Announcing a new podcast for Stratechery Plus subscribers: Sharp China With Sinocism’s Bill Bishop.
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Announcing Sharp China With Sinocism’s Bill Bishop
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Chips and China
Intel may not be the most obvious place to start when it comes to the China chip sanctions announced by the Biden administration three weeks ago (I covered the ban in the Daily Update here and here); the company recently divested its 3DNAND fab in Dalian, and only maintains two test and assembly sites in Chengdu. Sure, there is an angle about Intel’s future as a foundry and its importance in helping the United States catch up in terms of the most advanced processes currently dominated by Taiwan’s TSMC, but when it comes to exploring the implications and risks of these sanctions I am much more interested in Intel’s past.
Start with the present, though: two weeks ago Intel CEO Pat Gelsinger announced a restructuring of the company, with the goal of putting more distance between its design and manufacturing teams. From the Wall Street Journal:
Intel Corp. plans to create greater decision-making separation between its chip designers and chip-making factories as part of Chief Executive Pat Gelsinger’s bid to revamp the company and boost returns. The new structure, which Mr. Gelsinger disclosed in a letter to staff on Tuesday, is designed to let Intel’s network of factories operate like a contract chip-making operation, taking orders from both Intel engineers and external chip companies on an equal footing. Intel has historically used its factories almost exclusively to make its own chips, something Mr. Gelsinger changed when he launched a contract chip-making arm last year.
Back in 2018 I wrote about Intel and the Danger of Integration:
It is perhaps simpler to say that Intel, like Microsoft, has been disrupted. The company’s integrated model resulted in incredible margins for years, and every time there was the possibility of a change in approach Intel’s executives chose to keep those margins. In fact, Intel has followed the script of the disrupted even more than Microsoft: while the decline of the PC finally led to The End of Windows, Intel has spent the last several years propping up its earnings by focusing more and more on the high-end, selling Xeon processors to cloud providers. That approach was certainly good for quarterly earnings, but it meant the company was only deepening the hole it was in with regards to basically everything else. And now, most distressingly of all, the company looks to be on the verge of losing its performance advantage even in high-end applications.
That article was primarily about Intel’s reliance on high margin integrated processors and its unwillingness/inability to become a foundry serving 3rd-party customers, and how smartphones provided the volume for modular players like TSMC to threaten Intel’s manufacturing dominance. However, it’s worth diving into the implications of Intel’s integrated approach relative to TSMC’s modular approach, because it offers lessons for the long road facing China when it comes to building its own semiconductor industry, highlights why the U.S. is itself vulnerable in semiconductors, and explains why the risk for Taiwan has increased significantly.
TSMC’s Depreciation
Fabs are incredibly expensive to build, while chips are extremely cheap; to put it in economic terms, fabs entail massive fixed costs, while chips have minimal marginal costs. This dynamic is very similar to software, which is why venture capital rose up to support chip companies like Intel, and then seamlessly transitioned to supporting software (Silicon Valley, which is today known for software, is literally named for the material used for chips).
One way to manage these costs is to build a fab once and then run it for as long as possible. TSMC’s Fab 2, for example, the company’s sole 150-millimeter wafer facility, was built in 1990, and is still in operation today. That is one of seven TSMC fabs that are over 20 years old, amongst the company’s 26 total (several more are under construction, including the one in Arizona). The chips in these fabs don’t sell for much, but that’s ok because the fabs are completely depreciated: almost all of the revenue is pure profit.
This may seem like the obvious strategy, but it’s a very path dependent one: TSMC was unique precisely because they didn’t design their own chips. I explained the company’s origin story in Chips and Geopolitics:
A few years later, in 1987, Chang was invited home to Taiwan, and asked to put together a business plan for a new government initiative to create a semiconductor industry. Chang explained in an interview with the Computer History Museum that he didn’t have much to work with:
I paused to try to examine what we have got in Taiwan. And my conclusion was that [we had] very little. We had no strength in research and development, or very little anyway. We had no strength in circuit design, IC product design. We had little strength in sales and marketing, and we had almost no strength in intellectual property. The only possible strength that Taiwan had, and even that was a potential one, not an obvious one, was semiconductor manufacturing, wafer manufacturing. And so what kind of company would you create to fit that strength and avoid all the other weaknesses? The answer was pure-play foundry…
In choosing the pure-play foundry mode, I managed to exploit, perhaps, the only strength that Taiwan had, and managed to avoid a lot of the other weaknesses. Now, however, there was one problem with the pure-play foundry model and it could be a fatal problem which was, “Where’s the market?”
What happened is exactly what Christensen would describe several years later: TSMC created the market by “enabl[ing] independent, nonintegrated organizations to sell, buy, and assemble components and subsystems.” Specifically, Chang made it possible for chip designers to start their own companies:
When I was at TI and General Instrument, I saw a lot of IC [Integrated Circuit] designers wanting to leave and set up their own business, but the only thing, or the biggest thing that stopped them from leaving those companies was that they couldn’t raise enough money to form their own company. Because at that time, it was thought that every company needed manufacturing, needed wafer manufacturing, and that was the most capital intensive part of a semiconductor company, of an IC company. And I saw all those people wanting to leave, but being stopped by the lack of ability to raise a lot of money to build a wafer fab. So I thought that maybe TSMC, a pure-play foundry, could remedy that. And as a result of us being able to remedy that then those designers would successfully form their own companies, and they will become our customers, and they will constitute a stable and growing market for us.
It worked. Graphics processors were an early example: Nvidia was started in 1993 with only $20 million, and never owned its own fab.1 Qualcomm, after losing millions manufacturing its earliest designs, spun off its chip-making unit in 2001 to concentrate on design, and Apple started building its own chips without a fab a decade later. Today there are thousands of chip designers in all kinds of niches creating specialized chips for everything from appliances to fighter jets, and none of them have their own fab.
By creating this new market TSMC ended up with a massive customer base; moreover, most of those customers didn’t need cutting edge chips, but rather the same chip that they started with for as long as they made the product into which that chip went. That, by extension, meant that all of those old foundries had a customer base, enabling TSMC to make money on them long after they had been paid off.
Intel’s Margins
Intel’s path, though, preceded TSMC’s, which is to say that of course Intel both designed and manufactured their own chips (“real men have fabs”, as AMD founder Jerry Sanders once famously put it); to put it another way, the entire reason why Chang saw a market in being just a manufacturer was because every company that proceeded TSMC had done both out of necessity, because a company like TSMC didn’t exist.
And, it’s worth noting, there was no reason for TSMC to exist: Intel’s chips, for the two decades it existed before TSMC, were never good enough: every generation would result in such massive leaps in performance that it simply wouldn’t have made sense to keep the old assembly lines around. Still, this stuff was expensive, which is where being integrated helped.
This was the other way to manage the cost of cutting edge fabs: because Intel was at the cutting edge, it would charge a huge premium for its chips (and thus have the highest margins in the industry that I referenced earlier). At the beginning, when fabs were cheaper, Intel was happy to sell off its old equipment and make a few extra bucks on the back end. Over the last decade, though, as equipment became more and more expensive, and as Intel’s leadership started to care more about finances than about engineering, it increasingly became a priority to re-use equipment to the greatest extent possible. This wasn’t easy, I would note: Intel would stick with (relatively) outdated equipment in not just one fab but also in the fabs it built around the world.
This is where the integration point was critical: because Intel both designed and manufactured its chips, the latter could call the shots for the former; chips had to be designed to work with Intel manufacturing, not the other way around, and this extended to not just the designs themselves but all of the tooling that went into it. Intel, for example, used its own chip design software, and favored suppliers who would do what Intel told them to, and then hand the equipment off to Intel to do with it as they saw fit. Intel would then get everything to work in one fab, and Copy Exactly! that fab in another location: everything was identical, down to the position of the toilets in the bathrooms.
