Apple’s Services Event

Tim Cook closed yesterday’s Apple event with these words:

From everything we’ve shared with you, you can see how important these services are for us and for all the ways they extend the experiences of our customers even further. They entertain, inspire, inform, and enrich our lives. Because at Apple, the customer is, and always will be, at the center of everything that we do.

It’s a short statement, but a useful way to think about the event specifically, and the state of Apple generally.

From Everything We’ve Shared With You

Frankly, not much; there were far more announcements that were coming in the summer or fall than were ready today or in the next couple of weeks:

  • Today: Apple News+
  • May: Apple TV Channels
  • Summer: Apple Card
  • Fall: Apple Arcade, Apple TV+

Just as disconcerting was the lack of pricing information: Apple News+ is $9.99, and the Apple Card has no fees…and that’s all we know.

This raises the question of what the point of having this presentation now was. In an interview on the Accidental Tech Podcast about Apple’s upcoming Worldwide Developers Conference (WWDC) Senior Vice President of Worldwide Marketing Phil Schiller said:

We think about the audience for the keynote at WWDC as really three unique audiences. And the opening keynote is different than the rest of the week’s events and activities. That opening audience is developers, it’s customers, and of course it’s the press. Three unique audiences…

Of course this event was considerably different than WWDC, and so was the intended audience. Developers for the most part are out (although Apple Arcade is of interest), and while these services are certainly meant to be consumed by customers, the fact that most won’t launch for a while dulls the benefits Apple will gain from press coverage.

That leaves an unmentioned fourth audience: Wall Street. To that end, perhaps the more relevant comment from an Apple executive came in Tim Cook’s January Letter to Investors revising Apple’s guidance for 1Q2019:

We can’t change macroeconomic conditions, but we are undertaking and accelerating other initiatives to improve our results.

At the time Cook only mentioned improving the iPhone trade-in process, but it certainly seems possible that announcing so many new services so far ahead of their launch was an attempt to deliver on that promise ahead of the company’s next earnings call.1

How Important These Services Are for Us

That is why I thought Cook’s most telling phrase was “How Important These Services Are For Us”; if Cook wanted to signify how importantly Apple was taking its efforts in developing these services, “to us” would have been a more natural turn of phrase. And, while I grant that is probably what Cook meant, the preposition change, in my estimation, gets at the heart of the matter: the iPhone isn’t going anywhere — Apple is very much not doomed — but it is no longer growing, leaving Apple no choice but to look elsewhere.

There are, broadly speaking, three ways that already big companies like Apple, cash cows like the iPhone in hand, can achieve growth:

Create New Products: This is the most obvious path, and also the most difficult. Creating products that resonate is really hard.

Still, that hasn’t stopped Apple from trying, and frankly, the company is doing quite well: the Apple Watch is a hit, AirPods are becoming a cultural phenomena (and the potential foundation for audio-based augmented reality), and the company is well-placed to compete in the visual-based augmented reality space. The HomePod is a bit of a dud, but to management’s credit the company appears to have already moved on. All of these successful products fit Apple’s DNA of personal computing, and are the most encouraging signals that Apple will be fine.

The problem, though, is that there will never be a product like the iPhone again; Apple may have found its product future (good for developers and customers), but its financial future is less certain (not so good for Wall Street).

Extend Integration: Apple is, famously, vertically integrated; the company writes the software that differentiates the iPhones that it manufactures and sells for a profit. That does not mean, though, that the entire iPhone experience is integrated — there are significant amounts of modularity. For example, Apple sources nearly all iPhone components from 3rd-party suppliers (Samsung, to take a counter example, manufactures more of its own components), and of course the vast majority of apps that are used on iPhones are made by 3rd-parties as well.

However, Apple can and has extended its integration into areas that were previously modular. On the component side, Apple started selling devices with processors it designed for its exclusive use in 2010, very successfully increasing iPhone differentiation in terms of performance. And, on the App side, Apple from the beginning of the App Store integrated forward into payments, and has extended that integration through App Store rules. I illustrated these integrations in a 2015 article entitled Apple’s New Market:

The iPhone is both integrated and modular

Apple has also integrated Services like iCloud backup, Siri, and Photo Stream; those services, though, have been more akin to Apple’s integration into processors in that said services are meant to differentiate iPhones, not be revenue drivers in their own right.

Yesterday’s announcements were an important departure from that strategy in two respects. First, services like Apple Card, Apple Arcade, and Apple News+ (I will get into the details of these services later on) extend Apple’s integration forward with the goal of driving new revenue.

  • Previously credit cards in Apple Pay were fully modularized; Apple Card relies heavily on its integration with Apple Wallet to differentiate itself

    Apple is forward integrating into credit cards

  • Previously games in the App Store were sold individually; Apple Arcade relies on Apple’s control of the App Store (and the fact the company does not need to pay itself 30%) to create a new bundle

    Apple is forward integrating into games

  • Previously news and magazine apps could be subscribed to individually; Apple News+ relies on Apple’s control of the App Store (and the fact the company does not need to pay itself 30%) to create a new bundle

    Apple is forward integrating into news and magazines

Secondly, Apple also announced at least one service — Apple TV+ — that…well, it’s not quite clear to what extent it is an extension as opposed to a new product entirely. But, before I explore the implications of that distinction, it’s worth calling out the last avenue for growth:

Acquisitions: This is, by definition, the most expensive way to acquire growth. It is also often the one that makes the most sense for cash-generating behemoths like Apple — and exploring the prospects of Apple TV+ show why.

Extend the Experiences of our Customers

The Apple TV portion of yesterday’s announcement actually had two parts: the Apple TV+ streaming service, which I will get to in a moment, and Apple TV Channels. The latter is a service akin to Amazon Channels or the Roku Channel Store; customers can subscribe to a la carte “channels” like HBO or Showtime, the content of which will be incorporated into the Apple TV app.

If this sounds familiar it is because this is Apple’s second version of this concept (this time Apple hosts the streams and controls the player, as opposed to relying on 3rd-party apps); the first version was announced in October, 2016, and then, as is the case now, Netflix, whose management claims it accounts for 10% of all TV time in the US, was not included. I explained why at the time:

Apple’s desire to be “the one place to access all of your television” implies the demotion of Netflix to just another content provider, right alongside its rival HBO and the far more desperate networks who lack any sort of customer relationship at all. It is directly counter to the strategy that has gotten Netflix this far — owning the customer relationship by delivering a superior customer experience — and while Apple may wish to pursue the same strategy, the company has no leverage to do so. Not only is the Apple TV just another black box that connects to your TV (that is also the most expensive), it also, conveniently for Netflix, has a (relatively) open app platform: Netflix can deliver their content on their terms on Apple’s hardware, and there isn’t much Apple can do about it.

That article, by the way, was entitled Apple Should Buy Netflix: I argued that iPhone growth was on the verge of slowing, that Apple needed a new growth driver to give the company space to create new products, and that the company was uniquely suited to provide Netflix’s biggest need — cash — which actually wasn’t doing Apple itself much good:

Apple is at its best when it is creating new products that are the best they can possibly be; it is a capability that is rather independent from Apple’s biggest strategic assets: its dedicated user base and massive cash pile.

Instead Apple has decided to compete with Netflix, at least to an extent, using those strategic assets: the company is spending some billions of dollars to create original content that will be available on all Apple devices. Notably, though, Apple TV+ content will be available on other devices as well, including Amazon and Roku’s TV boxes and smart TVs from Samsung, LG, Sony, and Vizio.

It appears that Apple is attempting to thread the finest of needles: by not having players available on Android, Windows, or the web, Apple TV+ acts as another extension of Apple’s integrated model, differentiating Apple’s hardware in the process. The problem, though, is that creating or acquiring content is a fixed cost: that means that the economically optimal approach is to make that content available as widely as possible, increasing leverage on those fixed costs. Thus the partnerships with Amazon, Roku, and smart TV manufacturers.

Unfortunately for Apple, I’m not sure that this exclusion is sustainable when it comes to competing with Netflix. As demonstrated by the parade of celebrities during the second half of yesterday’s event, Hollywood is driven first-and-foremost by cash. Whoever pays more for a show gets that show, even if — as Netflix continues to demonstrate — the entity making the payment is in the process of upending the entire TV value chain.

To that end, Apple certainly has the cash to compete with Netflix on a show-by-show basis (thanks to the still fabulously popular and profitable iPhone in particular); what is critical to understand, though, is that outbidding Netflix for a show basically guarantees that said show will lose money for Apple, at least for the next few years, thanks to Netflix’s huge subscriber base.

