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

The best way to understand Disney+, meanwhile, 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 $13.99/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.

A Regulatory Framework for the Internet

This week, when the U.K.’s Secretary of State for Digital, Culture, Media and Sport and the Secretary of State for the Home Department released a white paper calling for significantly increased regulation for tech companies, the scope of the debate was predictable. The MIT Technology Review laid it out succinctly:

Technology giants will be forced to have a “duty of care” for their users, if a proposal announced by the government on Monday becomes law. The proposal — a “white paper,” in UK legal parlance, which is one of the first stages of a formal government policy — is, on the surface at least, sweeping in scope and is a serious shot across the bows for big tech companies. But it has also raised some serious concerns about how it will be implemented and the possible consequences it might have on citizens’ free speech…

The proposals have raised interest among academics and observers, and alarm among privacy campaigners. The former note that while the document is scant on details despite being tens of thousands of words long, it sets out a clear direction in a way few countries have been willing to do. But the latter fear that the way it is implemented could easily lead to censorship for users of social networks rather than curbing the excesses of the networks themselves.

This proposal comes on the tail of an exposé in Bloomberg entitled YouTube Executives Ignored Warnings, Letting Toxic Videos Run Rampant; the debate around that piece, which I wrote about last week in two Daily Updates (here and here), not only touched on the question of free speech, but also the sheer scale of the problem — and, relatedly, the sheer scale of Facebook of Google.

Problematic Regulation

In short, there are clear questions that arise around all of these exposés and proposals:

  • First, what content should be regulated, if any, and by whom?
  • Second, what is a viable way to monitor the content generated on these platforms?
  • Third, how can privacy, competition, and free expression be preserved?

You can see how these questions quickly arrive at competing answers when looking at recent attempts at regulation:

  • GDPR has certainly increased the number of website click-throughs; it has also strengthened Facebook and especially Google’s competitive position exactly as predicted.
  • The European Copyright Directive, specifically Article 13, makes platforms liable for copyright violations, and while the European Parliament took care to state that this wasn’t a requirement for a content filter, there is no other viable solution. Content filters are not only extremely difficult and expensive to develop (Google has spent $100 million plus on ContentID), entrenching the largest players that have the resources to fund development and the leverage to pay for it, they will also necessarily be overly strict, limiting user expression.
  • Even more egregious than the Copyright Directive, amazingly enough, is Australia’s new law about “abhorrent violent material” like the live-streaming of the horrific Christchurch mass shooting. Companies are liable if such content is discovered on their service period — being told it exists is sufficient evidence of recklessness — and worse, every company in the stack is liable, from ISPs to cloud providers to social networks. That leaves no choice but to spy on all user traffic or, for small-and-medium-sized platforms outside of Australia, avoid the country altogether.

At the same times, the Christchurch video and its spread are clearly problematic — there is something off about the current state of affairs.

The Christchurch Video

It hardly bears noting that in a pre-Internet world there would be no widespread video of the Christchurch hate crime. Capturing video required specialized equipment, and more importantly, broadcasting video was limited to a small number of television stations, all of which, even if they had the video, would have exercised their editorial judgment to keep it off the air.

What is critical to note, though, is that it is not a direct leap from “pre-Internet” to the Internet as we experience it today. The terrorist in Christchurch didn’t set up a server to livestream video from his phone; rather, he used Facebook’s built-in functionality. And, when it came to the video’s spread, the culprit was not email or message boards, but social media generally. To put it another way, to have spread that video on the Internet would be possible but difficult; to spread it on social media was trivial.

The core issue is business models: to set up a live video streaming server is somewhat challenging, particularly if you are not technically inclined, and it costs money. More expensive still are the bandwidth costs of actually reaching a significant number of people. Large social media sites like Facebook or YouTube, though, are happy to bear those costs in service of a larger goal: building their advertising businesses.

The key differentiator of Super-Aggregators is that they have three-sided markets: users, content providers (which may include users!), and advertisers. Both content providers and advertisers want the user’s attention, and the latter are willing to pay for it. This leads to a beautiful business model from the perspective of a Super-Aggregator:

  • Content providers provide content for free, facilitated by the Super-Aggregator
  • Users view that content, and provide their own content, facilitated by the Super-Aggregator
  • Advertisers can reach the exact users they want by paying the Super-Aggregator

Everything is aligned from the Super-Aggregator perspective: users give attention that content providers work to earn, and advertisers compete to buy their way in.

The three-way market of a Super-Aggregator

Moreover, this arrangement allows Super-Aggregators to be relatively unconcerned with what exactly flows across their network: advertisers simply want eyeballs, and the revenue from serving them pays for the infrastructure to not only accommodate users but also give content suppliers the tools to provide whatever sort of content those users may want.

