Cars and the Future

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Once again, a company, built around the hottest tech in the industry, stole the spotlight at CES. This time, though , the product was not a smartphone, and the company was not Apple. For my money the most interesting news of last week came from a most surprising source: General Motors.

First up was the news that the century-old American car maker was investing $500 million in ride-sharing startup Lyft. Then, a few days later, the company formally introduced the Chevrolet Bolt, a (relatively-speaking) no-frills electric car that promises to go 200 miles on a charge for about $30,000.1 Perhaps it was the company in question, or simply the timing, but it reinforced the sense that fundamental change is coming to the world of transportation.

What is interesting, though, is that while change is certainly coming, it is coming on multiple axes: The Lyft news is about the secular shift from individually owned-and-operated automobiles to transportation-as-a-service, while the Chevrolet Bolt is about how the cars themselves are made. Meanwhile, Google, Uber, Tesla, and others are working on obviating the need for a driver at all. To put it another way, when it comes to questioning the future of transportation, the “What?”, “How?”, and “Where?” are all in play.

The Future is Here?

It’s easy to predict a future where all of these trends coalesce: electrically-powered self-driving cars, summoned from our smartphones, take us where we need to go with plenty of time to finally beat Candy Crush. After all, the trends all reinforce each other:

  • The simpler drivetrain of an electric vehicle rearranges what matters when it comes to building a car: the engineering that matters is more software and less mechanical, opening the door to software companies that are vastly more suited to developing self-driving technology
  • Electrical vehicles have (relative to gas-powered cars) higher fixed costs but lower marginal costs. This is a natural fit with ride sharing services focused on reducing the average cost per ride. Range is a concern, but a car with an exchangeable battery based out of a central depot (much more viable for a transportation company than an individual) could work well
  • Similarly, self-driving cars remove the largest cost from ride-sharing services: the driver. This has import beyond any one ride in question: the big prize is consumers giving up cars completely, which would result in ride-sharing utilization increasing exponentially

So it’s set then. Welcome to our carless future.

Except for the small detail that car sales are headed in the wrong direction — they are skyrocketing. Last year saw a record 17.5 million cars and trucks sold in the United States; China sold a record 21.1 million (although growth is slowing), and India a record 2.03 million. The United Kingdom sold a record 2.6 million, Australia a record 1.6 million…are you sensing a theme?

To be sure many of these purchases were the result of pent-up demand from the Great Recession, when sales plummeted below 10 million in the U.S.; the average car in the U.S is 11 years old. But that stat itself suggests that transportation, at least in the U.S., won’t be changed overnight: the biggest argument for things staying the way they are is the sunk cost in your driveway.

This leads to three more questions: “When?”, “Who?”, and “Why?”.

When Will the Future Arrive?

What makes this moment in the transportation industry so fascinating is that while the three trends I described above are broadly related through their reliance on computers, each of them are independent of the other. An electric car could be owned and operated by its owner; a self driving car could be powered by an internal combustion engine and used exclusively by its owner; a ride-sharing network could rely on drivers operating gas-powered vehicles.

Indeed, that’s exactly what the market looks like today: while self-driving cars are obviously not yet available, Tesla, Nissan, and soon General Motors sell electric vehicles to owner-operators, while Uber and its competitors utilize drivers operating traditional cars. Of course all of these taken together are only a fraction of the market: the majority of us still get around the old-fashioned way, by pointing our own cars in the direction we want to go with a stop at the gas station on the way.

Moreover, each trend faces its own headwinds: the case for electric vehicles, particularly at the low, non status-concerned side of the market, was already hard to make given the propensity of buyers to anchor on the up-front price instead of the total cost of ownership. The task has only become more difficult with the plunge in oil prices. Add in the fact that low-price buyers are less able to make compromises to the car’s actual driving performance (someone buying a Chevrolet Bolt can’t take the family BMW to Grandma’s house 500 miles away) and I suspect the Bolt will end up like the Volt, General Motor’s disappointing electric+.2 Indeed, the drop in oil prices in particular has made Tesla’s decision to focus on the high-end consumer who buys the car for status and performance reasons look much smarter than most business theorists would admit.3 The same logic applies to Apple’s rumored entry.