The challenge for Apple goes back to the leverage point I mentioned above. Consider a drastically simplified example:

  • Assume Netflix has 200 subscribers who pay $10 each
  • Assume Apple has 50 subscribers who pay $10 each

Netflix’s break-even point for a show is $2,000 (200 x $10); sure, Apple could outbid Netflix and pay $2001, but that means a loss of $1501 ($2001 – (50 x $10)). Is Apple willing to stomach the years of losses necessary to increases its subscriber base to a level where it can profitably compete with Netflix for shows? And, as a short-term concern, can Apple really afford to ignore billions of Android and Windows devices?

Indeed, this is precisely why I argued that Apple should simply acquire Netflix back when the company was worth <$50 billion (the price tag is quite a bit more unrealistic now);2 truly competing in the streaming video space, with its horizontal model that works orthogonally to Apple’s core vertical business model, means that the only real advantages Apple has are the default apps on the iPhone and a huge amount of cash, and those advantages could be applied to an acquired Netflix far more efficiently than they could to a brand new streaming service — like Apple TV+.

That, though, takes me back to the needle Apple appears to be trying to thread: the only way that Apple TV+ makes sense strategically is not as a new product with a new business model, but rather as another extension of Apple’s integration, i.e. a way to not simply sell new iPhones but also Apple’s TV app generally, including the commissions Apple will collect from Apple TV channels.

Apple TV Channels as a platform to integrate forward into Apple TV+

In short, Apple may increasingly be a services company in terms of the recurring revenue it earns, but its strategy is still very much rooted in a product world where differentiation comes from vertical integration.

Entertain, Inspire, Inform, and Enrich

A few additional notes about the other services Apple announced:

Apple Card: This makes a ton of sense: Apple is uniquely placed to differentiate a credit card thanks to Apple Wallet and Apple Pay (a numberless card is particularly neat, and only possible because of the Apple Wallet integration); the rewards and interest rates are very average (in-line with the Amazon Rewards Visa but inferior to the Amazon Prime Rewards Visa) but, in true Apple fashion, the card is much cooler looking. Also, don’t be surprised that Apple is partnering with Goldman Sachs: the company (rightly) wants nothing to do with the regulations entailed by being a bank, even if it means sharing those lucrative transaction fees.

Apple Arcade: This will hurt the up-front purchase game market, at least what little is left of it. The most reliable way to make money in the App Store is with either a free-to-play model (where you have to buy in-app purchases to progress) or a free-to-win model (where in-app purchases are largely aesthetic, a la Fortnite). Games that support neither are left trying to adapt Apple’s in-app purchase mechanism to support trials (i.e. download the game for free, make two levels free, and make an in-app purchase to unlock the rest) and praying their game will be featured in the App Store so that they can recoup their costs.

Apple Arcade is a very different model: first, Apple is paying up-front for exclusivity — already a more sustainable model for game developers — and second, subscribers (i.e. people who are generally willing to try and buy new games regularly) will surely look to try other Apple Arcade games before they bother downloading new ones, making things tough for anyone not a part of the bundle. Again, though, it is not as if the current situation is great for traditional games that you pay once for anyways; there is a decent chance this is a more sustainable model for everyone (and, of course, a nice revenue stream for Apple).

Apple News+: This slide transition neatly encapsulates both the devastation wracked on the media by the Internet as well as why Apple can take 50% of every Apple News+ subscription:

The commodification of media

The vast majority of media is completely commoditized and, in a world of zero marginal costs, happy to accept whatever pennies Apple is willing to throw their way. What is more noteworthy are the publications that aren’t there, particularly newspapers that have managed to develop direct connections with customers based on subscriptions (and one that is — the Wall Street Journal — is severely limited in discoverability and availability). This is exactly the right decision for them, as I explained last month in The Cost of Apple News.

The Customer Is At the Center

That leaves Cook’s final line: At Apple, the customer is, and always will be, at the center of everything that we do.

Frankly, with the possible exception of Apple Arcade, it is hard to see this sentiment in yesterday’s announcements; I’m not saying any of these services are customer hostile, but most of them are imitations of what other companies are already doing, the revenues of which Apple wants a cut of. And that’s okay: a growing Apple is better placed to build the next great product that changes customers’ lives. Still, I can’t help but think of a famous Steve Jobs quote:

I want to put a ding in the universe. Your time is limited, so don’t waste it living someone else’s life. Don’t be trapped by dogma — which is living with the results of other people’s thinking.

Yesterday didn’t have many dings, and fair bit of other people’s business models. Only time will tell if the diversion from what the company does best leaves Apple trapped.

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

  1. There are other more practical reasons noted by John Gruber: to clear the decks before WWDC and avoid inevitable leaks from the entertainment and news industry []
  2. I did write a year later that Apple should no longer buy Netflix, but not because I thought my reasoning had been wrong; rather, Netflix’s market cap had increased by 77%. Frankly, I probably withdrew my recommendation too soon — Netflix’s market cap has doubled again since then []

Where Warren’s Wrong

Senator Elizabeth Warren deserves credit: I have been writing about antitrust, particularly in the context of Aggregation Theory, for years, but the most concrete proposal I have put forward is that social networks should not be allowed to acquire other social networks. Senator Warren, on the other hand, last week presented a far more wide-reaching proposal that specifically targeted Facebook, Google, and Amazon:

Today’s big tech companies have too much power — too much power over our economy, our society, and our democracy. They’ve bulldozed competition, used our private information for profit, and tilted the playing field against everyone else. And in the process, they have hurt small businesses and stifled innovation.

I want a government that makes sure everybody  — even the biggest and most powerful companies in America — plays by the rules. And I want to make sure that the next generation of great American tech companies can flourish. To do that, we need to stop this generation of big tech companies from throwing around their political power to shape the rules in their favor and throwing around their economic power to snuff out or buy up every potential competitor.

That’s why my administration will make big, structural changes to the tech sector to promote more competition — including breaking up Amazon, Facebook, and Google.

Senator Warren added Apple in an interview at SXSW with The Verge:

There was one company that fits that description that you did not mention.

Apple. They’re in.

You want to break up Apple as well.

Yep.

You were very specific about how you’d break up Google and the rest. How would you break up Apple?

Apple, you’ve got to break it apart from their App Store. It’s got to be one or the other. Either they run the platform or they play in the store. They don’t get to do both at the same time. So it’s the same notion.

Unfortunately, Senator Warren’s proposal helps highlight why I have not gone further with my own: hers would create massive new problems, have significant unintended consequences, and worst of all, not even address the issues Senator Warren is concerned about (with one possible exception I will get to in a moment). Worst, it would do so by running roughshod over the idea of judicial independence, invite endless lawsuits and bureaucratic meddling around subjective definitions, and effectively punish consumers for choosing the best option for them. Mike Masnick at TechDirt gets into many of these problems, and concludes:

This entire plan gets headlines (duh) because so many people are (perhaps reasonably!) angry at the power of big tech companies. But, very little in the actual plan makes much sense. The “platform utility” idea will lead to massive, wasteful, stupid lawsuits. The unwinding of old mergers will involve interfering with an independent agency, and seem unlikely to do much to change the main “concerns” that Senator Warren raises in the first place.

And, again, none of this is to say we shouldn’t be concerned about big internet companies with too much power. It’s a perfectly reasonable concern, but just because you want to “do something” and “this is something,” doesn’t mean that it’s the something we should do.

I do know what is the first thing Senator Warren should do: rectify three clear areas where I believe she is mistaken about technology. Her proposal is wrong about tech’s history, the source of the tech giants’ power, and the fundamental nature of technology itself. All three are, unsurprisingly, interrelated, and it is impossible to craft a cogent antitrust policy without getting all of them right.

History: Microsoft and Google

Senator Warren opens the article by crediting the Microsoft antitrust case for the emergence of Google and Facebook:

Twenty-five years ago, Facebook, Google, and Amazon didn’t exist. Now they are among the most valuable and well-known companies in the world. It’s a great story  —  but also one that highlights why the government must break up monopolies and promote competitive markets.

In the 1990s, Microsoft  —  the tech giant of its time  — was trying to parlay its dominance in computer operating systems into dominance in the new area of web browsing. The federal government sued Microsoft for violating anti-monopoly laws and eventually reached a settlement. The government’s antitrust case against Microsoft helped clear a path for Internet companies like Google and Facebook to emerge.

The story demonstrates why promoting competition is so important: it allows new, groundbreaking companies to grow and thrive — which pushes everyone in the marketplace to offer better products and services. Aren’t we all glad that now we have the option of using Google instead of being stuck with Bing?

Start with the most obvious error: Bing was not even launched until 2009, eight years after the Microsoft case was settled. MSN Search, its predecessor, did launch in 1998, but with licensed search results from Inktomi and AltaVista; Microsoft didn’t launch its own web crawler until 2005 (these details will matter in a moment).

