The First Post-iPhone Keynote

This article was previously title ‘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 []

Disney and the Future of TV

Yesterday started with a truly remarkable piece of TV broadcasting: Tiger Woods capped an incredible comeback from personal (self-inflicted) turmoil and physical injury with his first major championship win in twelve years at The Masters:

The moment was incredible on its own; that the CBS announcers saw fit to stay silent for two minutes and forty seconds and let the pictures and sounds from Augusta National’s 18th green tell the story spoke not only to their judgment but also to the unmatched drama that makes television the most valuable medium there is.

A few hours later the season premiere of the final season of Game of Thrones brought drama of a different type: scripted, and expensive. The episode is expected to draw around 14 million viewers (and many millions more in pirated streams), and is already a cultural phenomenon.

The greatest drama of all in the television world, though, was on the surface far more banal: on Thursday Disney webcast its Investors Day 2019, where it not only gave details on its upcoming Disney+ streaming service specifically, but also clarified the future of TV generally. And, like any great drama, what is happening it not only a compelling story in its own right, but a lens with which to understand far more than the subject matter at hand.

A Brief History of TV

In 2013, I posited that TV did multiple jobs for people: it informed, it educated, it provided a live view on sports and other breaking events, it told stories, and it offered an escape, from boredom if nothing else.

All of these jobs had the same business model: advertising. Consumers tuned in to watch programming, and native ads — that is, ads in the same format as the content they accompanied — were interspersed. Everything was aligned: consumers liked TV, they got it for free over the air, and advertisers wanted to reach as many people as possible with the most persuasive of mediums.

The picture began to change in the 1970s: communities across the country, particularly those whose remoteness or geography made it difficult for households to get a reliable broadcast signal, had for a couple of decades banded together to build a single large antenna to capture broadcast signals and then ran cable from that antenna to homes. It turned out, though, that those cables had both extra bandwidth and, even more importantly, no requirement for spectrum licenses, and first community access TV (i.e. TV that could only be accessed by the community attached to the community antenna network) and later, cable-only channels that leveraged satellite transmission to reach those community cable networks began to proliferate.

Then, with new technology and a new means of distribution came a new business model: affiliate fees. Now cable company were not simply collecting money from customers for access to ad-supported broadcast channels, but were also collecting money on behalf of cable channels themselves. This shift was led by ESPN, which introduced the concept of affiliate fees in 1982, made them nationwide by leveraging Sunday Night Football in 1987, and inspired countless imitators and transformed the TV industry along the way. I explained in 2015’s The Changing — and Unchanging — Structure of TV:

Over the ensuing years content companies realized that the reason consumers paid cable companies was because they wanted access to the creator’s content (like the aforementioned NFL deal); that meant content companies could make the cable companies pay them ever increasing affiliate fees for that content. Even better, if multiple channels banded together, the resultant conglomerates — Viacom, NBCUniversal, Disney, etc. — could compel the cable companies to pay affiliate fees for all their channels, popular or not. And best of all, it was the cable companies who had to deal with consumers angry that their (TV-only) cable bills were rising from around $22 in 1995 to $54 in 2010.

It’s difficult to overstate how lucrative this model was for everyone involved: content companies had guaranteed revenue and a dial to increase profits that seemed as if it could be turned endlessly; cable companies had natural monopolies that they soon augmented with broadband Internet service; and while consumers griped about their cable bills the truth is that bundles are a great deal.

I just mentioned, though, the elephant in the room: broadband Internet service.

The Internet’s Impact

It didn’t take long for the Internet and its marginal distribution cost of zero to quickly take over some of TV’s jobs: information and educational content, for example, were a natural fit for a medium unconstrained by linear time and a finite number of channels. Now you could look up information about anything you wanted to, and the rise of YouTube made that information available in video form.

Then, over the last decade, Netflix in particular has aggressively pursued the story telling and boredom-filling jobs that TV does: for a low-relative-to-cable monthly fee Netflix offers as much content as it can get its hands on, both licensed from traditional TV networks and increasingly Netflix-exclusive content from creators directly.

Note that in both cases — YouTube and Netflix — the experience and business model are superior to traditional television.

  • YouTube is ad-based, which on the surface seems similar to broadcast TV, but they are ads that can be applied to any and all content algorithmically; this aligns with a service that accepts all types of content, both broadly popular and incredibly niche, and which starts with search, not a channel guide.
  • Netflix, on the other hand, is subscription-based, which is broadly similar to cable TV, but without the intermediaries and advertising. That results in a far better experience for consumers, who can watch what they want when they want it without any annoyances.