Self-driving cars, meanwhile, face significant challenges when it comes to technology, data, and regulation. As with most complex technologies, the first 90% — driving down a highway with decent visibility — is the easy part; It’s that last 10%, especially the last 1%, that is devilishly difficult. Google is attempting to solve the problem exactly the way you would expect them to: by gathering an overwhelming amount of data. The problem is that traffic conditions can change rapidly; as of last year, for example, Google’s cars couldn’t handle a temporary stoplight. In other words, it’s not simply that Google needs to map the entire world in far more detail than they have previously — after all, the fact they have already done it shows just how capable the company is! — but rather that the maps need to be updated far more frequently than Google Street view ever needed to be. Existing car companies, were they to leverage all of their cars on the road, have an advantage here, but nothing that compares to Google software expertise (I suspect this mismatch is behind Google’s rumored tie-up with Ford).

Meanwhile California, the largest car market in the United States and the one who’s regulations are almost always copied by everyone else, has come out with proposed rules for self-driving cars that require a specially-licensed driver be capable of taking over a self-driving car in an emergency, a far cry from Google’s concept of cars that don’t even need a steering wheel. These regulations do, though, work well for the semi-autonomous driving capability focused on the 90% problem that is already being implemented by Tesla, Mercedes-Benz, and a host of other incumbent car companies (and, again, presumably Apple). Just like with electric cars, it seems likely the revolution will be gradual and from the high-end, at least for now.

That leaves Uber and the other ride-sharing companies. An underappreciated strength of Uber is the fact it relies almost completely on technology — on phones, in the cloud, and especially in the car — that already exists. To be sure, the service is still too expensive to replace cars for most people, but were the company to ever crack true ridesharing — where the driver is a rider — the cost of going car-free could be competitive far more quickly than anyone expects, especially for those who have not yet bought a car.

Who Will Drive the Future?

These answers are vaguely unsatisfying: I want my future transportation network, not piecemeal implementations that I can’t afford! Indeed, there is an aspect of car talk that reminds me of TV: specifically, folks have been claiming that the traditional cable bundle is dead for well over a decade in large part because they wish it were so, yet the bundle has kept trucking along. Admittedly, over the past 12 months the same folks have worked themselves into a frenzy as cable subscribers have finally started to decline, but I for one am a little stingy with credit for any prediction made annually for years.

What I suspect is happening with TV is a little more nuanced than long-standing cable customers getting fed up with the cost of bundled TV and cutting the cord. Rather, young people, who have grown up in a very different entertainment environment than their parents — i.e. an online one — are simply not signing up in the first place. The decline, slight as it is, is the older generation that was raised on TV dying off.

This generational pattern of adoption will, in the history books, look sudden, even as it seems to unfold ever so slowly for those of us in the here and now — especially those of us working in technology. The pace of change in the technology industry4 — which is young, hugely driven by Moore’s Law, and which has largely catered to change-embracing geeks5 — is likely the true aberration. After all, the biggest mistake consistently made by technologists is forgetting that for most people technology is a means to an end, and for all the benefits we can list when it comes to over-the-top video or a network of on-demand self-driving vehicles, change and the abandonment of long-held ideals like the open road and a bit of TV after supper is an end most would prefer to avoid.

Instead, the change is gradual. Netflix here, a bit of YouTube there. Or, in the case of cars, first hybrids and assisted parking, later electric vehicles that look and operate like normal cars, and the ability to take your hands off the wheel on the highway.

Why the Future Will Come

Make no mistake, though: change is happening, and as I hinted at above it’s of the morbid variety: people raised to value things like car ownership or sitting down to channel surf are, well, dying. Meanwhile, a new generation that doesn’t understand why you would want to sit behind the wheel — much less own the damn thing — when you could instead be on your smartphone is coming of age. It’s a bit over-used at this point but the Ernest Hemingway quote about bankruptcy seems appropriate:

“How did you go bankrupt?”
“Two ways. Gradually, then suddenly.”

Netflix is instructive in this regard: sure, the company is primed to be the biggest beneficiary when and if the cable bundle falls apart, but its position was secured years before that through a series of moves (which I recounted in detail last week) that primed the company to have the right user base and the right business model for a future that would eventually arrive.

Similarly, when it comes to evaluating who is in the best position to take advantage of future revolutionary changes in transportation — incumbents, technology leaders, big brands, startups — my money is on those that own the customers and have the right business models in place.6 Startups looking to disrupt other decades or century old industries should take note: be patient, get your business model and core user base right, and wait for the fundamental changes wrought by the Internet and mobile to come to you.