What is more striking is that, in retrospect, the core piece of the government’s case doesn’t make any sense: of course a browser should be bundled with an operating system; a new computer without a browser would be practically useless (for one, how do you install a browser?). Moreover, Apple, not without merit, argues that restricting rendering engines to the one that ships with the OS (all browsers on iOS have no choice but to use the built-in rendering engine) has significant security benefits; this is debatable, but ultimately, most don’t care, simply because browsers are means to information, not ends.

This, crucially, is something Microsoft did not understand in the 1990s; Microsoft’s operating system monopoly was predicated on owning the APIs with which applications were built, creating both lock-in and an ever expanding network effect. Unsurprisingly, Microsoft viewed the web through this exact same lens; that meant that Netscape was a threat because it was “middleware”, a potential means to run applications that were not locked into Windows. This is true, by the way — web apps work across operating systems and browsers — but this fact has absolutely nothing to do with the rise of Google. After all, when Google IPO’d in 2004, Internet Explorer had 95% market share; a browser was a means, not an end.

The reality is that Google is an operating system of sorts, but the system is not a PC but rather the entire web; what ties things together are not APIs, but links. And, crucially, the business model that makes sense is not licensing, but advertising. This is a value chain that never even occurred to Microsoft, and why would it? The entire company was predicated on controlling operating systems for physical computers, controlling the APIs on top, and earning revenue through licensing; it was fabulously profitable, and as history shows again and again, being fabulously profitable with an existing value chain is the best way to not only fail to recognize a new market opportunity (Microsoft didn’t even have a web crawler until after Google’s IPO!), but to in fact be at a massive disadvantage when you finally do so.

Look no further than mobile: Microsoft was not encumbered by antitrust when it came to their mobile ambitions, and yet they failed even more spectacularly there than they did online. In this case the company didn’t “miss” the opportunity — Windows Mobile came out back in 2000 — it was just stuck in a PC mindset when it came to product development, attached to its Windows licensing model when it came to monetization, and institutionally incapable of producing superior end user experiences thanks to the company’s traditional focus on platforms and compatibility.

In short, to cite Microsoft as a reason for antitrust action against Google in particular is to get history completely wrong: Google would have emerged with or without antitrust action against Microsoft; if anything the real question is whether or not Google’s emergence shows that the Microsoft lawsuit was a waste of time and money.1

Power: Google and Aggregation Theory

Senator Warren’s second mistake is a misstating of why large tech companies are dominant. She writes:

America’s big tech companies have achieved their level of dominance in part based on two strategies:

Using Mergers to Limit Competition. Facebook has purchased potential competitors Instagram and WhatsApp. Amazon has used its immense market power to force smaller competitors like Diapers.com to sell at a discounted rate. Google has snapped up the mapping company Waze and the ad company DoubleClick. Rather than blocking these transactions for their negative long-term effects on competition and innovation, government regulators have waved them through.

Using Proprietary Marketplaces to Limit Competition. Many big tech companies own a marketplace — where buyers and sellers transact — while also participating on the marketplace. This can create a conflict of interest that undermines competition. Amazon crushes small companies by copying the goods they sell on the Amazon Marketplace and then selling its own branded version. Google allegedly snuffed out a competing small search engine by demoting its content on its search algorithm, and it has favored its own restaurant ratings over those of Yelp.

The merger issue is a real one, but only when it comes to propagating power; Facebook was dominant before it bought Instagram and WhatsApp, Google before it bought DoubleClick or YouTube, and Amazon before it bought Diapers.com or Whole Foods (I do share Senator Warren’s concern about acquisitions; I will return to this point). Notably, Apple has not made any major acquisitions other than Beats headphones, and that too came well after the company had created the iPhone.

Similarly, the conflict of interest Senator Warren worries about is also post-dominance; none of Google, Facebook, Amazon, nor Apple achieved their power by “using proprietary marketplaces to limit competition”. That is not to say this, like acquisitions, isn’t a worthwhile issue, but it is flat out wrong to say that these are the reasons “big tech companies achieved their level of dominance.”

Then again, perhaps it is best for Senator Warren’s argument that her article never does explain how these companies became so big, because the reason cuts at the core of her argument: Google, Facebook, Amazon, and Apple dominate because consumers like them. Each of them leveraged technology to solve a unique user needs, acquired users, then leveraged those users to attract suppliers onto their platforms by choice, which attracted more users, creating a virtuous cycle that I have christened Aggregation Theory. Specifically:

  • Google solved search, which attracted users; Google’s supply (web pages), thanks to the fundamental nature of the web, were already effectively “on Google”, but even then web pages have worked diligently to deliver content in a way that Google expects. Why? Because users start at Google — demand is what matters.
  • Facebook digitized offline relationships, which attracted users, which were both consumers and suppliers of content; professional content creators followed, not only linking to their content on Facebook but creating content specifically tailored for Facebook’s audience, making Facebook that much more attractive for users. Again, what mattered was demand, not supply.
  • Amazon leveraged the Internet to achieve a dominant strategy of offering superior selection and the lowest price, starting with books. This gained Amazon customers, which gave the company leverage to bring on first other media like CDs and DVDs, which gained them more users, and later goods of all types; Amazon then launched the Amazon Marketplace, through which suppliers could come onto Amazon directly. Why? Because that is where demand was.
  • Apple defined the modern smartphone, gaining users who were blown away by Apple’s first-party apps; that attracted app developers, who were soon clamoring for access to iPhone users. Apple closed that loop by creating the App Store, which attracted more users, which attracted more developers, etc. Critically, though, the users came first; one of Microsoft’s many mobile mistakes was believing it could effectively “buy” a supply of apps and thus earn users, but that doesn’t work in a world where owning demand matters most.

Aggregation Theory is the reason why all of these companies have escaped antitrust scrutiny to date in the U.S.: here antitrust law rests on the consumer welfare standard, and the entire reason why these companies succeed is because they deliver consumer benefit.

The European Union does have a different standard, rooted in a drive to preserve competition; given that the virtuous cycle described by Aggregation Theory does tend towards winner-take-all effects, it is not a surprise that Google in particular has faced multiple antitrust actions from the European Commission. Even the EU standard, though, struggles with the real consumer benefits delivered by Aggregators.

Consider the Google Shopping case: Google was found guilty of antitrust violations in a case brought by a shopping comparison site called Foundem, which complained about their site being buried when consumers were searching for items to buy. This complaint made no sense, as I explained in Ends, Means, and Antitrust:

If I search for a specific product, why would I not want to be shown that specific product? It frankly seems bizarre to argue that I would prefer to see links to shopping comparison sites; if that is what I wanted I would search for “Shopping Comparison Sites”, a request that Google is more than happy to fulfill:

Screen Shot 2017-06-28 at 6.40.22 PM

The European Commission is effectively arguing that Google is wrong by virtue of fulfilling my search request explicitly; apparently they should read my mind and serve up an answer (a shopping comparison site) that is in fact different from what I am requesting (a product)?

There is certainly an argument to be made that Google, not only in Shopping but also in verticals like local search, is choking off the websites on which Search relies by increasingly offering its own results. At the same time, there is absolutely nothing stopping customers from visiting those websites directly, or downloading their apps, bypassing Google completely. That consumers choose not to is not because Google is somehow restricting them — that is impossible! — but because they don’t want to. Is it really the purview of regulators to correct consumer choices willingly made?

As I noted above, there are some important points made here by Senator Warren; at a fundamental level, though, any sort of antitrust proposal that does not seriously grapple with the reality that the power of these companies flows from controlling demand — that is, consumer choice, willingly made — not from controlling supply, like monopolies of old, is going to be fundamentally flawed.

Nature: What is Tech?

This mistake by Senator Warren only came into focus with that interview where she included Apple as a target for her proposal. Here’s more from that interview:

Pulling that apart, the App Store is the method by which Apple keeps the iPhone secure. It’s integrated into the platform. How would you propose that Apple and Google distribute apps if they don’t run the store?

Well, are they in competition with others who are developing the products? That’s the problem all the way through this, and it’s what you have to keep looking for. If you run a platform where others come to sell, then you don’t get to sell your own items on the platform because you have two comparative advantages. One, you’ve sucked up information about every buyer and every seller before you’ve made a decision about what you’re going to sell. And second, you have the capacity — because you run the platform — to prefer your product over anyone else’s product. It gives an enormous comparative advantage to the platform.

This would not be the first time in US history that this kind of arrangement had to be broken up. Back when the railroads were dominant, and you had to get steel or wheat onto the railroad, there was a period of time when the railroads figured out that they could make money not only by selling tickets on the railroad, but also by buying the steel company and then cutting the price of transporting steel for their own company and raising the price of transporting steel for any competitors. And that’s how the giant grows.

The problem is that’s not competition. That’s just using market dominance, not because they had a better product or because they were somehow more customer-friendly or in a better place. It’s just using market dominance. So my principle is exactly the same: what was applied to railroad companies more than a hundred years ago, we need to now look at those tech platforms the same way.