As I noted in the conclusion of Intel and the Danger of Integration, Intel’s strategy worked phenomenally well, right up until it didn’t:
What makes disruption so devastating is the fact that, absent a crisis, it is almost impossible to avoid. Managers are paid to leverage their advantages, not destroy them; to increase margins, not obliterate them. Culture more broadly is an organization’s greatest asset right up until it becomes a curse. To demand that Intel apologize for its integrated model is satisfying in 2018, but all too dismissive of the 35 years of success and profits that preceded it. So it goes.
So it goes, indeed — or rather, the correct conjugation is the past tense: so went Intel’s manufacturing advantage.
ASML’s Rise
I mentioned TSMC’s Fab 2 earlier and its 150-millimeter wafers; that is 1980’s era technology. The 1990s brought 200-millimeter wafers (which are used in seven of TSMC’s fabs). It was the transition to today’s 300-millimeter fabs in the early 2000’s, though, that marked the rise of ASML.
Intel’s partner in the lithography space — the use of light to draw transistors on wafers — was Nikon, and Nikon’s approach to 300-millimeter wafers was to scale up its 200-millimeter process. There was a downside to this approach, though: because the wafers were larger they had to move more slowly (more mass means more force, unless acceleration is decreased). This was fine with Intel, though: they were their own only customer, and their margins were plenty high enough to handle a decrease in throughput (indeed, Intel was well-known for running their machines well below capacity).
Lower speed wasn’t fine for TSMC and Samsung, the other up-and-comer in the space: like any challenger they were operating on much lower margins, and they didn’t want a decrease in throughput — the entire point of larger wafers was to increase the number of chips that could be produced, not to give away that gain by running everything more slowly. ASML saw the opportunity and designed an entirely new process around 300-millimeter wafers, creating dual wafer stage technology that aligned and mapped one wafer while another was being exposed.
TSMC and ASML were already close, in part because both were part of the Philips family tree (Philips was the only external investor in TSMC, which licensed Philips technology to start, and ASML was a joint venture of Philips and ASMI). What was more important is that both were ignored by the dominant players in the industry: the big chip makers, from Intel to Motorola to Texas Instruments, were matched up with Nikon and Canon; the former didn’t want equipment from a new entrant, and the latter didn’t have capacity for a foundry that was not only working on low margins but also, as part of its cost consciousness, wanted to learn how to service the machines themselves (the Japanese companies preferred to deliver black boxes that their own technicians would service).
ASML’s 300-nanometer process, though, required a reworking on the fab side as well. Now TSMC and ASML weren’t simply stuck together like two kids picked last at recess: they were deeply enmeshed in the process of working through the new process’s bugs, designing new fabs to support it, and maximizing output once everything was working. This increase in output had another side effect: TSMC started to make a bit more money, which it started pouring into its own research and development. It was TSMC that pushed ASML towards immersion lithography, where the space between the lens and the wafer was filled with a liquid with a higher refraction index than air. Nikon would eventually be forced to respond with its own lithography machines, but they were never as good as ASML’s, which meant that even Intel had to come calling as a customer.
ASML, meanwhile, had been working for years on a true moonshot: extreme ultraviolet lithography. Here is the Brookings Institution’s description of the process:
A generator ejects 50,000 tiny droplets of molten tin per second. A high-powered laser blasts each droplet twice. The first shapes the tiny tin, so the second can vaporize it into plasma. The plasma emits extreme ultraviolet (EUV) radiation that is focused into a beam and bounced through a series of mirrors. The mirrors are so smooth that if expanded to the size of Germany they would not have a bump higher than a millimeter. Finally, the EUV beam hits a silicon wafer — itself a marvel of materials science — with a precision equivalent to shooting an arrow from Earth to hit an apple placed on the moon. This allows the EUV machine to draw transistors into the wafer with features measuring only five nanometers — approximately the length your fingernail grows in five seconds. This wafer with billions or trillions of transistors is eventually made into computer chips.
An EUV machine is made of more than 100,000 parts, costs approximately $120 million, and is shipped in 40 freight containers. There are only several dozen of them on Earth and approximately two years’ worth of back orders for more. It might seem unintuitive that the demand for a $120 million tool far outstrips supply, but only one company can make them. It’s a Dutch company called ASML, which nearly exclusively makes lithography machines for chip manufacturing.
It’s not just ASML, though: that mirror is made by Zeiss, and the laser is made by TRUMPF using carbon dioxide sources pioneered by Access Laser (a U.S. company later acquired by TRUMPF). They are the two most important of over 800 suppliers for EUV, but it’s the end users that are equally essential.
When TSMC Passed Intel
In 2012 Intel, TSMC, and Samsung all invested in ASML to help the company finish the EUV project that had started 11 years earlier: there were very real questions about whether or not ASML would ever ship, or die trying, while it was clear that immersion lithography was reaching the limits of what was possible. The investment amounts are interesting in retrospect:
Company Intel TSMC Samsung Investment in stock 15% for $3.1 billion 5% for $1.03 billion 3% for $630 million Investment in R&D $1 billion $345 million $345 million Intel, despite investing the most (and having contributed a big chunk of the underlying technology), was convinced it could stick with immersion lithography as it transitioned first to 10-nanometer and then 7-nanometer chips. Yes, those were awfully small lines to be drawing with a light source that was 193-nanometers in width, but it wasn’t clear that EUV yields were going to be high enough, and besides, Intel had a lot of lithography equipment that, if used for one or two more generations, would make for some very fat margins. That was more of a priority for Intel than technological leadership, even as decades of said leadership had created the arrogance to believe that Intel could use quad-patterning — i.e. doing four exposures on a single wafer — to create those ever thinner lines.
TSMC, on the other hand, had three reasons to commit to EUV:
- First, TSMC had a multi-decade relationship with ASML that included two significant process transitions (to 300-millimeter wafers and immersion lithography).
- Second, because TSMC was a foundry, it needed to manufacture smaller lots of much greater variety; this meant that fiddly multi-pattern approaches that took many runs to improve yields didn’t make sense. EUV’s 13.5 nanometer light offered the potential for much simpler designs that fit TSMC’s business model.
- Third, Apple was willing to pay to have the fastest chips in the world, which meant that TSMC had a guaranteed first customer with massive volume whenever it could get EUV working.
In the end, TSMC started using EUV for non-critical layers at 7 nanometers, and for critical layers at 5 nanometers (in 2020); Intel, meanwhile, failed for years to ship 10 nanometer chips (which are closer to TSMC’s 7 nanometer chips), and had to completely rework its 7 nanometer process to incorporate EUV. Those chips are only starting mass production this fall — the same time period when TSMC is shipping new 3 nanometer chips. Intel, by the way, is a customer for TSMC’s 3nm process: the company’s performance was falling too far behind AMD, which abandoned its own fabs in 2009 and has been riding TSMC’s improvements (along with its own new designs) for the last five years.
China’s Integrated Path
Only now, 3,500 words in, do I turn to China, and the country’s path forward to building the sort of advanced chips that the U.S. has just cut off access to. That, though, is the point: the chip industry’s path to today is China’s path to the future.
This is a daunting challenge: it’s not just that China needs to re-create TSMC, but also ASML, Lam Research, Applied Materials, Tokyo Electronic, and all of the other pieces of the foundry supply chain. And, to go one layer deeper, not only does China need to re-create ASML, but also Zeiss, and TRUMPF, and Access Laser, and all of the other pieces of the global supply chain, much of which is not located in China. China’s manufacturing prowess is centered on traditionally labor-centric components; even though Chinese labor is now much more expensive than it was, and automation much more common, path dependency matters, and China’s capability is massive but in some respects limited.
Globalization made all of those Chinese factories extremely valuable, because the world was China’s market. At the same time, globalization also meant that China could buy high-precision capital-intensive goods abroad: it didn’t need to build them itself to get the benefits immediately. By the same token high-precision capital-intensive goods are exactly what Western countries like the U.S., Germany, Netherlands, Japan and Taiwan invested in, in part because they couldn’t compete with China on labor. To put it another way, the principles of comparative advantage governed an infinite number of decisions on the margins that led to the U.S. government having the ability to impose these sanctions on China; the realities of semiconductor manufacturing, where every paradigm shift costs massive amounts of money, years in R&D, and the willingness of partners to take the leap with you, are a further manifestation of comparative advantage: it simply makes the most sense for one company to do lithography, and another to lead the world in fabrication.