  1. After U.S. federal government electric vehicle subsidies ↩

  2. It has a gas engine that acts solely as a generator ↩

  3. I responded to the “Tesla isn’t disruptive” gripe here and here  ↩

  4. IBM to Microsoft to Apple and Google in a career! ↩

  5. Tech Twitter basically devoting an entire day to David Bowie was no accident; rest in peace ↩

  6. I.e. Uber ↩

A Politics For Technology

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From a certain perspective, Uber’s surge-pricing, which was again in the headlines this past New Year’s Eve, is easy to defend: the only way to balance supply and demand is to adjust the price. In fact, there is a lot of fundamental economic theory behind this simple explanation, specifically the idea of a “price mechanism.” A price mechanism (i.e. the surge pricing) has three functions:

  • Signaling: A higher price tells suppliers to increase production, while a lower price tells suppliers to do the opposite; in the case of Uber surge prices signal drivers who might prefer to not work to that it is worth the inconvenience to get on the road
  • Rationing: If supply is insufficient, a higher price reduces demand and ensures those who most want the good in question can obtain it; in the case of Uber surge pricing ought to compel many riders to take alternative modes of transportation or to wait until there is more supply and/or less demand, while those who need a ride right now can be sure they get one
  • Transmission of preference: Signaling and rationing are all well and good, but what makes the price mechanism so amazing is that it ties the two together: disparate consumers inform disparate suppliers about how much supply is needed without the need for any coordination

Key to the price mechanism is money; while barter works, it carries a huge information burden: who can quickly and easily compare the value of a cow to the value of a bushel of grain to the value of a piece of pottery to the value of an Uber ride? It is much easier to have an intermediary that easily transmits relative value, which is why Uber rides are priced in dollars and cents and not in ounces of meat.

The end result is a system that ensures that those who need a ride are guaranteed to get one; those who really could do without self-select out of the system, at least until more drivers are compelled to increase the supply. It is much better than the alternative, where someone who could just as easily walk a couple of blocks might by pure chance grab the taxi needed by, say, a woman in labor. That’s an extreme example, but I use it to make the point: pricing ensures those who truly need a good can get it, and, on a holiday defined by champagne, we should all be grateful.

The Problem with Money

In the context of the price mechanism, money serves the role of a medium of exchange. The problem, though, is that money serves other functions as well: specifically, money is a unit of account and a store of value. It is the latter that is the rub when it comes to Uber and the idea of allocating rides based on price. To return to the extreme example above, what if the woman in labor is poor, and the person who only needs to travel a few blocks is rich? It very well may be that the latter’s ability-to-pay will trump the former’s willingness-to-pay; this is, to my mind anyways, the most valid reason to oppose surge pricing.

What, though, are the alternatives? As I noted, the current taxi system basically reduces rides to a lottery: you either get an empty taxi or you don’t.1 That in itself is frustrating enough, but the bigger cost is the uncertainty of it all: if you are not sure whether or not you will be able to get a ride, you are less likely to depend on the ride service in question at all. This is especially problematic on occasions like New Year’s Eve: when those needing a ride are drunk, the last thing we as a society should hope for is that folks default to a ride that is guaranteed, i.e. their own car. And, frankly, those needing a ride should, in the grand scheme of things, be similarly grateful that surge pricing guarantees that rides are available: sure, an unexpected $200 fare is annoying, but a DUI with all its attendant cost is far worse (and that’s not even close to the worst-case scenario when it comes to driving drunk).

It is also not realistic to expect traditional taxi companies to have sufficient supply for high demand times like New Year’s Eve: the problem is that all of the supply necessary to fulfill peak demand would sit idle the vast majority of the time. That idleness has a very real cost — specifically, opportunity cost. Any resource, whether it be vehicular or human, that is devoted to one activity is by definition not devoted to another. That may not seem like much when it comes to a few taxis, but in aggregate this makes the “pie”, which is the total pool of economic resources available, smaller for everyone.

This gets at why Uber is a much bigger deal than any one New Year’s Eve: the way in which the service much more efficiently utilizes resources, both vehicular and human, actually grows the pie: indeed, the only possible way to grow gross domestic product is through increased efficiency, which frees up resources for new value-generating activities.

Still, what of the poor woman in labor?