This is pretty explicitly taking Senator Warren’s critique of Amazon in particular and applying it to Apple, and to be fair, it is not completely without merit: Apple has quite clearly leveraged the fact it owns the platform to compete with Spotify, for example, and has definitely suppressed competition when it comes to built-in apps like Mail and the aforementioned Safari.

At the same time, do consumers not matter at all here? Is Senator Warren seriously proposing that smartphone be sold with no apps at all? Was Apple breaking the law when they shipped the first iPhone with only first-party apps? At what point did delivering an acceptable consumer experience out-of-the-box cross the line into abusing a dominant position? This argument may make sense in theory but it makes zero sense in reality.

What is even more striking, though, is that the App Store does have a massive antitrust problem: it is not Apple unfairly competing with app developers, it is Apple unfairly imposing massive complexity and extracting 30% of revenue with its contractual requirement, enforced by App Review, that developers use Apple’s payment mechanism. I wrote about this extensively last year in Antitrust, the App Store, and Apple (also see this follow-up); I think there is a case Apple’s policies would be found anticompetitive under a Quick Look review, and may even be a per se antitrust tying violation.

The important takeaway for this Article, though, is the degree to which Senator Warren missed the point: there is significant consumer benefit both to having preinstalled apps and also to Apple controlling the installation of apps. There is a big benefit to suppliers (app developers) as well: the app market on PCs died in large part due to security concerns, which Apple obviated with the App Store to the tremendous benefit of every participant in the ecosystem. Senator Warren’s proposal would make the App Store worse for everyone.

That leads to a broader point: “tech” is not simply another category, like railroads or telecom. Tech is a means, not an end, but Senator Warren’s approach presumes the latter. That is why she proposes the same set of rules for the sale of toasters and the sale of apps, and everything in between. The truth is that Amazon is a retailer; Apple a combination of hardware maker and platform makers. Google is a search and advertising company, and Facebook a publishing and advertising company. They all have different value chains and different ways of impacting competition, both fairly and unfairly, and to fail to appreciate just how different they are is a great way to make bad laws that not only fail to fix problems but also create entirely new ones.


That is not to say there aren’t genuine concerns about the biggest tech companies; I was absolutely genuine when I stated at the beginning that Senator Warren deserves credit for bringing these issues to the forefront. To my mind there are three major issues that deserve antitrust attention:

Issue 1: Digital Advertising

Senator Warren expresses concern in her article about kill zones when it comes to new startups:

Weak antitrust enforcement has led to a dramatic reduction in competition and innovation in the tech sector. Venture capitalists are now hesitant to fund new startups to compete with these big tech companies because it’s so easy for the big companies to either snap up growing competitors or drive them out of business. The number of tech startups has slumped, there are fewer high-growth young firms typical of the tech industry, and first financing rounds for tech startups have declined 22% since 2012.

This is decidedly not the case when it comes to enterprise-focused startups: that sector is thriving with all kinds of new businesses being created, acquired, and going public. The problem is the consumer Internet, which is to say that the problem is digital advertising. As I explained last year, both Google and Facebook are Data Factories; writing about Facebook specifically:

Facebook quite clearly isn’t an industrial site (although it operates multiple data centers with lots of buildings and machinery), but it most certainly processes data from its raw form to something uniquely valuable both to Facebook’s products (and by extension its users and content suppliers) and also advertisers (and again, all of this analysis applies to Google as well):

  • Users are better able to connect with others, find content they are interested in, form groups and manage events, etc., thanks to Facebook’s data.
  • Content providers are able to reach far more readers than they would on their own, most of whom would not even be aware those content providers exist, much less visit of their own volition.
  • Advertisers are able to maximize the return on their advertising dollar by only showing ads to individuals they believe are predisposed to like their product, making it more viable than ever before to target niches (to the benefit of their customers as well).

And then, in exchange for these benefits that derive from data, Facebook sucks in data from all three entities:

  • Users provide Facebook with data directly, both through information and media they upload, and also through their actions on Facebook properties.
  • Content is not simply data in its own right, but also a catalyst for generating user action data.
  • Advertisers, like content providers, not only provide data in its own right, which acts as a catalyst for generating user action data, but also upload huge amounts of data directly in order to better target prospective customers.

The end result is that Facebook and Google are far more valuable to advertisers than anyone else: they offer the most efficient spend when it comes to a return on advertising, and thanks to their ability to reach practically everyone, combined with the infinite nature of digital content, require the lowest investment. Put plainly, the ROI on Google and Facebook digital advertising is unmatched, and the chasm is only growing.

This is a tremendous problem for any would-be consumer Internet company, particular any product that depends on a network effect. The single most important feature when it comes to building a large user base and a leverage-able network effect is that the product be free-to-use, which means the only viable business model is advertising. As I just noted, though, the only place that advertisers want to be — for good reason! — is Google or Facebook. Ergo, consumer Internet companies are increasingly difficult to get started.

Snap is an unfortunate example of this reality: Snapchat is a clear demonstration that it is possible to build a competing social network in a world dominated by Facebook; unfortunately, it also appears to be an example of how is is even more difficult to build a profitable advertising business.

I don’t have a clear solution to this problem; if anything, privacy-focused regulation like GDPR are only exacerbating the issue, given that Google and Facebook acquire most user data on their platforms. Any solution that seeks to actually make a positive impact on competition, though, has to start with advertising.

Issue 2: Acquisitions

As I’ve hinted at a couple of times in this article, this is where I do mostly agree with Senator Warren. The truth is that Snapchat would have been a far greater threat to Facebook had the latter not been allowed to acquire Instagram. In a Daily Update last year I explored an alternate history where Instagram stayed independent:

This is where it is critical to consider the entire ecosystem. Had Instagram continued as a standalone company I do believe it would have been successful in building out an advertising business; it just would have taken a lot more time and effort…What is more important, though, is that an independent Instagram would have been the best possible thing that could have happened to Snapchat. The fundamental problem facing Snapchat is that it wasn’t enough for the company to have higher usage or deeper engagement with teens and young adults, demographic groups advertisers are desperate to reach. As long as Instagram was using Facebook’s ad infrastructure, it would always be more cost effective to reach those groups using Facebook’s ad engine.

This is why I have called Facebook’s acquisition of Instagram The Greatest Regulatory Failure of the Past Decade, and called for an end to social networks being allowed to buy other social networks. I do have qualms about the idea of retroactively undoing deals, but I do think Senator Warren is directionally correct in this case.

More broadly, as I explained in The Value Chain Constraint, the price of being an Aggregator is tuning your company to the value chain within which you compete; it follows that all of these companies will face significant challenges moving into new spaces with new value chains. To that end, what makes the most sense from a management perspective is leveraging the tremendous amounts of cash thrown off by their core businesses to acquire and invest in companies competing in different value chains.

On the flipside, to the extent regulators wish to constrain Aggregators, the single most effective lever is limiting acquisitions. There are significant problems with this, to be sure, particularly when it comes to the incentives for new company creation (most successful exits are acquisitions, not IPOs), but at least this is a remedy that is somewhat approaching the problem.

Issue 3: Contracts

As I have detailed, Aggregators already have massive structural advantages in their value chains; to that end, there should be significantly more attention paid to market restrictions that are enforced by contracts.

Go back to Microsoft: in my estimation the most egregious antitrust violations committed by Microsoft were the restrictions placed on OEMs, both to ensure the installation of Internet Explorer as well as to suppress alternative operating systems. These were not violations rooted in market dominance, at least not directly, but rather contracts that OEMs could not afford to say ‘No’ to.

This is an area where the European Commission has gotten it right with regard to Google: as a condition of access to Google apps, most critically the Play Store, OEMs were prohibited from selling any phones with Android forks. This is a restriction on competition produced not by market dominance, at least not directly, but rather contracts that OEMs could not afford to say ‘No’ to.

This is also the issue with Apple’s App Store: the restriction on linking to a website for purchasing an ebook or subscribing to a streaming service is not rooted in any sort of technical limitation; rather, it is an arbitrary rule in the App Developer Agreement enforced by Apple’s App Review team. It has nothing to do with consumer security, and everything to do with Apple’s bottom line.

This is an area ripe for enhanced antitrust enforcement: these large tech companies have enough advantages, most of them earned through delivering what customers want, and abetted by the fundamental nature of zero marginal costs. Seeking to augment those advantages through contracts that suppliers can’t say ‘No’ to should be viewed with extreme skepticism.


Let me reiterate a point I have made twice now: I appreciate Senator Warren raising these issues; they are indeed critical not only for the world today, but also the world we wish to create in the future. That, though, only increases the importance of getting things right: the history, the fundamental problem, and the nature of tech. Only then can we start to grope for solutions that actually make the situation better rather than worse.