That, there, is the rub: given that these platforms are basically reflections of humanity, what users want varies from the beautiful to the profane — and things far more ugly than that. And worse, there is no editorial judgment to keep users from what they want, or suppliers from providing it. Indeed, that such sordid content can exist on YouTube and Facebook is testament to just how popular they are; that such content is effectively incentivized speaks to the fact that YouTube and Facebook’s moneymaking mechanism is completely divorced from this content match-making.

Market Failure

This is, in its own way, a market failure, albeit not, to be clear, in an economic sense: the allocation of goods and services by a Super-Aggregator is not only efficient, but also generates significant consumer surpluses. The failure, rather, comes from videos like that of the Christchurch massacre, or problematic YouTube content. It is not good for society that terrorists be able to freely broadcast their videos, or that child-exploitation videos spread on YouTube.

The problem is that there is no way to check this behavior: the vast majority of Facebook and YouTube users self-select away from this content, and while advertisers raise a fuss if they find out their ads are alongside this content, they have no incentive to leave the platforms entirely. That leaves Facebook and YouTube themselves, but while they would surely like to avoid PR black eyes, what they like even more is the limitless supply of attention and content that comes from making it easier for anyone anywhere to upload and view content of any type.

Note how much different this is than a traditional customer-supplier relationship, even one mediated by a market-maker: users disgusted by Uber, for example, could switch to Lyft, directly impacting Uber’s bottom-line. Or go back a few years, when GoDaddy expressed support for SOPA copyright legislation: the company was forced to change its position in the face of widespread boycotts (including by yours truly). When users pay they have power; when users and those who pay are distinct, as is the case with these advertising-supported Super-Aggregators, the power of persuasion — that is, the power of the market — is absent.

The Three Frees

There are, in Internet parlance, three types of “free”:

  • “Free as in speech” means the freedom or right to do something
  • “Free as in beer” means that you get something for free without any additional responsibility
  • “Free as in puppy” means that you get something for free, but the longterm costs are substantial

Most in the West agree, at least in theory, with the idea that the Internet should preserve “free as in speech”; China in particular represents a cautionary tale as to how technology can be leveraged in the opposite direction. The question that should be asked, though, is if preserving “free as in speech” should also mean preserving “free as in beer.”

Specifically, Facebook and YouTube offer “free as in speech” in conjunction with “free as in beer”: content can be created and proliferated without any responsibility, including cost. Might it be better if content that society deemed problematic were still “free as in speech”, but also “free as in puppy” — that is, with costs to the supplier that aligned with the costs to society?

A Regulatory Framework for the Internet

This distinction might square some of the circles I presented at the beginning: how might society regulate content without infringing on rights or destroying competitive threats to the largest incumbents?

Start with this precept: the Internet ought to be available to anyone without any restriction. This means banning content blocking or throttling at the ISP level with regulation designed for the Internet. It also means that platform providers generally speaking should continue to not be liable for content posted on their services (platform providers include everything from AWS to Azure to shared hosts, and everything in-between); these platform providers can, though, choose to not host content suppliers they do not want to, whether because of their own corporate values or because they fear boycott from other customers.

I think, though, that platform providers that primarily monetize through advertising should be in their own category: as I noted above, because these platform providers separate monetization from content supply and consumption, there is no price or payment mechanism to incentivize them to be concerned with problematic content; in fact, the incentives of an advertising business drive them to focus on engagement, i.e. giving users what they want, no matter how noxious.

This distinct categorization is critical to developing regulation that actually addresses problems without adverse side effects. Australia, for example, has no need to be concerned about shared hosting sites, but rather Facebook and YouTube; similarly, Europe wants to rein in tech giants without — and I will give the E.U. the benefit of the doubt here — burdening small online businesses with massive amounts of red tape. And, from a theoretical perspective, the appropriate place for regulation is where there is market failure; constraining the application to that failure is what is so difficult.

The result is a regulatory framework that looks like this:

The regulatory framework for the Internet

“Free as in speech” is guaranteed at the infrastructure level, the market polices platform providers generally (i.e. “free as in puppy”), while regulation is narrowly limited to businesses that are primarily monetized through advertising (i.e. “free as in beer”) and thus impervious to traditional content marketplace pressures.


This framework, to be clear, leaves many unanswered questions: what regulations, for example, are appropriate for companies like YouTube and Facebook? Are they even constitutional in the United States? Should we be concerned about the lack of competition in these regulated categories, or encouraged that there will now be a significant incentive to build competitive services that do not rely on advertising? What about VC-funded companies that have not yet specified their business models?

Still, I think this framework provides a very important foundation for addressing many of the flaws in today’s regulatory proposals, particularly the unintended effects on small-and-medium sized businesses and the platforms that support them which, I believe, are critical for the economy of the future. Regulators and lawmakers should, as always, be wary that in the well-meaning attempt to shape the world as it is they foreclose the world that might be.

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. []