In fact, the relative wealth of the woman in labor and the lazy rich person ought to have nothing to do with ride allocation at all: however, due to the fact that money works as both a medium of exchange and a store of value they are easily intermingled. The answer is to disentangle them; instead of ruining the brilliant mechanism by which rides are both distributed to those who signal the greatest need and through which resources are most efficiently allocated, It would be far better to focus on ensuring that everyone has the same opportunity to signal their preference. To contort Uber into a welfare provider is to ruin both.

A New Politics For a New World

At the heart of the Uber conundrum and its potential solution is a new political philosophy for technology. Mobile and ubiquitous connectivity have the potential to unlock efficiencies that were never before possible. Take taxis, to stick with the Uber theme: the justification for most taxi regulations were important ones like safety, dependability, and consumer protection. Given the fact that taxis would be out on the street unsupervised it made sense to tightly control entrance to the market. However, were it possible to address all those same concerns far more effectively, through, say, precise tracking and full histories of both drivers and passengers, as well as knowledge about pick-up and intended drop-off points, would not the regulations look significantly different?

Similarly, in a world where the key to building a sustainable business was controlling distribution, the greatest gains naturally accrued to the biggest companies. And, by extension, it was reasonable to ask those companies to not only pay their workers well, but to also provide for needs beyond salary, like health insurance and disability insurance. But do those same assumptions hold in a world where distribution is free, and where preferences and needs can be distilled to an individual or gig basis?

The money problem — the fact it is both a means of exchange and a store of value — is an allegory for the dysfunctional nature of what passes for a social safety net, particularly in the United States: things like health insurance and disability are intermingled with a salary or fee. This is problematic on both sides: new efficiencies that are unlocked through mobile and ubiquitous connectivity are not fully realized thanks to regulations from an era that operated on fundamentally different assumptions. This, ultimately, hurts everyone because it limits the growth of the economic pie,

On the other side are the people actually doing these new jobs, or those who would like to. Given the fact many social safety nets are built by traditional companies, those not in those companies are left completely exposed. This is unacceptable both morally and economically: morally because to deny healthcare or basic insurance is to deny the humanity of those in need; economically both because of higher costs incurred because of treatments not received, but especially because of the cost of opportunities not pursued for fear of having no net.

It would be far better — and a far better match for the reality of today’s labor market — to disentangle once-and-for-all employment from the social safety net. This should be the central political focus of technologists in particular. Outdated regulations forged under fundamentally different assumptions are one of the chief obstacles to the opportunities afforded by mobile and the Internet, particularly when it comes to the aggregation of consumers in markets that weren’t even imaginable 10 years ago.

What Technology Owes

Of course, to argue for less regulation is hardly controversial in Silicon Valley: what is missing is the necessary trade-off. Specifically, as the opportunities for technologists and their investors continue to grow, so should the willingness to pay: that pregnant woman still needs a ride.

This is where articles like Paul Graham’s weekend piece Economic Inequality ring hollow. Graham’s defense of the broad-based gains that accrue from new technology is absolutely correct: increased efficiency, which technology is uniquely suited to deliver, is the only way to grow the pie for everyone’s benefit. But given that much of those efficiency gains also contribute to winner-take-all dynamics, it is reasonable to expect that those winners — and their investors — pay commensurately more. Imagine if Graham had written his article accompanied with a call to close the carried interest tax loophole, which allows venture capitalists to be taxed at the (significantly lower) capital gains rate on money they themselves did not invest: his defense of getting rich — which wasn’t necessarily wrong! — would have had much more gravitas.2

Still, I’m glad Graham opened the debate. Technology is changing the world, and it is naive to not expect the world to begin to push back. Rather than always be reactionary, it is past time for the technology industry broadly and Silicon Valley in particular to get serious about what that world will look like in the future, especially given the fact there is actually a way forward that is a win for not just technology companies and their investors, but for those who are impacted — i.e. everyone. Just as we should separate the means by which Uber allocates drivers from the ability to pay for a ride, it makes sense to separate work from the provision of a social safety net, and those most able to capitalize on this new world order should be the most willing to pay.

  1. And the driver has far greater discretion to discriminate based on appearance ↩

  2. Not to say this would be sufficient, but it’s a place to start that would mean more coming from someone like Graham ↩

The 2015 Stratechery Year in Review

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2015 was Stratechery’s third year, and the first one I spent completely devoted to it full-time. This year I wrote 47 free Weekly Articles and 180 subscriber-only Daily Updates. Given that most were between 1800 and 2000 words, that’s the equivalent of about 6.5 books!