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

  1. It appears that Senator Warren’s argument is based on a New York Times Magazine piece entitled The Case Against Google; I refuted the article directly in this Daily Update. It’s worth repeating a few additional points:

    • First, Microsoft executives blaming antitrust oversight for their failure to compete with Google is self-serving of the highest order. It is a ready-made excuse for the company missing out on search — but as I noted, it doesn’t explain mobile. The reality is far more prosaic: Microsoft didn’t have the structure or culture to compete in either; to CEO Satya Nadella’s credit the company has realized this and is now focused on being an enterprise platform.
    • Second, as I noted above, Microsoft’s Google competitor was woefully inadequate; Google was so much better — and only a click away — that setting the default to MSN Search made no difference.
    • Third, there are far-fetched arguments that Microsoft could have somehow made Google inaccessible on Internet Explorer. Beyond the fact that this would only work with a transparent black list (unlike applications, Microsoft couldn’t play any tricks with APIs), such a block would be easily circumvented by…downloading another browser! Indeed, this would have been the surest route for Netscape to survive.

    In short, while there are arguments to be made about the impact of the antitrust decision on the emergence of web apps — which again, was Microsoft’s core concern — it has nothing to do with the emergence of Google, which was not only not competitive with Microsoft but not even on the company’s radar at the time of the antitrust case. []

Facebook’s Privacy Cake

What was striking about the reaction to Mark Zuckerberg’s latest missive about the future of Facebook, A Privacy-Focused Vision for Social Networking, were the two very distinct reactions that, in my estimation, made the same mistake, but in opposite directions; one set of folks didn’t take Zuckerberg seriously at all:

Another set took Zuckerberg entirely too seriously:

In fact, what Zuckerberg announced is quite believable, precisely because it makes perfect sense for Facebook: this is a privacy cake that Facebook can have — and eat it too.

The Social-Communications Map

Zuckerberg began by describing two distinct kinds of social networks:

Over the last 15 years, Facebook and Instagram have helped people connect with friends, communities, and interests in the digital equivalent of a town square. But people increasingly also want to connect privately in the digital equivalent of the living room. As I think about the future of the internet, I believe a privacy-focused communications platform will become even more important than today’s open platforms. Privacy gives people the freedom to be themselves and connect more naturally, which is why we build social networks.

Today we already see that private messaging, ephemeral stories, and small groups are by far the fastest growing areas of online communication. There are a number of reasons for this. Many people prefer the intimacy of communicating one-on-one or with just a few friends. People are more cautious of having a permanent record of what they’ve shared. And we all expect to be able to do things like payments privately and securely.

Public social networks will continue to be very important in people’s lives — for connecting with everyone you know, discovering new people, ideas and content, and giving people a voice more broadly. People find these valuable every day, and there are still a lot of useful services to build on top of them. But now, with all the ways people also want to interact privately, there’s also an opportunity to build a simpler platform that’s focused on privacy first.

I first explored the idea of there being different types of social networks in 2013 when I created The Social/Communications Map:

A drawing of the Social/Communications Map

Keep in mind, this image is from 2013, but there are still some important points worth calling out:

  • First, the axes are about user perception, not technical implementations; back then tweets were very much experienced as being ephemeral; now they have more permanence, leading to people both being called-out for old tweets and/or deleting their archives.
  • That Twitter and Instagram should have perhaps been on the “permanent” side of the axis is further emphasized by the success of Instagram Stories, which is much more ephemeral than Instagram posts, along with the rise of tweet threads replacing blogging.
  • I noted in the post that LINE was representative of multiple chat networks, including WeChat and WhatsApp; obviously I should have illustrated both instead.

The most important thing to note, though, are the relative positions of Facebook and Snapchat (it was Facebook’s attempted acquisition of Snapchat that inspired the map in the first place).

Facebook Versus Snapchat

Perhaps the most important moment in Facebook’s history was its shift from the private to public space on the Social/Communications Map with the introduction of the News Feed. Again, to be clear, this map is about public perception, not technical reality, and this is a perfect example: data on Facebook was public to everyone in your network from day one. What the News Feed did, though, was change Facebook data from a pull to a push model: instead of needing to seek out your friends’ profiles Facebook would push their updates to you directly.

This inspired a strong backlash amongst users, who not only complained online but actually organized rallies in person; ultimately, though, it turned out that people loved the News Feed, and once Facebook embraced mobile, it turned out the News Feed was perfect for advertising.

Still, that transition exposed a soft underbelly in Facebook’s product: private ephemeral communication that allowed users to be their true selves. This was the premise undergirding Snapchat, which I described in Facebook, Phones, and Phonebooks:

It is increasingly clear that there are two types of social apps: one is the phone book, and one is the phone. The phone book is incredibly valuable: it connects you to anyone, whether they be a personal friend, an acquaintance, or a business. The social phone book, though, goes much further: it allows the creation of ad hoc groups for an event or network, it is continually updated with the status of anyone you may know or wish to know, and it even provides an unlimited supply of entertaining professionally produced content whenever you feel the slightest bit bored.

The phone, on the other hand, is personal: it is about communication between you and someone you purposely reach out to. True, telemarketing calls can happen, but they are annoying and often dismissed. The phone is simply about the conversation that is happening right now, one that will be gone the moment you hang up.

In the U.S. the phone book is Facebook and the phone is Snapchat; in Taiwan, where I live, the phone book is Facebook and the phone is LINE. Japan and Thailand are the same, with a dash of Twitter in the former. In China WeChat handles it all, while Kakao is the phone in South Korea. For much of the rest of the world the phone is WhatsApp, but for everywhere but China the phone book is Facebook.

Make no mistake, the phonebook has been more valuable: it lends itself better to both data collection and advertising. Snapchat, though, threatened to break out of the phone space into the phonebook space with Stories — a product that shifted Snapchat out of the private space into the public one.

To that end, it is instructive that it is Stories where Facebook finally mounted its Snapchat defense: I wrote in The Audacity of Copying Well:

Instagram and Facebook are smart enough to know that Instagram Stories are not going to displace Snapchat’s place in its users lives. What Instagram Stories can do, though, is remove the motivation for the hundreds of millions of users on Instagram to even give Snapchat a shot.

That is exactly what happened: Snap retained its place as the core of 1×1 communication for young people, but the segments more removed from Snapchat’s core use case of chat were suddenly far less likely to even give the service a try, thanks to Instagram’s intelligent leveraging of its network.

By the same token, though, just because Facebook capped Snapchat’s growth doesn’t mean that Snapchat’s core insight about the desire for private, ephemeral communication was wrong: what Zuckerberg wrote yesterday is basically Snapchat’s reason-for-existing. In other words, while Instagram Stories built a wall around Snapchat by copying Snapchat’s secondary feature, this “Privacy-Focused Vision for Social Networking” is a clear attempt to build the core of Snapchat for everyone else.

Zuckerberg’s Vision

Look again at what Zuckerberg outlined:

  • Private interactions
  • Encryption
  • Reducing Permanence
  • Safety
  • Interoperability
  • Secure data storage

The first three are all about owning the 1×1 private ephemeral space; critically, none of them have anything to do with Facebook’s core feed-based products. Facebook is going to continue to exist as it has to date, as will Instagram, including all of the data collection and ad targeting that currently exist. The “Privacy-Focused Vision for Social Networking” is in addition to Facebook’s current products, not in place of. This is the mistake made by those that took Zuckerberg too seriously.

As for those who didn’t take Zuckerberg seriously enough, why wouldn’t Facebook want to move in this direction? There are multiple benefits:

  • First, this is a valuable space to own for all of the reasons that Snapchat succeeded in the first place. People want a place to communicate freely without fear of snooping or a historical record.
  • Second, to the extent the rise of 1×1 networking is inexorable, it is better for Facebook that it happen on their properties. Not only does Facebook preserve the ability to advertise on privacy-focused platforms — the company can leverage data from Facebook to advertise in its messaging products (although I am skeptical that messaging products are well-suited to advertising) — it also prevents would-be competitors from capturing leverageable attention.
  • Third, as we have seen over the last 24 hours, there are tremendous PR benefits from a privacy-focused service. Facebook has changed nothing about its core service or data collection policies, yet the assumption is that the company is pivoting and the only debate is whether to believe them or not.

Perhaps most compelling, though, is the degree to which this move locks in Facebook’s competitive position. As I noted above, Snapchat already showed that Facebook is vulnerable in the realm of private ephemeral communications, but soon that will no longer be the case. Moreover, given Facebook’s focus on end-to-end encryption, the company has made it that much harder to even get off the ground: not even Snapchat is fully end-to-end encrypted (pictures are, but not text messages).