This alignment is critical. Perhaps the single most defining feature of the Internet from a business perspective is the removal of the means of distribution as the primary point of differentiation in a value chain, and TV is a perfect example. What used to matter was first broadcast licenses and then cable, and everything else about the business flowed from there — that is why all of TV’s “jobs” had the exact same business model.

On the Internet, though, anyone can reach everyone with anything. That dramatically increases competition for consumer attention, and to win that competition means developing a business model that is aligned with the job to be done. And, because there are many jobs, there will be many business models.

ESPN+ and Traditional TV

Look no further than that Disney investor event: while most of the time and subsequent attention was given to the new Disney+ offering, the company also spent time talking about ESPN+ and Hulu. At first glance, it might seem odd that the company has three distinct streaming services; why not put all of the company’s efforts behind a single offering?

In fact, I just explained why: in a world where distribution mattered more than anything else it made sense for Disney to put all of its television properties together; that offered maximum leverage with the cable companies. On the Internet, though, it is best to start with jobs.

Consider ESPN: the sports conglomerate’s number one job is providing a live view of sporting events, and the truth is that the traditional TV model is a perfect fit for that:

  • Sports are highly differentiated, which mean that people will pay more to get access; this is why ESPN was able to create the affiliate fee business model in the first place, and can continue to drive the highest fees in the industry — by far.
  • Sports are best consumed live, which means that traditional TV distribution like cable or satellite is in fact preferable to streaming. This is in part an issue of reliability but also the result of services like Twitter; speaking as someone who by virtue of my location consumes most sports via streaming, finding out about the big shot on your phone before you see it on your screen is incredibly frustrating.
  • Sports have natural breaks in the action which are perfect for advertising — and thanks to the previous point, there is no option to simply skip the commercials.

This is why I have argued that the traditional cable bundle will slowly become the de facto sports bundle; I would add news as well. This is the exact bet that Rupert Murdoch made with Fox; remember that Disney didn’t buy the entire company: Murdoch kept the Fox Broadcasting Company, Fox Television Stations, Fox News Group, and the Fox Sports Media Group. What these assets have in common is that they are perfectly aligned with the traditional TV model: news and sports are best live and drive both advertising and affiliate fees.

To that end — and this is where ESPN+ comes in — one of the smartest moves Disney made in the last decade was going on a huge sports rights buying binge. Rights are the most valuable commodity for this business model, and ESPN tried to buy all of them (in part to prevent Fox in particular from encroaching on their dominance). At the same time, for all of the benefits of the traditional TV model, there is still the fundamental constraint of time: ESPN only has so many channels and so many slots to show games, which means it has the rights to many more games than it can ever show on its traditional networks.

Enter ESPN+: this service is not a new business model; it is simply an opportunity to earn incremental revenue on the assets (sports rights) that ESPN has already invested in. Sure, ESPN has and will acquire more rights for the service, and make some original programming, but make no mistake: traditional TV is and will remain the core business model for a very long time to come.

Disney+ and the Disney Universe

Meanwhile, the best way to understand Disney+, which will cost only $7.99/month, starts with the name: this is a service that is not really about television, at least not directly, but rather about Disney itself. This famous chart created by Walt Disney himself remains as pertinent as ever:

I first posted that chart on Stratechery when Disney first announced it was starting a streaming service in 2017, and said at the time:

At the center, of course, are the Disney Studios, and rightly so. Not only does differentiated content drive movie theater revenue, it creates the universes and characters that earn TV licensing revenue, music recording revenue, and merchandise sales.

What has always made Disney unique, though, is Disneyland: there the differentiated content comes to life, and, given the lack of an arrow, I suspect not even Walt Disney himself appreciated the extent to which theme parks and the connection with the customer they engendered drive the rest of the business. “Disney” is just as much of a brand as it Mickey Mouse or Buzz Lightyear, with stores, a cable channel, and a reason to watch a movie even if you know nothing about it.

This is the only appropriate context in which to think about Disney+. While obviously Disney+ will compete with Netflix for consumer attention, the goals of the two services are very different: for Netflix, streaming is its entire business, the sole driver of revenue and profit. Disney, meanwhile, obviously plans for Disney+ to be profitable — the company projects that the service will achieve profitability in 2024, and that includes transfer payments to Disney’s studios — but the larger project is Disney itself.