Here are the highlights (here are the 2014 and 2013 editions):

The Five Most-Viewed Articles:

  1. Why Web Pages Suck — Everyone complains about web pages that suck, but the reality is that it is advertisers who call the shots. This should, at a minimum, put Facebook’s Instant Articles and Apple’s News app in a new light
  2. Why BuzzFeed is the Most Important News Organization in the World — The key to sustainable, ethical journalism is aligning the business and editorial sides of a publication. No company has done a better job of doing that on the Internet then BuzzFeed
  3. Apple’s New Market — Apple is on the verge of leaving the narrowly-defined smartphone market behind entirely, instead making a play to be involved in every aspect of its consumers’ lives. And, if the importance of an integrated experience matter more with your phone than your PC, because you use it more, how much more important is an integrated experience that touches every detail of your life?
  4. Twitter’s Moment — Twitter has had a rough stretch, and most are pessimistic about its chances. I was previously, but I think the upside is looking much brighter than it did before this week
  5. Apple Watch and Continuous Computing — The Apple Watch’s success depends on three things: the physical design, the interaction model, and how it interacts with its environment. It’s on the right track
Apple's services are extending the iPhone's impact to every part of our lives
Apple’s services are extending the iPhone’s impact to every part of our lives

Five Big Ideas

  • Aggregation Theory — The disruption caused by the Internet in industry after industry has a common theoretical basis described by Aggregation Theory
  • Netflix and the Conservation of Attractive Profits — Netflix has a lot more in common with Uber and Airbnb than you might think: it all comes back to the Law of Conservation of Attractive Profits, a core principle of disruption
  • Airbnb and the Internet Revolution — Airbnb gets less press than Uber, but in some respects its even more radical: understanding how it works leads one to question many of the premises of modern society from hotels to regulations. It’s an important marker in the Internet Revolution
  • Beyond Disruption — Clayton Christensen claims that Uber is not disruptive, and he’s exactly right. In fact, disruption theory often doesn’t make sense when it comes to understanding how companies succeed in the age of the Internet
  • The End of Trickle-Down Technology — Reaching developing markets depends on understanding that consumers with a small budget are very different from consumers who aren’t interested in spending much
Aggregation Theory
Aggregation Theory

Five Company-Specific Posts

  • The Facebook Epoch — First came the PC, and on top of the PC the Internet. Then, mobile, but what will rule mobile?
  • From Products to Platforms — Apple was at its best in its most recent keynote: unveiling the sorts of products the company is uniquely capable of creating. The question, though, is whether the company has the vision and capability of making those products into platforms
  • The AWS IPO — AWS has long been a question mark when it comes to Amazon: it’s a good idea, and it makes money, but like it’s parent company, will it ever be profitable? The revelation that AWS is already very profitable indeed is a really big deal both for AWS but also for Amazon itself. (Related: Venture Capital and the Internet’s Impact)
  • Old-Fashioned Snapchat — How Snapchat is positioning itself to win an outsized share of television’s brand advertising
  • Slack and the State of Technology at the End of 2015 — Slack has announced the Slack Platform. It’s an obvious move, but it’s the obviousness that indicates what a huge opportunity it is
The Facebook Epoch
The Facebook Epoch

Five Posts About the Media Business

Popping the Publishing Bubble
Popping the Publishing Bubble

Five Daily Updates

(Please note that these are subscriber-only links; you can sign-up here)

  • June 5 — Tim Cook’s Unfair and Unrealistic Privacy Speech, Strategy Credits, The Privacy Priority Problem
  • August 17 — The New York Times on Amazon, Jeff Bezos’ Email, Why Work for Amazon
  • August 31 — Ballmer’s Bad Bundle Economics, Netflix Loses Epix Movie Deal
  • September 21 — Malware Hits iOS, The Importance of the App Store, XcodeGhost: What Happened and What Now?
  • October 12 — AWS Re:invent, Pure Storage IPOs, Dell to Buy EMC; Enterprise Disruption; Dell’s Logic

Plus five more:

  • October 27 — Chase Pay and the Payments Stack, Apple Pay and Opportunity Cost, Applying Aggregation Theory
  • October 28 — Stop Doubting the iPhone, The Macintosh Company
  • Novenber 17 — Marriott Acquires Starwood, Online Travel Agents and Aggregation, Surviving as an Incumbent
  • November 20 — Adele Won’t Stream 25, Windowing Versus Piracy
  • December 22 — SpaceX Makes History, SpaceX and Unicorns, Disney in the Age of Abundance
Curation and Algorithms
Curation and Algorithms

Happy New Year. I’m looking forward to a great 2016!

