  • A breakdown of Uber’s many offerings (Black versus UberX versus UberPool etc.)

This is at best disappointing, and at worst feels like a cruel trick on retail investors: after all of these years, and all of these theoretical arguments about Uber’s potential, all we have are clichés about small pieces of gigantic markets and a heap of numbers that reveal nothing concrete about the business.

Despite it all, Uber may still be worth the investment: the theory of the company remains plausible, and the company is decreasing its losses (and could do so more quickly if it spun off its autonomous driving unit, as I believe they should). Moreover, I noted above how suitable China and Southeast Asia are for ride-sharing: investing in Uber is the most practical way of investing in ride-sharing everywhere.

However, if I bought individual stocks (I don’t per my ethics policy), I would be out: this S-1 is so devoid of meaningful information (despite its length) that it makes me wonder what, if anything, Uber is trying to hide. If I am going to be taken for a ride I want at least some idea of where I am going — isn’t that the point of Uber in the first place?

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

  1. Argentina, Germany, Italy, Japan, South Korea, and Spain []
  2. Financial Twitter mainstay @modestproposal1 put forth a good effort here; I tried for literally hours to come up with something better, but it’s frankly mostly guesswork, exacerbated by the fact that Uber and Lyft handle tolls, taxes, and other government fees differently: Uber includes them in revenue, while Lyft does not []