In other words, China is going to need to build up these capabilities from the ground up, and it’s going to be a long hard road. Moreover, China will not have the benefit of partnership and distributed expertise that have driven the last decade of innovation: in some respects China is going to need to be Intel, doing too much on its own.
That said, the country does have three big advantages:
- First, it is much easier to follow a path than to forge a new one. China may not be able to make EUV machines, but at least they know they can be made.
- Second, China has benefited from all of the technological sharing to date: Semiconductor Manufacturing International Corporation (SMIC) has successfully manufactured 7nm chips (using ASML’s immersion lithography machines), and Shanghai Micro Electronics Equipment (SMEE) has built its own immersion lithography machines. Granted, those 7nm chips almost certainly had poor yields, and the trick is for SMIC to use SMEE on the cutting edge, but that leads to the third point:
- China has unlimited money and infinite motivation to figure this out.
Money is not a panacea: you can’t simply spend your way to faster chips, but instead must move down the learning curve on both the foundry and equipment level. Money does, though, pay for processes that don’t have great yields: the problem for Intel at 7 nanometer, for example, wasn’t that they couldn’t make chips, but that they couldn’t get yields high enough to make them economically. That won’t be a concern for China when it comes to chips for military applications.
What is more meaningful, though, will be the alignment of China’s private sector behind China’s chip companies: TSMC didn’t only need ASML, it also needed Apple and AMD and Nvidia, end users who were both willing to pay for performance and also work deeply with TSMC to figure out generation after generation of faster chips. Tencent and Alibaba and Baidu will now join Huawei in being the China chip industry’s most demanding customers, in the best possible sense.
China’s Trailing Edge
There is one more advantage China has: remember all of those old fabs that TSMC is still operating? It turns out that as more and more products incorporate microprocessors, trailing edge chips are exploding in demand. This was seen most clearly during the pandemic when U.S. automakers, who foolishly canceled their chip orders when the pandemic hit, suddenly found themselves at the back of the line as demand for basic chips skyrocketed.
In the end it was China that picked up a lot of the slack: the company’s commitment to building its own semiconductor industry is not a new one (just much more pressing), and part of the process of walking the path I detailed above is building more basic chips using older technologies. China’s share of >45 nanometer chips was 23% in 2019, and probably over 35% today; its share of 28-45 nanometer chips was 19% in 2019 and is probably approaching 30% today. Moreover, these chips still make up most of the volume for the industry as a whole: when you see charts like this, which measure market share by revenue, keep in mind that China has achieved 9% market share with low-priced chips:
The Biden administration’s sanctions are designed to not touch this part of the industry: the limitations are on high end fabs and the equipment and people that go into them, not trailing edge fabs that make up most of this volume. There is good reason for this: these trailing edge factories are still using a lot of U.S. equipment; for most equipment makers China is responsible for around a third of their revenue. That means cutting off trailing edge fabs would have two deleterious effects on the U.S.: a huge number of the products U.S. consumers buy would falter for lack of chips, even as the same U.S. companies that have built the advantage the administration is seeking to exploit would have their revenue (and future ability to invest in R&D) impaired.
It’s worth pointing out, though, that this is producing a new kind of liability for the U.S., and potentially more danger for Taiwan.
Go back to Intel’s strategy of selling off and/or reusing its old fabs, which again, made sense given the path Intel started on decades ago: that means that Intel, unlike TSMC, doesn’t have any trailing edge capacity (outside of what it acquired in the Tower Semiconductor deal). Global Foundries, the U.S.’s other foundry, had the same model as Intel while it was the manufacturing arm of AMD; Global Foundries acquired trailing edge capacity with its acquisition of Chartered Semiconductor, but there is a reason why the U.S. >45 nanometer market share was only 9% in 2019 (and likely lower today), and 28-45 nanometer market share was a mere 6% (and again, likely lower today).
Again, these aren’t difficult chips to make, but that is precisely why it makes little sense to build new trailing edge foundries in the U.S.: Taiwan already has it covered (with the largest marketshare in both categories), and China has the motivation to build more just so it can learn.
What, though, if TSMC were taken off the board?
Much of the discussion around a potential invasion of Taiwan — which would destroy TSMC (foundries don’t do well in wars) — centers around TSMC’s lead in high end chips. That lead is real, but Intel, for all of its struggles, is only 3~5 years behind. That is a meaningful difference in terms of the processors used in smartphones, high performance computing, and AI, but the U.S. is still in the game. What would be much more difficult to replace are, paradoxically, trailing node chips, made in fabs that Intel long ago abandoned.
China meanwhile, has had good reason to keep TSMC around, even as it built up its own trailing edge fabs: the country needs cutting edge chips, and TSMC makes them. However, if those chips are cut off, then what use is TSMC to China? This isn’t a new concern, by the way; I wrote after the U.S. imposed sanctions on Huawei:
I am, needless to say, not going to get into the finer details of the relationship between China and Taiwan (and the United States, which plays a prominent role); it is less that reasonable people may disagree and more that expecting reasonableness is probably naive. It is sufficient to note that should the United States and China ever actually go to war, it would likely be because of Taiwan.
In this TSMC specifically, and the Taiwan manufacturing base generally, are a significant deterrent: both China and the U.S. need access to the best chip maker in the world, along with a host of other high-precision pieces of the global electronics supply chain. That means that a hot war, which would almost certainly result in some amount of destruction to these capabilities, would be devastating…one of the risks of cutting China off from TSMC is that the deterrent value of TSMC’s operations is diminished.
My worry is that this excerpt didn’t go far enough: the more that China builds up its chip capabilities — even if that is only at trailing nodes — the more motivation there is to make TSMC a target, not only to deny the U.S. its advanced capabilities, but also the basic chips that are more integral to everyday life than we ever realized.
MAD Chips
So is this chip ban the right move?
In the medium term, the impacts will be significant, particularly in terms of the stated target of these sanctions — AI. Only now is it becoming possible to manufacture intelligence, and the means to do so is incredibly processor intensive, both in terms of quality and quantity. Moreover, not only does AI figure to loom large in military applications, but is also likely to spur innovation in its own right, perhaps even in terms of figuring out how to keep pushing the frontier of chip design.
In the long run, meanwhile, the U.S. may have given up what would have been, thanks to the sheer amount of cost and learning curve distance involved, a permanent economic advantage. Absent politics there simply is no reason to compete with TSMC or ASML or any of the other specialized parts of the supply chain; it would simply be easier to buy instead of build. Now, though, it is possible to envision a future where China undercuts U.S. companies in chips just like they once did in more labor-intensive industries, even as its own AI capabilities catch up and, given China’s demonstrated willingness to use technology in deeply intrusive ways, potentially surpass the West with its concerns about privacy and property rights.
The big question that I am raising in this article is the short run: while I have spent most of the last two years cautioning Americans who thought Taiwan was Thailand to not go from 0 to 100 in terms of the China threat, this move has in fact raised my concern level significantly. I am still, on balance, skeptical about a conflict, thanks in large part to how intertwined the U.S. and Chinese economies still are: any conflict would be mutually assured economic destruction.
Chips did, until three weeks ago, fall under the same paradigm; I wrote earlier this year in Tech and War:
This point applies to semiconductors broadly: as long as China needs U.S. technology or TSMC manufacturing, it is heavily incentivized to not take action against Taiwan; when and if China develops its own technology, whether now or many years from now, that deterrence is no longer a factor. In other words, the short-term and longer-term are in opposition to the medium-term…
There is no obvious answer, and it’s worth noting that the historical pattern — i.e. the Cold War — is a complete separation of trade and technology. That is one possible path, that we may fall into by default. It’s worth remembering, though, that dividers in the street are no way to live, and while most U.S. tech companies have flexed their capabilities, the most impressive tech of all is attractive enough and irreplaceable enough that it could still create dependencies that lead to squabbles but not another war.