Exponent Podcast: OpenAI and Strategy Credits

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On Exponent, the weekly podcast I host with James Allworth, we discuss OpenAI’s new mission and what it says about capitalism. Or is it just a strategy credit that we are reading too much into?

Listen to it here.

Slack and the State of Technology at the End of 2015

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Last December I wrote an article entitled The State of Consumer Technology at the End of 2014. That article was more than a year-in-review though: in it I both defined the different epochs of computing — PC, Internet, and mobile — as well as the distinct arenas of competition within each epoch: the operating system and killer applications for productivity and communications.

threeepochs

The question I raised is what comes next?

The Facebook Epoch

The answer, at least when it comes to the consumer space (and excluding China) is Facebook. I laid out why in an article entitled, appropriately enough, The Facebook Epoch:

Mobile is a great market. It is the greatest market the tech industry, or any industry for that matter, has ever seen, and the reason why is best seen by contrasting mobile with the PC: first, while PCs were on every desk and in every home, mobile is in every pocket of a huge percentage of the world’s population. The sheer numbers triple or quadruple the size, and the separation is increasing. Secondly, though, while using a PC required intent, the use of mobile devices occupies all of the available time around intent. It is only when we’re doing something specific that we aren’t using our phones, and the empty spaces of our lives are far greater than anyone imagined.

Into this void — this massive market, both in terms of numbers and available time — came the perfect product: a means of following, communicating, and interacting with our friends and family. And, while we use a PC with intent, what we humans most want to do with our free time is connect with other humans: as Aristotle long ago observed, “Man is by nature a social animal.” It turned out Facebook was most people’s natural habitat, and by most people I mean those billions using mobile.

Note that in that piece I rearranged the epochs slightly: specifically, I defined the “Internet Epoch” — which was dominated by Google — as sitting on top of PCs, which meant the relative size of this epoch was constrained by the fact that PCs were, relatively speaking, not mobile; rather, both PC usage and Google uses was defined by intent. Mobile, and by extension Facebook, were different: their usage was defined not only by increased availability, but also by the “empty spaces” in our lives.

What, though, about enterprise computing? And what is the killer app when it comes to work and productivity on mobile?

The Reorganization of the Enterprise Stack

Microsoft has arguably dominated enterprise computing even more than they dominated the PC epoch generally, in part because they delivered an integrated solution that, to put it simply, made life easier for Chief Information Officers in particular. I wrote in Redmond and Reality:

Consider your typical Chief Information Officer in the pre-Cloud era: for various reasons she has bought in to some aspect of the Microsoft stack (likely Exchange). So, in order to support Exchange, the CIO must obviously buy Windows Server. And Windows Server includes Active Directory, so obviously that will be the identity service. However, now that the CIO has parts of the Microsoft stack in place, she is likely to be much more inclined to go with other Microsoft products as well, whether that be SQL Server, Dynamics CRM, SharePoint, etc. True, the Microsoft product may not always be the best in a vacuum, but no CIO operates in a vacuum: maintenance and service costs are a huge concern, and there is a lot to be gained by buying from fewer vendors rather than more. In fact, much of Microsoft’s growth over the last 15 years can be traced to Ballmer’s cleverness in exploiting this advantage through both new products and also new pricing and licensing agreements that heavily incentivized Microsoft customers to buy ever more from the company.

Microsoft’s dominance, though, has been chipped away via the one-two punch of the cloud and mobile. Cloud-based applications not only offered a payment model that was more attractive to many businesses, but they also removed the need for troublesome upkeep. This, then, allowed other aspects of the product to rise in relative importance when it came to the purchase decision, whether that be specific features or just the general user experience.

It’s here that mobile mattered: for years Microsoft products were well behind the competition when it came to the mobile experience on non-Microsoft platforms like iOS and Android. This is the one-two punch I was referring to: the cloud removed one of Microsoft’s biggest lock-ins in the enterprise, while mobile gave enterprises a reason to try something different.