There is an even more important benefit to Facebook voluntarily forgoing the data within messages and limiting the time it keeps surrounding metadata (make no mistake, end-to-end encryption is a real thing — Facebook will not be able to see encrypted messages); as Zuckerberg told Wired:

Certainly, ad targeting can benefit from having access to as much content or signal as possible. You know, I’m more optimistic about this for a few reasons. One is that we aren’t really using the content of messages to target ads today anyway. So we weren’t planning on doing that. So it’s not like building a system and making it end-to-end encrypted and now we can’t see the messages is really going to hurt ads that much because of the way we were already thinking about that. Keeping metadata around for less time will have some impact, although I’m optimistic that we’ll build systems that can basically deliver most of the value with a fraction of the amount of data.

Why can Facebook deliver most of the value? Because they are still Facebook! They still have the core Facebook app, Instagram, ‘Like’-buttons scattered across the web — none of that is going away with this announcement. They can very much afford a privacy-centric messaging offering in a way that any would-be challenger could not. Privacy, it turns out, is a competitive advantage for Facebook, not the cudgel the company’s critics hoped it might be.

Safety, Interoperability, and Strategy Credits

The last three items in Zuckerberg’s list are interesting in their own right; to take them one-by-one:

Safety: This is about the very real trade-offs that come with end-to-end encryption. One obvious issue is law-enforcement: Apple has already been down this road with the FBI when it comes to phone security; end-to-end encryption is both more challenging and yet simpler, simply because it is, properly implemented, truly unbreakable.

Another issue is misinformation: for all of the issues surrounding misinformation on Facebook, at least misinformation is traceable; that is not the case if messages are encrypted, which has already been an issue with WhatsApp in India. One could certainly make the cynical argument that, in the process of cloaking itself in privacy, Facebook is washing its hands of misinformation.

To be sure, Facebook is confident it can leverage its ability to analyze metadata to stop bad actors; that the exact same sort of audience analysis is perfectly portable to advertising is a rather happy benefit as far as Facebook is concerned.

Interoperability: This is perhaps the feature that is easiest to be cynical about; while it can certainly be frustrating to have to balance multiple messaging apps, for much of the world consolidating Facebook-owned messaging will not fully address the problem, thanks to alternatives like Messages, LINE, Kakao, etc. Moreover, even in areas where Facebook owns both the Phone (via WhatsApp) and the phonebook (via Facebook and Instagram), exactly how much consumer demand is there for integration?

There is, to be sure, a business argument: Facebook has already unified much of the ad infrastructure underlying its services, and unifying messaging is, to the extent Facebook wants to build a business platform on messaging, a natural next step. There is also a regulatory argument: while it is difficult to make the argument that Facebook has broken antitrust laws, the remedy, should that be accomplished, is obvious — split off Instagram and WhatsApp. That will be harder to do if they are fully integrated with Facebook, not simply on the advertising side but also the user side.

Secure Data Storage: This is an interesting addition to this piece, as it has little to do with messaging in the communications sense, but a lot to do with messaging in the political sense. This is what Zuckerberg wrote:

There’s an important difference between providing a service in a country and storing people’s data there. As we build our infrastructure around the world, we’ve chosen not to build data centers in countries that have a track record of violating human rights like privacy or freedom of expression. If we build data centers and store sensitive data in these countries, rather than just caching non-sensitive data, it could make it easier for those governments to take people’s information.

Upholding this principle may mean that our services will get blocked in some countries, or that we won’t be able to enter others anytime soon. That’s a tradeoff we’re willing to make. We do not believe storing people’s data in some countries is a secure enough foundation to build such important internet infrastructure on.

The most obvious country worth avoiding is China, which means this is clearly a Strategy Credit:

A strategy credit is an uncomplicated decision that makes a company look good relative to other companies who face much more significant trade-offs.

Facebook is already banned in China, so not putting data centers in China costs the company nothing (it may soon cost the company in Russia; one imagines Facebook will not mind being banned there of all places). This is in sharp contrast to Facebook’s most vociferous critic in tech, Tim Cook and Apple; the latter absolutely stores customer data in China along with encryption keys, because that is the law for companies that wish to operate in the country.

To be clear, this is understandable, but that is what makes that Strategy Credit article rather ironic; I coined the term in response to Apple’s posturing about user data in the wake of the Snowden revelations, noting that forgoing data wasn’t really a tradeoff given Apple’s business model. Now Apple is on the other side of the coin.

Privacy Moats

Ultimately there are three broad takeaways from Zuckerberg’s article:

  • Stop expecting companies to act against their interests. Facebook isn’t killing their core business anymore than Apple, to take a pertinent example, is willing to go to the mat to protect user data in China.
  • Facebook doing something that benefits itself is not inherently bad for end users. It is perfectly reasonable that the company can be instituting genuinely user-friendly changes like end-to-end encryption even as it furthers its own self-interests.
  • Relatedly, and most importantly, there needs to be much more appreciation for the anti-competitive trade-offs inherent in an absolutist approach to privacy. Facebook is doing what its fiercest critics supposedly want, and enhancing its competitive position as a result.

This was a point I made last year in Open, Closed, and Privacy:

If an emphasis on privacy and the non-leakage of data is a priority, it follows that the platforms that already exist will be increasingly entrenched. And, if those platforms will be increasingly entrenched, then the more valuable might regulation be that ensures an equal playing field on top of those platforms. The reality is that an emphasis on privacy will only increase the walls on those gardens; it may be fruitful to rule out the possibility of unfair expansion.

This is a debate that is woefully lacking. The reality is that the only user-friendly way to enforce privacy — which is another way of saying the only scalable way in a demand-driven world — is to severely limit inter-operability and over-burden would-be challengers. Regulators need to be far more aware of this and either choose another approach to privacy — i.e. entrust it to individuals — or regulate data-platforms, at least in terms of competition on top of their platforms, even more severely.

The Value Chain Constraint

On June 16, 2017, minutes after Amazon announced it was buying Whole Foods Market Inc. for $13.7 billion, grocery store stocks fell through the floor; from MarketWatch (emphasis mine):

Shares of grocery stores took an unexpected hit Friday as investors reeled from the news that Amazon.com Inc. was moving into their space by acquiring Whole Foods Market Inc. After Amazon announced that it was buying Whole Foods in a $13.7 all-cash deal, shares of grocery store chain Kroger Co. slid to close down 9.2%, shares of Costco Wholesale Corp closed down 7.2%, Target Corp.’s stock closed down 5.2% and shares of Wal-Mart Stores Inc. closed down 4.6%…

The stock prices of grocers when Amazon bought Whole Foods

Mark Hamrick, a senior economic analyst at Bankrate.com, said Amazon’s technological innovation in traditional retail is a “earthquake” for the sector, which it may have hinted at with its recent launches of brick-and-mortar Amazon bookstores. “We can only imagine the technological innovation that Amazon will bring to the purchasing experience for the consumer,” Hamrick said.

This is why I found Walmart’s recent earnings so interesting: the company cited groceries as the biggest drivers of its ecommerce business, both last year and going forward — the company plans to expand grocery pickup to an additional 1,000 stores — because, as Walmart CEO Doug McMillon put it on the company’s earnings call:

We strive to make every day easier for busy families as we increase convenience and save them money and time. Part of our strategy is to build on our existing strengths, such as having a broad assortment including fresh and perishable foods within 10 miles of 90% of the U.S. population.

Amazon, meanwhile, appears to be struggling; from Bloomberg:

The number of Amazon Prime members who shop for groceries at least once a month declined in 2018 compared with 2017, according to the results of an annual consumer survey released Wednesday by UBS analysts. The drop was surprising given the company’s Whole Foods investment and expansion of two hour delivery service Prime Now, the analysts wrote in a note to investors.

A separate study by research firm Brick Meets Click found that households using grocery delivery and pickup services from physical retailers spend about $200 per month and place orders more frequently than Amazon grocery shoppers, who spend $74 a month.

So where is the promised technological innovation?

The Conservation of Groceries

I have written several times about the Conservation of Attractive Profits, most notably with regards to Netflix, Facebook and BuzzFeed, and Zillow. To put it in generic terms, profit in a value chain flows to whatever company is able to successfully integrate different component pieces of that value chain; the other parts of the value chain then modularize and are driven into commodity competition.

For example, this is what Walmart’s traditional value chain looked like:

Walmart's value chain

Walmart was able to integrate wholesale purchasing with an expansive network of stores; this provided a moat of sustainably lower prices for customer driven by purchasing power over suppliers.

Amazon, though, thanks to technological innovation — specifically, the Internet — was able to build a different integration in the value chain:

Amazon's value chain

Amazon integrated wholesale purchasing and fulfillment centers with Amazon.com, relying on modularized delivery services for distribution; this provided a moat of superior selection and, at least at the beginning, lower prices, and with Prime, superior convenience, at least for non-perishable goods.