Those dependencies are being severed; hopefully we still find sufficient reason to go no further than squabbles.
The very first Nvidia chips were manufactured by SGS-Thomson Microelectronics, but have been manufactured by mostly TSMC from the original GeForce on ↩
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Microsoft Full Circle
In last week’s interview with Stratechery, Microsoft CEO Satya Nadella explained why the company was open to partnering with Meta for VR:
The way I come at it, Ben, is that I like to separate out, “What is the system, what are the apps”? Of course, we want to bring the two things together where we can create magic, but at the same time, I also want our application experiences in particular to be available on all platforms, that’s very central to how our strategy is.
For example, when I think about the Metaverse, the first thing I think about is it’s not going to be born in isolation from everything else that’s in our lives, which is you’re going to have a Mac or a Windows PC, you’re going to have an iOS or an Android phone, and maybe you’ll have a headset. So if that is your life, how do we bring, especially Microsoft 365, all of the relationships that are set up, the work artifacts I’ve set up all to life in that ecosystem of devices? That’s at least how I come to it and that’s where when Mark started talking to us about his next generation stuff around Quest was pretty exciting, so it made a lot of sense for us to bring — whether it’s Teams with its immersive meetings experience to Quest or whether it’s even Windows 365 streaming, and then, of course, all our management and security and even Xbox — [to Quest]; that’s what is the motivation behind it.
This seems obvious today in 2022, but it was a fairly radical point of view when Nadella took over Microsoft in 2014. Nadella’s first event in April 2014 centered on the announcement of Microsoft’s iconic Office Suite on Apple’s iPad; the apps had been developed under former CEO Steve Ballmer, but had been withheld from launch until the company had touch-centric versions ready for Windows-based touch devices. From the beginning of Stratechery I was adamant that this was a major mistake driven by Microsoft’s inability to imagine a future without Windows at the center; from 2013’s Services, Not Devices:
The truth is that Microsoft is wrapping itself around an axle of its own creation. The solution to the secular collapse of the PC market is not to seek to prop up Windows and force an integrated solution that no one is asking for; rather, the goal should be the exact opposite. Maximum effort should be focused on making Office, Server, and all the other products less subservient to Windows and more in line with consumer needs and the reality of computing in 2013.

The trouble for Microsoft in the devices layer is that they only know horizontal domination. When there was nothing but PC’s, the insistence on one experience no matter the hardware worked perfectly. However, a Dell and an HP are much more similar than a tablet and a web page, for example, each of which has its own input method, user expectations, and constraints. A multi-device world demands bespoke experiences, not one size fits all. Microsoft simply doesn’t seem to understand that, and the longer they seek to “horizontalize” devices the greater the write-offs will become.
However, look again at that picture: there remains a horizontal layer — services — and it’s there that Microsoft should focus its energy. For Office and Server specifically:
- Documents remain essential and ubiquitous to all of the world outside of Silicon Valley; an independent Office division should be delivering bespoke experiences on every meaningful platform. Office 365 is a great start that would be even better with a version for iPad.
- A great many apps are simply front-ends for web-based services; an independent Server division should be delivering best-in-class interfaces and tools for app developers on every meaningful platform.
[…]“Devices and services” is only half right; unfortunately Ballmer picked the wrong half.
This is why it was so important that Office for iPad was Nadella’s first major announcement; I wrote after the event in When CEOs Matter:
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.
Four years later Nadella’s reworking of the culture was all but complete, as I wrote in The End of Windows:
The story of Windows’ decline is relatively straightforward and a classic case of disruption…What is more interesting, though, is the story of Windows’ decline in Redmond, culminating with last week’s reorganization that, for the first time since 1980, left the company without a division devoted to personal computer operating systems (Windows was split, with the core engineering group placed under Azure, and the rest of the organization effectively under Office 365; there will still be Windows releases, but it is no longer a standalone business).
This new reality couldn’t have been clearer at last week’s Microsoft Inspire worldwide partner conference: Nadella’s keynote was all about the cloud, from Azure to Teams; Windows was demoted to one section of the company’s Surface announcements held as a precursor to the main event.
Do More With Less
This is how Nadella opened his keynote:
We’re going through a period of historic economic, societal, and technological change. But for all the uncertainty we continue to see in the world, one thing is clear: organizations in every industry are turning to you and your digital capability to help them do more with less, so that they can navigate this change and emerge stronger. You are the change agents who make doing more with less possible. Less time, less cost, less complexity, with more innovation, more agility, and more resilience. Doing more with less doesn’t mean working harder or longer — it’s not going to scale — it means applying technology to amplify what you can do and ultimately what an organization can achieve amidst today’s constraints.
Over the past few years, we have talked extensively about digital transformation. But today we need to deliver on the digital imperative for every organization. It all comes down to how we can help you do this with the Microsoft cloud. No other cloud offers the best of category products, and the best of suite solutions, and that’s what we’ll focus on at Ignite this week as we walk through the five key imperatives.
This “do more with less” message recurred throughout Nadella’s presentation. Three separate times Nadella emphasized how much customers would save by going with a Microsoft bundle, but that was only the “with less” part of the message; each pitch also explained why the Microsoft approach was also better (i.e. “do more”). Start with security:
Protecting is complex and get expensive. Every organization experiences this with so many different devices, connections to partners, and an ever shifting cloud resource deployment. The more agile you become, the more your security team struggles to manage the risk; the more connected we become, the faster a successful attacker can move laterally through the enterprise to their target. For far too long customer have been forced to adopt multiple disconnected solutions from disparate sources that don’t integrate well and leave gaps. We offer a better option: a natively integrated security solution that is supported by a vibrant partner ecosystem…you get a comprehensive solution that closes gaps and works for you at machine speed. On average, customers save more than 60% when they turn to use compared to a multi-vendor solution.
Nadella’s argument: not only can you save money, but because all of the products come from one vendor you can rest assured that they are comprehensive and are designed to work together.
Now let’s turn to data: with our Microsoft Intelligent Data Platform we provide a complete data fabric, from the operational stores to the analytics engines to data governance so that you can spend more time creating value and less time integrating and managing your data estate. Our goal is to provide you with the most comprehensive end-to-end data platforms so you don’t have to wrestle with the complexities of building and operating cloud scale data infrastructure yourself. Analytics alone on our data intelligence platform cost up to 59% less than any other cloud analytics out there.
That bit about “spend more time creating value and less time integrating and managing” is the part of Microsoft’s value proposition that Silicon Valley startups so frequently miss. Slack, perhaps most famously, was so certain its superior chat experience would beat out Teams (and it is superior), that company CEO Stewart Butterfield took out an ad in the New York Times welcoming Microsoft to the space; four years later, after Teams had over six times the daily active users (and before Slack was acquired by Salesforce), I explained in Teams OS and the Slack Social Network what Butterfield got wrong:
This is what Slack — and Silicon Valley, generally — failed to understand about Microsoft’s competitive advantage: the company doesn’t win just because it bundles, or because it has a superior ground game. By virtue of doing everything, even if mediocrely, the company is providing a whole that is greater than the sum of its parts, particularly for the non-tech workers that are in fact most of the market. Slack may have infused its chat client with love, but chatting is a means to an end, and Microsoft often seems like the only enterprise company that understands that.
That end is, to use Nadella’s words, “creating value”; “integrating and managing” is exactly what companies want to avoid.
With Microsoft 365 we provide a complete cloud-first experience that makes work better for today’s digitally connected and distributed workforce. Customers can save more than 60% compared to a patchwork of solutions. Microsoft 365 includes Teams plus the apps you always relied on — Word, Excel, Powerpoint, and Outlook — as well as new applications for creation and expression like Loop, Clipchamp, Stream, and Designer, and it’s all built on the Microsoft graph, which makes available to you the information about people, their relationships, all their work artifacts, meetings, events, documents, in one interconnected system. Thanks to the graph you can understand how work is changing and how your digitally distributed workforce is working. This is so critical, and it all comes alive in the new Microsoft 365 application.