By controlling distribution of its content and going direct-to-consumer, Disney can deepen its already strong connections with customers in a way that benefits all parts of the business: movies can beget original content on Disney+ which begets new attractions at theme parks which begets merchandising opportunities which begets new movies, all building on each other like a cinematic universe in real life. Indeed, it is a testament to just how lucrative the traditional TV model is that it took so long for Disney to shift to this approach: it is a far better fit for their business in the long run than simply spreading content around to the highest bidder.

This is also why Disney is comfortable being so aggressive in price: the company could have easily tried charging $9.99/month or Netflix’s $12.99/month — the road to profitability for Disney+ would have surely been shorter. The outcome for Disney as a whole, though, would be worse: a higher price means fewer customers, and given the multitude of ways that Disney has to monetize customers throughout their entire lives that would have been a poor trade-off to make.

The Hulu Hedge

This gets at another reason why Disney+ is not really competitive with Netflix (again, with the rather obvious exception that consumers only have 24 hours in a day). Note that in the app there are dedicated Disney, Pixar, Marvel, Star Wars, and National Geographic buttons:

The Disney+ App

There is other content in the app, including The Simpsons and a smattering of family-friendly Disney Studios movies that don’t fall under these brands, but this is not a service that will be focused on acquiring content for content’s sake, a la Netflix. This is about the larger Disney machine.

Instead it falls on Hulu to be the Netflix competitor, or, probably more accurately, the Netflix hedge. As long as Hulu is around Netflix is not the only alternative for selling streaming rights or original content that happens to exist for its own sake, not because it is part of something bigger. Disney, of course, makes plenty of that type of content as well (particularly after the 21st Century Fox acquisition) and would benefit from there being more buyers than fewer (even if one of the buyers is itself). Hulu also sells the traditional cable bundle as a streaming service, something else Disney remains interested in supporting.

It will also be interesting to see what sort of bundle offer Disney comes up with for Disney+, Hulu, and ESPN+; thanks to Hulu Live that bundle could include basically all types of content except what is on Netflix (and Amazon Prime Video and Apple TV+ — more on those in a moment), which would make Disney not simply the Disney of the traditional TV bundle but the Comcast as well.

The Future of TV

This, then, is what I think the future of TV looks like:

The Future of TV

Netflix is an Aggregator, leveraging its massive subscriber base to buy the shows it wants from ever-weakening suppliers unable to break away from their traditional revenue streams, even if they are shrinking (thanks to Netflix). The focus for Netflix will be having all types of shows for all kinds of people all being charged a slowly-but-surely rising monthly rate. To put it another way, the best way to think about Netflix is not as a channel but rather as the new cable company, albeit one solely focused on evergreen content (i.e. not live).

Disney is, well, it’s Disney, pursuing a strategy as unique as the company itself. Disney+ will be a popular service, but the goal is not to build an Aggregator like Netflix but rather something that enhances and expands the Disney machine. Hulu, meanwhile, will continue as a nominal Netflix competitor and general guardian of Disney’s non-branded content businesses.

Traditional TV will be dominated by news and sports, with ESPN, Fox, and Turner the biggest players. All have very strong assets in sports and/or news, and will remain dependent (and why not!) on the traditional TV mix of advertising and ever-increasing affiliate fees.

The long tail of content, including most information and education, will continue to be dominated by YouTube and its advertising-based model.

That leaves the specialists and the resellers, who will have a symbiotic relationship:

  • The specialists include longtime direct-to-consumer networks like HBO and Showtime, as well as the various attempts by traditional networks to go direct-to-consumer. I suspect most of them will find it difficult to achieve the sort of scale with streaming that will justify making the sort of investments that Disney has committed to, leaving a muddle-along approach that includes traditional TV, sales to Netflix and Hulu, and standalone streaming services.
  • The resellers will help the specialists get in front of consumers and facilitate the transaction, taking a cut along the way. This was always the model for HBO and Showtime, but now instead of the cable companies being in the middle it is Amazon Prime Video and Roku, and later this year, Apple TV. I think this is also the best way to understand Amazon and Apple’s original content ambitions; the point isn’t to compete with Netflix, but rather to make their storefronts the place consumers go to to subscribe to other services.

Note that each of those five categories does a different “job”, and has a different business model; if “the single most defining feature of the Internet from a business perspective is the removal of the means of distribution as the primary point of differentiation in a value chain”, it follows that the most important part of succeeding on the Internet is building a business model that aligns with jobs instead of the other way around.