Walmart has worked for years to respond to Amazon’s threat; the problem, though, as I explained in 2016’s Walmart and the Multichannel Trap, is that an integration built around stores was fundamentally unsuited to offering the sort of selection and convenience that Amazon does. The company needed to build up an entirely new set of capabilities and integrations, even as Amazon was leveraging theirs to integrate forward into logistics, adding on a 3rd-party marketplace to expand selection even more, and integrating backwards into their own brands. The result is that Amazon has around 50% share in e-commerce while Walmart has less than 5%.

That, though, is precisely why groceries is worth examining: as I explained when Amazon bought Whole Foods, perishable goods are not well-suited to Amazon’s value chain. Superior selection has diminishing returns, quality varies on an item-by-item basis within a single SKU, and, most importantly, the quality of items degrades with time and transport. In other words, they are a great fit for stores, not distribution centers.

In this view, Amazon’s purchase of Whole Foods was an attempt to acquire a first best customer for its grocery delivery operation, one that would efficiently store and sell perishable goods that weren’t suitable for Amazon’s traditional e-commerce model. And, to be clear, this strategy may yet succeed, but only to the extent Amazon builds a completely new set of capabilities and integrations that will probably end up looking a lot like Walmart, which has a massive head start it is clearly taking advantage of.

In other words, what matters is not “technological innovation”; what matters is value chains and the point of integration on which a company’s sustainable differentiation is built; stray too far and even the most fearsome companies become also-rans.

Google Cloud Struggles

Consider Google, a company that, more than any other, has been predicated on “technological innovation”. This was possible because the company’s core product — Internet search — entered a value chain with no integrations whatsoever. On the supply side there were countless websites and even more individual web pages, increasing exponentially, and on the demand side were a similarly increasing number of Internet users looking for specific content.

Crucially, all of the supply was easily accessible — just link to it — and all of the demand was capturable — they only needed to type in google.com. This meant that the best search engine — and by best, I mean the purest form of the word, i.e. best performing — could win, and so it did. Google was leaps and bounds better than the competition, thanks to its focus on understanding links — the fabric of the web — instead of simply pages, and consumers flocked to it.

This set off the positive cycle I have described in Aggregation Theory: owning demand gave Google increasing power over supply, which came onto Google’s platform on the search engine’s terms, first by optimizing their web pages and later by delivery content directly to Google’s answer boxes, AMP program, etc., all of which increased demand, resulting in a virtuous cycle.

At the same time Google was building out two critical pieces of the value chain in integration with Search: the first was infrastructure — supporting that much demand required huge investments in servers, fiber optic cables, etc. — and the second was advertising. Ultimately the company’s model looked like this:

Google's value chain

Note how Google is so dramatically optimized on all three sides of this integration: users, suppliers, and advertisers interact with Google through their own volition, thanks to the infrastructure Google has built to facilitate that interaction, with almost no person-to-person contact with anyone from Google. It is a model that works very, very well — for search and digital advertising, anyways.

Things have not gone so well for Google Cloud. At first glance, selling infrastructure seems like an obvious opportunity for Google, and much ink has been spilled about how the company — any day now! — will threaten Amazon or Microsoft. After all, Google was building out worldwide infrastructure before anyone else, and the company remains at the forefront of technological innovation.

The problem, though, is that the company’s value chain is completely wrong. The world of enterprise software is not a self-serve world (and to the extent it is, AWS dominates the space); what is necessary is an intermediary layer to interact with relatively centralized buyers with completely different expectations from consumers when it comes to product roadmap visibility, customer support, and pricing.

It has taken Google many years to learn this lesson: Google Cloud remains a distant third to AWS and Microsoft with a strategy that simply wasn’t working. I wrote in a November Daily Update upon the occasion of Google Cloud changing CEOs:

A strategy predicated on being “better” on specific product attributes, though, may fit the culture of Google, but it doesn’t necessarily lead to a winning enterprise strategy. To that end, Google Cloud faces three major problems:

  • First, Google has not made an effective case about how specifically machine learning can benefit business that is appreciably different than traditional business analytics. That is not to say it can’t, just that the company hasn’t really made the case.
  • Second, Google isn’t competing with Lycos and Yahoo: AWS and Microsoft have machine learning offerings of their own, and Microsoft in particular is much more accomplished at productizing offerings in a way that are understandable and approachable to CIOs.
  • Third, and most importantly, the technical attributes of a product are only one piece of what matters to success in the enterprise. Just as important are customization, support, and the ability to sell. Google is widely regarded as being the worst in all three areas.

In short, what Google Cloud needs is not a CEO that fits the culture, because the culture of Google is about making the best product technologically and waiting for customers to line-up. That may have worked for Search and for VMWare, but it’s not going to work for Google Cloud. Instead the company needs to actually get out there and actually sell, develop the capability and willingness to tailor their offering to customers’ needs, be willing to build features simply because they move the needle with CIOs, and actually offer real support.

In short, Google Cloud is competing in a different value chain than is Google search, and it needs to build new integrations accordingly. To that end, note the strategy chosen by Thomas Kurian, Google Cloud’s new CEO; from the Wall Street Journal:

The new leader of Google’s cloud-computing business plans to dramatically expand its sales team, addressing one of the biggest challenges he faces as rivals Amazon.com Inc. and Microsoft Corp. race ahead in the market…While Google has long offered cloud technology, it has seen Amazon and Microsoft surge ahead to become the leaders in providing computing power and storage services for rent over the web. Those companies have robust sales and service staffs that large corporate customers demand to support their technology needs, an area where Google has trailed, analysts have said.

In other words, Google Cloud needs to look a lot more like Microsoft.

Microsoft’s Enterprise Value Chain

Microsoft, unlike Google, has always been first-and-foremost an enterprise company. That means its integration was between its operating system and the associated APIs on which enterprise apps were built:

Microsoft's value chain

Note, though, that unlike Google’s value chain, Microsoft is much further from the end-user: devices were built and sold by OEMs, sometimes to end users, but especially to enterprise IT departments by dedicated sales forces. Similarly, Microsoft developers were by-and-large enterprise software developers, working not for end users but for management.

This had obvious downsides in the consumer market: products in the Microsoft value chain were typically feature rich and user experience poor, exactly what you would expect from a world run by top-down purchase order, not individual consumer choice. To the extent Microsoft did succeed in the consumer space, the reason was a spillover from their dominance in enterprise; by the time pure consumer markets like the web or mobile came along, Microsoft was woefully unprepared to compete. They were basically the opposite of Google.

That, though, is also why Microsoft is succeeding with Azure even as Google struggles with Google Cloud: the company is used to value chains that include sales forces and top-down decision-making, and has the right business model and integrations to take advantage.

The Netflix Exception

Perhaps the most famous example of a prominent company “pivoting” and succeeding is Netflix, but that is very much the proverbial exception that proves the rule. Netflix built its initial customer base and IPO’d through a business model predicated on renting DVDs via mail. The value chain looked like this:

Netflix's value chain

What was critical to making this value chain work was the first-sale doctrine: when a DVD was sold the rights of the copyright holder were exhausted; that means that Netflix could buy all of the DVDs it wanted and rent them to customers without copyright owners restricting them in any way. Critically, this meant that Netflix could integrate the customer relationship with content ownership.

Notice that that is the exact same integration that Netflix enjoys today: more and more of the company’s content catalog — particularly the portions that attract new customers — is original content owned by Netflix. In other words, the point of integration — the customer relationship and content ownership — is the same as in the DVD days.

To be sure, it took time for Netflix to transition to this model, and the company was absolutely helped along by hapless studio executives more interested in bumping up their annual profit than in considering their long-term position in the content value chain. There are any number of points in the early days of streaming when Netflix — because it was, if only temporarily, in a vulnerable non-integrated position in its value-chain — could have been stopped. I suspect, though, those days have past, which is why Netflix Flexes.

More generally, from a value chain perspective, Netflix’s transformation was less of a pivot than it might have first appeared: sure, the technology of DVDs by mail and streaming video are fundamentally different, but the value chain is the same. That is a far more viable transition than trying to leverage broadly similar technology into completely new markets and value chains.

The Solipsism Trap

It is understandable why the Internet giants in particular move into seemingly adjacent territories: the growth imperative is strong, both for financial and strategic reasons, and the technology seems easy enough, particularly given the resources these companies bring to bear. And yet, the truth is that those massive resources do not stem, at least in the long run, from technical excellence, but rather integration in specific value chains that produces positive feedback loops and outsize profits.

It follows, then, that without that integration, the positive feedback loops quickly disappear, along with the profits, which is the exact pattern we see again and again. Microsoft spent billions on phones and consumer Internet services, Amazon spent billions on Whole Foods, Google has spent billions on not just Google Cloud but a whole host of initiatives that have nothing to do with Search, Facebook has spent billions on Watch and VR, and now Apple is getting in the game with billions spent on Video, and the expected outcome of all these should be that they will fail.