Ah, there are the Office applications I referenced at the beginning. But notice the word that is missing: Office.
From Office to Microsoft
From The Verge:
Microsoft is making a major change to its Microsoft Office branding. After more than 30 years, Microsoft Office is being renamed “Microsoft 365” to mark the software giant’s collection of growing productivity apps. While Office apps like Excel, Outlook, Word, and PowerPoint aren’t going away, Microsoft will now mostly refer to these apps as part of Microsoft 365 instead of Microsoft Office.
Microsoft has been pushing this new branding for years, after renaming Office 365 subscriptions to Microsoft 365 two years ago, but the changes go far deeper now. “In the coming months, Office.com, the Office mobile app, and the Office app for Windows will become the Microsoft 365 app, with a new icon, a new look, and even more features,” explains a FAQ from Microsoft. That means if you use any of the dedicated Office apps, they’ll all be branded with Microsoft 365 soon, and with a new logo. The first logo and design changes will appear at Office.com in November, followed by the Office app on Windows, iOS, and Android all getting rebranded in January.
I’ll be honest: as an increasingly old man in technology the end of the “Office” name kind of bums me out. My nostalgia is satisfied, though, by a Microsoft that has truly come full circle.
The truth about Microsoft is that while Windows’ relationship with hardware has traditionally been modular (the Surface line notwithstanding), the company’s strategy has always been about integration and bundling. This is why Ballmer was so hesitant to give up on Windows as the center of the company’s go-to-market: sure, people wanted the Office applications on different devices, but it was Windows that tied Office to Outlook to Exchange to Active Directory to Windows Server and on down the line. This, by extension, is why Nadella’s willingness to embrace reality was a risk: Office on its own was a nice business, but it wasn’t the center of enterprise like Windows had been.
It turned out, though, that facing reality brought another benefit: the ability to see and grasp an opportunity when it appeared. Teams, which started development in 2015, a year after Nadella’s announcement, wouldn’t simply be a chat app: it would be the new hub around which Office orbited. Teams (and Outlook) development leader Brian MacDonald said at a press event in 2019:
One of the really key things and drivers of what we wanted to do with Teams was have that be a hub for Office 365. Before what we had done was just taken all those personal productivity workloads and then moved them to the cloud, but we wanted something that was purpose-built for the cloud that could be a hub across all of Office and frankly across the rest of what we’re doing at Microsoft. A lot of the Power BI, Power Apps, and Dynamics tools that James was building, but also third party. So we built a platform for that and the third-party platform and the first-party platform are actually the same.
If that sounds a lot like Windows — a hub that hosted not just Office, but other Microsoft applications and services, and a platform for 3rd-party developers — Nadella agrees with you. From the same event:
Sometimes I think the new OS is not going to start from the hardware, because the classic OS definition, that Tanenbaum, one of the guys who wrote the book on Operating Systems that I read when I went to school was: “It does two things, it abstracts hardware, and it creates an app model”. Right now the abstraction of hardware has to start by abstracting all of the hardware in your life, so the notion that this is one device is interesting and important, it doesn’t mean the kernel that boots your device just goes away, it still exists, but the point of real relevance I think in our lives is “hey, what’s that abstraction of all the hardware in my life that I use?” – some of it is shared, some of it is personal. And then, what’s the app model for it? How do I write an experience that transcends all of that hardware? And that’s really what our pursuit of Microsoft 365 is all about.
Office being on its own gave Teams an easy go-to-market: Microsoft just bundled it in. Today, though, it is Teams and everything built on that scaffolding that is Microsoft’s new Windows. It is the company and its operating system, not its apps, that are back at the center. In this sense, renaming Office 365 to Microsoft 365 is the most natural thing in the world: Office was a ship that set sail from the declining civilization that was Windows, with an uncertain destination. Today, though, that ship is but a footnote in Microsoft’s new empire in the cloud.
Moreover, it seems likely this empire will be more durable than the old Microsoft republic: the entire reason why Windows faltered as a strategic linchpin is that it was tied to a device — the PC — that was disrupted by a paradigm shift in hardware. Microsoft 365, on the other hand, is attached to the customer. Nadella again:
What we are trying to do [with Microsoft 365] is bring home that notion that it’s about the user, the user is going to have relationships with other users and other people, they’re going to have a bunch of artifacts, their schedules, their projects, their documents, many other things, their to-do’s, and they are going to use a variety of different devices.
This is why Microsoft, instead of being late to the iPad, is remarkably early to VR. Why not? Devices are but mere conduits to the cloud, which means that Microsoft is well-placed to navigate this new paradigm if it becomes a major platform — and to not miss a beat if it is not.1 In other words, to say that Microsoft has come full circle may be selling Nadella’s transformation short: the all-encompassing dominant Microsoft of old may be back, but in a version that is even stronger and more resilient than before.
This also, it must be said, casts doubt on Meta’s determination to go in the opposite direction, and give up its position as a user-centric service to be a hardware-dependent platform ↩
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Sharp Tech and Stratechery Plus
I am excited to announce both a new podcast and a substantial expansion in the value of a Stratechery subscription. We’ll start with the podcast:
Sharp Tech with Ben Thompson is a new podcast from Andrew Sharp and myself about how technology works, and the ways it is impacting the world. We will publish one free episode weekly, and there are already six episodes in the catalog:
- Introducing Sharp Tech — September 20, 2022
- What AI Is Today and What It Might Be Tomorrow — September 13, 2022
- Google-as-Government and Netflix vs. HBO Max — August 24, 2022
- Apple’s Privacy Power Play and TikTok Concerns — August 17, 2022
- Meta’s Murky Future and the Transformed New York Times — August 11, 2022
- CHIPS History and Pelosi’s Taiwan Visit — August 4, 2022
In addition, there will be a weekly subscriber-only episode that will be built on listener questions and feedback; the first paid episode dropped yesterday. You can get Sharp Tech for Apple Podcasts, Overcast, or the podcast player of your choice by loging in at the Sharp Tech website, or search for it in Spotify.
Here is the good news: Sharp Tech Premium is included with a Stratechery subscription.
That leads to today’s second announcement: the Stratechery Daily Update subscription is transforming into Stratechery Plus:
Stratechery Plus is the same $12/month or $120/year price as the Stratechery Update, but it is now expanded to include not just the Stratechery Update and Stratechery Interviews but also Dithering and Sharp Tech.
The Stratechery Update consists of substantial analysis of the news of the day delivered via three weekly emails or podcasts (including free bi-weekly Stratechery Articles). If you enjoy Stratechery Articles you will love the Stratechery Update.
Stratechery Interviews include interviews with leading public CEOs like Mark Zuckerberg, Jensen Huang, and Satya Nadella; the Founder Series with private company founders like Parker Conrad, Laura Behrens Wu, and Shishir Mehrotra; and discussions with fellow analysts like Eric Seufert, Matthew Ball, and Bill Bishop.
Dithering is a twice-weekly podcast from Daring Fireball’s John Gruber and myself: 15 minutes an episode, not a minute less, not a minute more. Dithering, which costs $5/month, was previously available as a $3 add-on for Stratechery subscribers; now it is available to all Stratechery subscribers. You can get Dithering for Apple Podcasts, Overcast, or the podcast player of your choice by logging in at the Dithering website.
This is, I hope, only the beginning for Stratechery Plus. Right now the content is obviously very Ben-centric, but my hope is to expand the offering over time. For now, I am delighted to be doing my part to make Stratechery more valuable than ever.
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The Services iPhone
Back when Stratechery first launched there was no bigger day than iPhone announcement day, and there was arguably no bigger year than 2013, when I was just getting started. That was the year Apple was, for the first time, coming out with a non-top-of-the-line iPhone, what ultimately became known as the iPhone 5C. We would find out later that the iPhone 5C was a bit of a one-off: the iPhone 5 with its chamfered edges was simply too expensive to make (and the edges chipped horribly), making it unsuitable for Apple’s “our cheaper phones are our older phones with a lower price” strategy; Apple would one day come out with the iPhone SE to address the lower end, but the real expansion came when the iPhone X was priced at $300 more than the iPhone 8 — up-market, not down.
