Google Fights Back

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

“I liked that very much.”

"I liked that very much"

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

Google’s Mission

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

Google's Mission

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

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

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

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

Google's goal

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

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

Google’s Data Collection

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

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

Duplex on Web uses your data

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

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

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

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

Google’s Strategy Credits

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

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

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

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

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

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

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

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

Google’s Opportunities

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

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

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

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

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

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

Google’s Challenges

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

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

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

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

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

Microsoft, Slack, Zoom, and the SaaS Opportunity

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

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

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

At least in part.

The SaaS Business Model

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

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

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

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

SaaS and Current Use Cases

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

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

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

Microsoft’s SaaS Challenge

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

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

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

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

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

Zoom and Being Better

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

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

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

Slack and New Use Cases

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

First, the company argued that Slack transforms internal communications:

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

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

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

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

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

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

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

What Microsoft is Missing

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

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

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

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

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

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

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

Slack's cohort growth

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

The Enterprise Growth Framework

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

Use case versus existing customer relationships in enterprise software

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

Teams expands the use cases within Microsoft's existing userbase

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

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

Uber Questions

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

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

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

The Personal Mobility Question

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

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

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

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

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

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

The Lyft Question

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

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

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

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

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

The Scooter Question

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

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

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

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

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

The Self-Driving Question

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

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

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

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

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

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

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

The Profitability Question

Unsurprisingly, many folks have fastened onto this risk factor:

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

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

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

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

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

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

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

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

Disney and the Future of TV

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

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

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

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

A Brief History of TV

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

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

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

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

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

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

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

The Internet’s Impact

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

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

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

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

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

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

ESPN+ and Traditional TV

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

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

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

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

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

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

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

Disney+ and the Disney Universe

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

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

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

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

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

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

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

The Hulu Hedge

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

The Disney+ App

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

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

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

The Future of TV

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

The Future of TV

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

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

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

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

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

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

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

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 []