To be sure, failure takes time: these companies do have nearly unlimited resources thanks to their core business models, and the reckless optimism bred by structural success. And, I suppose, sometimes they can actually push products across the line to profitability, kind of. Bing, for example is profitable — if you exclude traffic acquisition costs, which makes my point.

The reality is that technology has an amplification effect on business models: it has raised the Internet giants to unprecedented heights, and their positions in their relevant markets — or, more accurately, value chains — are nearly impregnable. At the same time, I suspect their ability to extend out horizontally into entirely different ways of doing business — new value chains — even if those businesses rely on similar technology, are more limited than they appear.

What does work are (1) forward and backwards integrations into the value chain and (2) acquisitions. This makes sense: further integrations simply absorb more of the value chain, while acquisitions acquire not simply technology but businesses that are built from the ground-up for different value chains. And, by extension, if society at large wants to limit just how large these companies can be, limiting these two strategies is the obvious place to start.

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

The Cost of Apple News

Apple is, according to the Wall Street Journal, driving a hard bargain with publishers ahead of the launch of its rumored News subscription service:

Apple Inc.’s plan to create a subscription service for news is running into resistance from major publishers over the tech giant’s proposed financial terms, according to people familiar with the situation, complicating an initiative that is part of the company’s efforts to offset slowing iPhone sales. In its pitch to some news organizations, the Cupertino, Calif., company has said it would keep about half of the subscription revenue from the service, the people said. The service, described by industry executives as a “Netflix for news,” would allow users to read an unlimited amount of content from participating publishers for a monthly fee. It is expected to launch later this year as a paid tier of the Apple News app, the people said.

The rest of the revenue would go into a pool that would be divided among publishers according to the amount of time users spend engaged with their articles, the people said. Representatives from Apple have told publishers that the subscription service could be priced at about $10 a month, similar to Apple’s streaming music service, but the final price could change, some of the people said…

Another concern for some publishers is that they likely wouldn’t get access to subscriber data, including credit-card information and email addresses, the people said. Credit-card information and email addresses are crucial for news organizations that seek to build their own customer databases and market their products to readers.

Probably the most obvious way to understand this story is that it, along with the report that Apple would have a launch event on March 25, appear to be attempts to negotiate through the media. I’m reminded of the January 2010 report in the Wall Street Journal that Apple’s impending tablet would cost $1,000; when Steve Jobs announced the iPad three weeks later, the $499 starting price seemed like a bargain. Perhaps leaking a 50/50 revenue share, along with an impending deadline for negotiations, is a way to make a 60/40 or 70/30 revenue share seem like a reasonable compromise?

The Growth of Apple News

Let’s back up for a moment: Apple News has grown to be a major force in publishing, at least in terms of traffic. According to a New York Times story that Apple cooperated with, the service “is read regularly by roughly 90 million people.” That has translated into traffic for news publishers that, according to Slate, often outpaces Facebook post-last January’s algorithm change.

The problem, as Digiday explained, is that traffic — which is almost completely realized within the Apple News app, not on publisher’s web pages — comes with minuscule amounts of revenue. Yes, Apple News allows for advertising, but that advertising is either sold (poorly) by Apple or sold directly by the publisher with no allowance for either programmatic ads nor data about users.

So why do publishers bother?

Apple News and Aggregation

There are a number of factors that should ring familiar to anyone familiar with the travails of publishers on the Internet.

To start, Apple News readers visit Apple News and, for the most part, read what Apple News presents to them; the front-page may be human-selected, as Apple sought to make clear in that New York Times article, but just as is the case with algorithmic selection (which is what determines what users see for the rest of Apple News, it just happens to be called “Suggested by Siri”), no one publication is favored:

Apple News Today view

On one hand, this is obviously not good for publishers: there is limited wherewithal to build brand affinity, there is no customer data shared (for purposes of follow-up, much less ads), and as noted above, there really isn’t much money to be made.

On the other hand, what are publishers really giving up? Readers going to the Apple News app have already made the decision to not visit a particular publisher’s website directly, and, given that digital content has zero marginal cost, why not support Apple News on the off chance some article hits it big?

It should be noted that publisher pages within Apple News complicate this narrative a bit: on one hand, they are a place to build brand affinity; on the other hand, they are more likely to cannibalize direct visits to the publisher’s website. But how many Apple News users are likely to switch to a browser for a particular publisher should they leave Apple News?

What is happening is Aggregation: Apple News attracts the users, which means publishers are coming onto Apple’s platform on Apple’s terms, which makes Apple News more attractive to users, making publishers ever more reticent to leave even though they aren’t getting much out of the deal.

Apple News and Publisher Subscriptions

For suppliers, the antidote for Aggregation is to go direct to consumers; the key is to embrace the same forces that drive Aggregation. First, the addressable market should be the entire world, not just a limited geographic area. Second, the same sort of automated payment tools available to advertisers on Aggregators can be leveraged for consumers; indeed, the tools for consumers, particularly given the lower dollar amounts and decreased need for paperwork, can be as simple as Apple Pay, and they can scale indefinitely. Third, a freemium approach to content means that social networks can be used for user-generated marketing.

Apple News as currently construed is actually somewhat helpful in this regard: publishers can push subscription-only content (as well as free content) into Apple News, and give users the option to subscribe using the App Store. For example, the Wall Street Journal elected to make the piece that triggered this Article free:

Free Wall Street Journal article in Apple News

However, the next story over, about Google Cloud, requires a subscription:

Subscription story in Apple News

It’s not perfect: clicking on that subscription link means the publisher has to pay Apple 30% the first year and 15% after that, and they don’t get any customer data (unless the customer creates an account in order to use their subscription on other platforms). Still, to my mind it is somewhat less egregious than Apple’s restrictions on in-app purchase; Apple News is driving the customer to a publisher’s content and charging accordingly (as opposed to taking a tax simply because there is no alternative to the App Store), but at the end of the day the publisher is still establishing a direct paying relationship with a subscriber.

The Spotify of News

What Apple is reportedly building now, though, is decidedly different. The so-called “Netflix of News” — although, given that Apple will pay out on a marginal basis as opposed to buying content, a better descriptor would be the Spotify of News — would entail customers paying one monthly fee to Apple which Apple distributes to publishers based on what subscribers read.

Publishers should be very clear about the implications of this model: it is not a direct-to-consumer model. Rather, it is an Aggregation model that happens to monetize via subscriptions instead of ads. That means it has all of the same problems for publishers that are posed by Aggregators:

  • Publishers do not form a direct connection with users; that connection is with Apple News
  • Publishers get no meaningful data (including no email addresses); there is no means to increase engagement or monetization down the road
  • Publishers must compete with every other publisher for attention

That last point is the most important, and should weigh heavily on publishers that have committed to the subscription model. What makes subscriptions work is an alignment between editorial and business model: the former is incentivized by quality and differentiation because the payoff is a customer with a high lifetime value; the New York Times put this succinctly in their 2020 Report:

We are, in the simplest terms, a subscription-first business. Our focus on subscribers sets us apart in crucial ways from many other media organizations. We are not trying to maximize clicks and sell low-margin advertising against them. We are not trying to win a pageviews arms race. We believe that the more sound business strategy for The Times is to provide journalism so strong that several million people around the world are willing to pay for it. Of course, this strategy is also deeply in tune with our longtime values. Our incentives point us toward journalistic excellence.

The proposed Apple News model, on the other hand, which pays out according to reader engagement, pushes in the opposite direction — the Facebook direction. The motivation is “to maximize clicks” and “win a pageviews arms race”, with some “time-spent” variables mixed in; sure, the driver isn’t low-margin advertising, but shifting the means of monetization doesn’t change the ends as far as incentives go.

The Cost of Apple News

It is absolutely worth noting what a great deal for consumers an Apple News subscription bundle would be: I totally get the idea of subscription fatigue, and having one place to get all of the best journalism would be amazing. That, though, doesn’t mean that Apple News wouldn’t be an Aggregator: that confirms it! Aggregators win because consumers prefer them, leaving publishers no choice but to go where the consumers are.

To that end, I am sure that a significant number of publications will sign up for Apple’s offering; clearly the company is confident enough to leak a date. And, frankly, many publications should: most publishers are already locked into the volume game when it comes to their editorial direction, and Apple News subscription payouts will be additive to the bottom line.

Publishers that have truly committed to subscriptions, though, should say no: not only will it be difficult to make up revenue that will be cannibalized lower per-customer payouts from Apple News, but more importantly a reversion to a model predicated on page views will hurt their business in the long run. This is especially the case if Apple News becomes a major revenue driver; yes, digital content can be distributed with zero marginal cost, but the incentive cost should not be discounted — it works directly against the quality imperative that is the critical factor in making the Aggregator-avoiding direct-to-consumer business model work.

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