Still, it’s interesting to look back at how much time I spent on that product launch:
- Before the event I wrote Thinking about iPhone Pricing, where I guessed that the 5C would cost $450 (but made the case $550 might make more sense).
- After the event I wrote Two Minutes, Fifty-six Seconds, which referred to how long into the keynote it took me to realize that $550 would be the price; it was clear that Apple was focused on differentiation, justifying its prices, not lowering them.
- A week later I wrote The $550 iPhone 5C Makes Perfect Sense, which was mostly about subsidies and how they might have impacted Apple’s pricing decisions.
- A couple of days after that I wrote what I consider one of the seminal Articles of early Stratechery — the ideas in What Clayton Christensen Got Wrong are one of the reasons I wanted to start the site. This was in response to critics who were sure Apple was setting themselves up for disruption with their pricing strategy; my argument was that differentiation in the user experience derived from integration was a sustainable moat that justified higher pricing.
- Finally, a week after that I wrote Obsoletive, which made the case that thinking about the iPhone as a disruptive product was mistaken; rather, what made it so compelling — including its high price — was the fact it obsoleted so many other products in our lives.
(Oh, and for what it’s worth, I asked a month later: So the 5S is (allegedly) killing the 5C. Why is this bad news?. If customers were actually heavily favoring the more expensive 5S then this actually made all of the points I had written over the previous month.)
I was originally inspired to look up this history as part of an introduction explaining why iPhone events no longer seem Article worthy, but are worth saving an Update slot for; what struck me while reading through these old pieces though, is not only the degree to which they show Apple’s consistency, but also how much the company has changed — and that is Article worthy.
Apple’s Increasing ARPU
CEO Tim Cook is fond of citing Apple’s ability to integrate hardware and software; over the last few years he has taken care to add “and services” as well. What was interesting about his opening in yesterday’s keynote, though, was that he has now moved up to a higher level of abstraction: devices.
Products that are intuitive and easy-to-use, that have a unique integration of hardware and software, and that are incredibly personal. Today we’re here to talk about three products that have become essential in our lives: iPhone, AirPods, and Apple Watch. They’re always with you, whenever and wherever you need them, and are designed to work seamlessly together. On their own, each is industry-leading. Together, they provide a magical experience.
This is an expression of a strategy that became clear several years ago; I wrote in Apple’s Middle Age:
Apple’s growth is almost entirely inwardly-focused when it comes to its user-base: higher prices, more services, and more devices.
Very few people just buy an iPhone: they upgrade to a higher-priced model, they spend money in the App Store and on subscriptions, and they buy an Apple Watch and AirPods that work seamlessly with their phone. The end result is that Apple isn’t making $550 per customer, to go back to the iPhone 5C, or $650 in the case of the 5S: they’re making upwards of $2000 — $1,000+ for a top-of-the-line iPhone, $400+ for a Watch, $200+ for AirPods, and all of that App Store revenue (and this doesn’t even include what is likely a thriving accessories business, AppleCare, or the Google search deal).
It is, to be frank, justified: all of these devices really do work well together, and iPhones remain top-of-class. And, for all of the kvetching about the App Store, and Apple’s arguably anticompetitive actions to maintain its control, it is true that the concept was revolutionary.
The Service Narrative
It was in January 2016 that Apple first articulated the so-called “Services Narrative”; after a quarter in which the company’s new iPhone 6S posted relatively disappointing sales, CFO Luca Maestri made the case on the earnings call that it was a mistake to think of Apple as a hardware company, subject to the vagaries of consumer demand. I wrote at the time (forgive the long excerpt, but it’s directly applicable to the point):
Cook and CFO Luca Maestri went to a lot of effort to sell the narrative that Apple is becoming a services company, and frankly, I think they kind of overdid it.
Specifically, Apple created a new way of evaluating their services called “Installed Base Related Purchases.” This is basically Apple’s services revenue plus the amount they pay to developers from the App Store and to most digital content owners on the iTunes Store. Said payouts don’t appear on Apple’s balance sheet, nor should they: Apple isn’t some sort of middle man for Candy Crush Saga, buying it wholesale and then selling it at a profit. Rather, they are facilitating a transaction between a content creator and a consumer, and taking a 30% tax.
Moreover, one of the benefits of being recognized as a services company is that your revenue is valued more highly with the presumption that it is higher margin; by adding in the 70% Apple pays out they are certainly able to crow about a higher revenue number, but they are dramatically reducing their associated margin by doing so. It’s silly.
To be sure, Apple’s services revenue numbers are impressive (although it should be noted that services revenue on a per-active-user basis actually decreased year-over-year). But it is very clear that the company remains a differentiated hardware company, as evidenced by everyone’s favorite question:
In the past, Apple’s been very known in always having a premium product. With the slowdown in the macro FX and also GDP revision, is Apple’s strategy go-to-market still always at premium product, or is there a need to go to more also a middle market or lower price point to attract more customers?
Ah, it’s the ol’ “Will Apple make a cheaper iPhone?” query. This one, though, was smarter than it appears, thanks to the next sentence:
Just because it seems like growing that installed base and services, as you pointed out, really economically could really help out Apple in the long-term.
As I’ve written innumerable times, services (horizontal) and hardware (vertical) companies have very different strategic priorities: the former ought to maximize their addressable market (by, say, making a cheaper iPhone), while the latter ought to maximize their differentiation. And, Cook’s answer made clear what Apple’s focus remains:
Our strategy is always to make the best products…We have the premium part of our line is the 6s and the 6s Plus. We also have a mid-price point, with the iPhone 6 and the iPhone 6 Plus. And we continue to offer the iPhone 5s in the market and it continues to do quite well. And so we offer all of those and I don’t see us deviating from that approach.
To be clear, I think this is the exact right approach for Apple, and as I noted above, I think these results show that the strategy continues to work. But let’s be honest: that means Apple is not a services company; they have a nice services revenue stream, but the company is rightly judged now and for the foreseeable future on the performance of its hardware.
I revisited this take a few years later, in an Update entitled Apple the Services Company (for Real!), where I noted that Apple’s estimated $44/user per year in services revenue still paled in comparison to Google or Facebook, but was meaningful all the same, particularly once you realized that Apple’s users had to spend a whole lot of money to even enter their ecosystem. I concluded:
Of course only looking at services revenue is not quite right either: that number does not include the cost of the iPhone itself, the price of entry to Apple’s ecosystem (although that payment may not necessarily flow to Apple, as is the case with phones handed down or resold). Apple, though, by de-emphasizing unit sales and focusing on the installed base, is making clear that the number that matters is average revenue per installed device; in other words, to the extent a company is what it measures — or at least reports — Apple is now a services company for real.
This was perhaps a bit generous, given the strategic tension I noted in the earlier excerpt: Apple may have been shifting its metrics to ones that reflected a focus on services, but at the end of the day, the company was still charging a pretty high price for entry.
The Services Company
I thought the products Apple introduced yesterday were pretty impressive:
- The Apple Watch Ultra looks like the SUV of watches: it will be sold as a tool for extreme athletes, and mostly bought because it is so clearly new and different, clearly distinguishable from all of the other Apple Watches on the market.
- AirPods Pro was a killer product in its first iteration; the 2nd generation looks set to address the 1st generation’s few flaws while delivering the sort of improvements we might expect from every tech product.
- The iPhone Pro is increasingly differentiated from the iPhone, not just in terms of having a faster processor — a first — but also with software-driven differentiation like the new Dynamic Island functionality.
The most surprising announcement of all, though, were the prices. Everything stayed the same! This was not what I, or close followers of Apple like John Gruber, expected at all. After all, Apple’s strategy the past several years seemed to be focused on wringing more revenue out of existing customers. More importantly, the last year has seen a big increase in inflation:
What this means is that in real terms Apple’s products actually got cheaper. Apple did, to be sure, raise prices around the world, but this is better explained by the fact the company runs on the dollar, which is the strongest in years; to put it another way, those foreign prices are derived from the U.S. price, and that price stayed the same, which means the price is lower.
This doesn’t make much sense for the product company Apple has always been thought to be, and doesn’t fully align with the approach I laid out in Apple’s Middle Age. It does, though, make all kinds of sense for a services company, which is focused first-and-foremost on increasing its install base. Indeed, this is the missing piece from that Update I wrote about Apple’s changing metrics. To measure its business based on users, not products, was to measure like a services company; to lower the prices of the products that lead to services revenue is to price like one.
This is, in a weird way, a relief: it has been disconcerting for people who think of Apple as a product company to see the company fight so fiercely for its App Store model, and to see the way it is willing to approach if not cross the line of anticompetitive behavior when it comes to App Tracking Transparency and its clear ambitions in the advertising space. To declare that the company is now clearly driven by Services doesn’t refute these narratives; rather, it at least justifies them, because they are exactly what a Services company ought to do. Here’s hoping that the products that made the company great don’t suffer from what is, at this point, a clear shift in strategy.
I wrote a follow-up to this Article in this Daily Update.
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Rights, Laws, and Google
The first and most important takeaway from Kashmir Hill’s excellent article in the New York Times about Mark, the man flagged by Google as a purveyor of Child Sexual Abuse Material (CSAM) for taking pictures of his son’s penis and sending them to their family doctor, and who subsequently lost nearly every aspect of his digital life when Google deleted his account, are the tremendous trade-offs entailed in the indiscriminate scanning of users’ cloud data.
On one hand, it seems like an incredible violation of privacy to have a private corporation effectively looking through every photo you upload, particularly when those uploads happen as part of the expected way in which your smartphone operates (users technically agree to this scanning, but as part of an endless End User License Agreement that is both ridiculously long and, more pertinently, inescapable if you want to use your phone as it was intended). Moreover, Google doesn’t simply scan for CSAM photos that are already known to exist via the PhotoDNA database of photos of exploited children; the company also leverages machine learning to look for new CSAM that hasn’t yet been identified as such.
On the other hand, as horrific as the material in the PhotoDNA database is, much of it has been floating around the Internet for years, which is to say the abuse depicted happened long ago; Google’s approach has the potential to discover abuse as it is happening, making it possible for the authorities to intercede and rescue the child in question. Hill’s story noted that in 2021 the CyberTipline at the National Center for Missing and Exploited Children, the only entity legally allowed to hold CSAM (NCMEC also manages the PhotoDNA database), “alerted authorities to ‘over 4,260 potential new child victims’”. We don’t know how many of those children were subsequently rescued, but a question worth posing to anyone unilaterally opposed to Google’s approach is how big that number would have to be to have made it worthwhile?
But, to return to the original hand, one of those 4,260 potential new child victims was Mark’s son (and another was taken by Cassio, a second father found by Hill caught in the same predicament, for the same reasons): the question for those applauding Google’s approach is how big the number of false positives would have to be to shut the whole thing down?
It was the exploration of these trade-offs that was at the heart of the Update I wrote about Hill’s story last week; as I noted there are no easy answers:
Nearly every aspect of this story is incredibly complex, and I understand and respect arguments on both sides: should there be scanning of cloud-related content? Should machine learning be leveraged to find new photos? Is it reasonable to obliterate someone’s digital life — except for what you give the police — given the possibility that they may be committing horrific crimes? These are incredibly difficult questions, particularly in the absence of data, because the trade-offs are so massive.
However, it seemed to me that one aspect of the case was very clear:
There is, though, one part of the story that is black-and-white. Google is unquestionably wrong to not restore the accounts in question. In fact, I am stunned by the company’s approach in these cases. Even if you grant the arguments that this awesome exercise of surveillance is warranted, given the trade-offs in question, that makes it all the more essential that the utmost care be taken in case the process gets it wrong. Google ought to be terrified it has this power, and be on the highest alert for false positives; instead the company has gone in the opposite direction, setting itself as judge, jury, and executioner, even when the people we have collectively entrusted to lock up criminals ascertain there was no crime. It is beyond arrogant, and gives me great unease about the company generally, and its long-term investments in AI in particular.
Not that it matters, one may argue: Google can do what they want, because they are a private company. That is an argument that may ring familar.
Tech and Liberty
In 2019 I discussed the distinction between public and private restrictions on speech in Tech and Liberty:
Alexander Hamilton was against the Bill of Rights, particularly the First Amendment. This famous xkcd comic explains why:
According to Randall Munroe, the author, the “Right to Free Speech” is granted by the First Amendment, which was precisely the outcome Hamilton feared in Federalist No. 84:
I go further, and affirm that bills of rights, in the sense and to the extent in which they are contended for, are not only unnecessary in the proposed Constitution, but would even be dangerous. They would contain various exceptions to powers not granted; and, on this very account, would afford a colorable pretext to claim more than were granted. For why declare that things shall not be done which there is no power to do? Why, for instance, should it be said that the liberty of the press shall not be restrained, when no power is given by which restrictions may be imposed? I will not contend that such a provision would confer a regulating power; but it is evident that it would furnish, to men disposed to usurp, a plausible pretense for claiming that power. They might urge with a semblance of reason, that the Constitution ought not to be charged with the absurdity of providing against the abuse of an authority which was not given, and that the provision against restraining the liberty of the press afforded a clear implication, that a power to prescribe proper regulations concerning it was intended to be vested in the national government. This may serve as a specimen of the numerous handles which would be given to the doctrine of constructive powers, by the indulgence of an injudicious zeal for bills of rights.
Hamilton’s argument is that because the U.S. Constitution was created not as a shield from tyrannical kings and princes, but rather by independent states, all essential liberties were secured by the preamble (emphasis original):
WE, THE PEOPLE of the United States, to secure the blessings of liberty to ourselves and our posterity, do ORDAIN and ESTABLISH this Constitution for the United States of America.
Hamilton added:
Here, in strictness, the people surrender nothing; and as they retain every thing they have no need of particular reservations.
Munroe, though, assumes the opposite: liberty, in this case the freedom of speech, is an artifact of law, only stretching as far as government action, and no further. Pat Kerr, who wrote a critique of this comic on Medium in 2016, argued that this was the exact wrong way to think about free speech:
Coherent definitions of free speech are actually rather hard to come by, but I would personally suggest that it’s something along the lines of “the ability to voluntarily express (and receive) opinions without suffering excessive penalties for doing so”. This is a liberal principle of tolerance towards others. It’s not an absolute, it isn’t comprehensive, it isn’t rigorously defined, and it isn’t a law.
What it is is a culture.
The context of that 2019 Article was the differing decisions between Facebook and Twitter in terms of allowing political ads on their platforms; over the ensuing three years the willingness and length to which these and other large tech platforms have been willing to go to police speech has expanded dramatically, even as the certainty that private censorship is ‘good actually’ has become conventional wisdom. I found this paragraph in a New York Times article about Elon Musk’s attempts to buy Twitter striking:
The plan jibes with Mr. Musk’s, Mr. Dorsey’s and Mr. Agrawal’s beliefs in unfettered free speech. Mr. Musk has criticized Twitter for moderating its platform too restrictively and has said more speech should be allowed. Mr. Dorsey, too, grappled with the decision to boot former President Donald J. Trump off the service last year, saying he did not “celebrate or feel pride” in the move. Mr. Agrawal has said that public conversation provides an inherent good for society. Their positions have increasingly become outliers in a global debate over free speech online, as more people have questioned whether too much free speech has enabled the spread of misinformation and divisive content.
In other words, the culture has changed; the law persists, but it does not and, according to the New York Times, ought not apply to private companies.
Scienter
The Google case is not about the First Amendment, either legally or culturally. The First Amendment is not absolute, and CSAM is an obvious example. In 1957’s Roth v. United States the Supreme Court held that obscene speech was not protected by the First Amendment; Justice William Brennan Jr. wrote:
All ideas having even the slightest redeeming social importance — unorthodox ideas, controversial ideas, even ideas hateful to the prevailing climate of opinion — have the full protection of the guaranties, unless excludable because they encroach upon the limited area of more important interests. But implicit in the history of the First Amendment is the rejection of obscenity as utterly without redeeming social importance. This rejection for that reason is mirrored in the universal judgment that obscenity should be restrained, reflected in the international agreement of over 50 nations, in the obscenity laws of all of the 48 States, and in the 20 obscenity laws enacted by the Congress from 1842 to 1956.
This reasoning is a reminder that laws ultimately stem from culture; still, the law being the law, definitions were needed, which the Supreme Court provided in 1973’s Miller v. California. Obscene works (1) appeal to the prurient interest in sex, (2) portrays in a patently offensive way sexual conduct specifically defined by a relevant law and (3) lack serious literary, artistic, political, or scientific value. The Supreme Court went further in terms of CSAM in 1982’s New York v. Ferber, holding that the harm inflicted on children is sufficient reason to make all forms of CSAM illegal, above and beyond the standards set forth by Miller. Justice Byron White wrote:
Recognizing and classifying child pornography as a category of material outside the protection of the First Amendment is not incompatible with our earlier decisions. “The question whether speech is, or is not, protected by the First Amendment often depends on the content of the speech”…
The test for child pornography is separate from the obscenity standard enunciated in Miller, but may be compared to it for the purpose of clarity. The Miller formulation is adjusted in the following respects: a trier of fact need not find that the material appeals to the prurient interest of the average person; it is not required that sexual conduct portrayed be done so in a patently offensive manner; and the material at issue need not be considered as a whole. We note that the distribution of descriptions or other depictions of sexual conduct, not otherwise obscene, which do not involve live performance or photographic or other visual reproduction of live performances, retains First Amendment protection. As with obscenity laws, criminal responsibility may not be imposed without some element of scienter on the part of the defendant.
“Scienter”, the “knowledge of the nature of one’s act”, is what ties this judicial history back to the original discussion of Google’s actions against Mark. As Hill explained in the New York Times:
I have seen the photos that Mark took of his son. The decision to flag them was understandable: They are explicit photos of a child’s genitalia. But the context matters: They were taken by a parent worried about a sick child.
The problem in this case comes from who is determining scienter.
Google and the Bill of Rights
Quite clearly Mark did not intend for the pictures he took for his son’s telemedicine to be used for pornographic purposes. The San Francisco Police Department, which had been notified by Google after a human reviewer confirmed the machine learning-driven discovery of Mark’s photos of his son, agreed. From Hill’s story:
In December 2021, Mark received a manila envelope in the mail from the San Francisco Police Department. It contained a letter informing him that he had been investigated as well as copies of the search warrants served on Google and his internet service provider. An investigator, whose contact information was provided, had asked for everything in Mark’s Google account: his internet searches, his location history, his messages and any document, photo and video he’d stored with the company.
The search, related to “child exploitation videos,” had taken place in February, within a week of his taking the photos of his son. Mark called the investigator, Nicholas Hillard, who said the case was closed. Mr. Hillard had tried to get in touch with Mark but his phone number and email address hadn’t worked. “I determined that the incident did not meet the elements of a crime and that no crime occurred,” Mr. Hillard wrote in his report. The police had access to all the information Google had on Mark and decided it did not constitute child abuse or exploitation.
Mark asked if Mr. Hillard could tell Google that he was innocent so he could get his account back. “You have to talk to Google,” Mr. Hillard said, according to Mark. “There’s nothing I can do.” Mark appealed his case to Google again, providing the police report, but to no avail…A Google spokeswoman said the company stands by its decisions, even though law enforcement cleared the two men.
In short, the questions about Google’s behavior are not about free speech; they do, though, touch on other Amendments in the Bill of Rights. For example:
- The Fourth Amendment bars “unreasonable searches and seizures”; while you can make the case that search warrants were justified once the photos in question were discovered, said photos were only discovered because Mark’s photo library was indiscriminately searched in the first place.
- The Fifth Amendment says no person shall be deprived of life, liberty, or property, without due process of law; Mark lost all of his data, email account, phone number, and everything else Google touched forever with no due process at all.
- The Sixth Amendment is about the rights to a trial; Mark was not accused of any crime in the real world, but when it came to his digital life Google was, as I noted, “judge, jury, and executioner” (the Seventh Amendment is, relatedly, about the right to a jury trial for all controversies exceeding $20).
Again, Google is not covered by the Bill of Rights; all of these Amendments, just like the First, only apply to the government. The reason why this case is useful, though, is it is a reminder that specific legal definitions are distinct from questions of right or wrong.
Working backwards, Google isn’t legally compelled to give Mark a hearing about his digital life (Sixth Amendment); they are wrong not to. Google isn’t legally compelled to give Mark due process before permanently deleting his digital life (Fifth Amendment); they are wrong not to. Google isn’t legally compelled to not search all of the photographs uploaded to Google (by default, if you click through all of the EULA’s); they are…well, this is where it gets complicated.
I started out this Article discussing the impossible trade-offs presented by questions of CSAM. People can and do make the case that to not search for this vileness, particularly if there is a chance that it can lead to the rescue of an abused child, is its own wrong. Resolving this trade-off in this way, though — that is, to violate the spirit and culture of the Fourth Amendment — makes it all the more essential to honor the spirit and culture of the Fifth and Sixth.
Paper Barriers
James Madison answered Hamilton’s objections in a speech to Congress introducing the Bill of Rights. What is interesting is that while Hamilton took it as a given that people would know and value their rights, Madison assumed the culture would run in the opposite direction, making an articulation of those rights important not just to restrain the government, but to remind the majority to not trample the rights of the minority:
But I confess that I do conceive, that in a Government modified like this of the United States, the great danger lies rather in the abuse of the community than in the Legislative body. The prescriptions in favor of liberty ought to be levelled against that quarter where the greatest danger lies, namely, that which possesses the highest prerogative of power. But this is not found in either the Executive or Legislative departments of Government, but in the body of the people, operating by the majority against the minority.
It may be thought that all paper barriers against the power of the community are too weak to be worthy of attention. I am sensible they are not so strong as to satisfy gentlemen of every description who have seen and examined thoroughly the texture of such a defence; yet, as they have a tendency to impress some degree of respect for them, to establish the public opinion in their favor, and rouse the attention of the whole community, it may be one means to control the majority from those acts to which they might be otherwise inclined.
This Article is a manifestation of Madison’s hope. Start with the reality that it seems quaint in retrospect to think that any of the Bill of Rights would be preserved absent the force of law. This is one of the great lessons of the Internet and the rise of Aggregators: when suppressing speech entailed physically disrupting printing presses or arresting pamphleteers, then restricting government, which retains a monopoly on real world violence, was sufficient to preserve speech. Along the same lines, there was no need to demand due process or a restriction on search and seizure on any entity but the government, because only the government could take your property or send you to jail.
Aggregators, though, make private action much more possible and powerful than ever before: yes, if you are kicked off of Twitter or Facebook, you can still say whatever you want on a street corner; similarly, if you lose all of your data and phone and email, you are still not in prison — and thank goodness that is the case! At the same time, it seems silly to argue that getting banned from a social media platform isn’t an infringement on individual free speech rights, even if it is the corporations’ own free speech rights that enable them to do just that legally, just as it is silly to argue that losing your entire digital life without recourse isn’t a loss of property without due process. The big Internet companies are manifesting Madison’s fears of the majority operating against the minority, and there is nothing the Bill of Rights can do about it.
What remains are those paper barriers, and what respect they might still engender, if it is possible to “rouse the attention of the whole community.” Rights are larger than laws, and Google has violated the former, even if they are not bound by the latter. The company ought not only change its policy with regards to Mark and Cassio, but fundamentally re-evaluate the balance it has struck between its unprecedented power over people’s lives and the processes it has in place to ensure that power is not abused. If it doesn’t, the people ought to, with what power they still conserve, do it for them.
I wrote a follow-up to this Article in this Daily Update.






