The Cloud Epoch

Indeed, the way in which cloud and mobile worked hand-in-hand to uproot Microsoft is no accident. When it comes to the enterprise side of computing, I would place the cloud as the fourth epoch, and just as the Internet (or in the case of enterprise, on-premise applications) rested on PCs, the cloud very much rests on a mobile foundation: not only do all workers, blue collar or white, have a phone, but they also have that phone in more and more places, and the fact you always have your phone with you means you are, effectively, always available to work.1

To Satya Nadella’s credit, he has over the past two years strongly pushed Microsoft to be competitive on all those other platforms, and in fact the article I just quoted was written in the context of Office adding file picker support for Dropbox and Box, despite the fact both were direct competitors. The reality is that leveraging one piece of software to sell another is a strategy that simply doesn’t make sense in the cloud: there is no implementation advantage, so you have to simply compete on a feature and user experience basis.

Still, that doesn’t mean integration isn’t desirable: what will tie all of these cloud services together? Back in 2014 I theorized that the key player — the “OS” of the cloud epoch — might be whoever owns a company’s data, like, for example, Box:

Pure storage isn’t a great business. The cost is trending towards zero…Data, though, is priceless; it can’t be replaced, and it’s the essence of what makes a particular organization unique. For this reason, and for regulatory ones, there are all kinds of specialized controls that IT departments need for data. This is where Box has worked diligently to differentiate themselves from consumer-focused competitors like Dropbox…

Just because the operating system is no longer the platform does not mean that the need — and opportunity — for a platform does not exist. Something needs to tie together all those computing devices, and data, which needs to be everywhere, is the logical place to start.

I think, in retrospect, I outsmarted myself: companies aren’t made of data, they’re made of people, just like every other single institution on earth. And, as I noted in the context of Facebook, what people love to do, more than anything else in the world, is communicate. Why wouldn’t you start there?

Enter messaging broadly, and Slack (and its competitors like HipChat) specifically.

Messaging: The Cloud’s OS

I have been writing about the importance of messaging ever since this blog started, most notably in Messaging: Mobile’s Killer App.2 Messaging, in conjunction with mobile, is one of the most powerful platforms this industry has ever seen:

Still, it’s only recently that the killer app for this era, when the nodes of communication are smartphones, has become apparent, and it is messaging. While the home telephone enabled real-time communication, and the web passive communication, messaging enables constant communication. Conversations are never ending, and friends come and go at a pace dictated not by physicality, but rather by attention. And, given that we are all humans and crave human interaction and affection, we are more than happy to give massive amounts of attention to messaging, to those who matter most to us, and who are always there in our pockets and purses.

Those words are an awfully close match to the words I used to describe the cloud epoch just a couple of paragraphs ago: everyone, everywhere, always available. Indeed, combined with the human desire to connect and communicate, how could the operating system of the cloud be anything but messaging? This is what makes Slack’s announcement yesterday of the Slack Platform so compelling — obvious, even.3 From the company’s blog:

We live in an exciting time for work. Instead of three or four big vendors providing end-to-end software suites, we have a variety of top notch products at our fingertips ready to make us more powerful and productive in our jobs. But all of these great products come with a small cost: the tools we use every day don’t always play well together. Progress and productivity can end up in silos instead of being reviewed and tracked by the whole team.

The Slack Platform aims to make your experience with apps even better. We know that just a fraction of improvement in everyday interactions between the business services you use makes a world of difference. And so today we’re taking a few bigs steps forward in bringing them all together.

Right now, the Slack Platform consist of a new Slack App Directory, already populated with over 160 apps, a Slack Fund, to invest in new apps, and Botkit, a new framework to easily build new apps. Just as important, though, is Slack’s business model of paid licensing: I’ve noted previously in the context of Facebook that advertising-based businesses don’t make good platform providers:

It’s better for an advertising business to not be a platform. There are certain roles and responsibilities a platform must bear with regards to the user experience, and many of these work against effective advertising. That’s why, for example, you don’t see any advertising in Android, despite the fact it’s built by the top advertising company in the world. [On the other hand,] a Facebook app owns the entire screen, and can use all of that screen for what benefits Facebook, and Facebook alone.

That’s actually ideal for a consumer-focused company: after all, consumers don’t pay for software. Enterprises, though, are a different story: they don’t tolerate advertising, and are eager to pay for a service that provides a real return on investment. Indeed, going forward, outside of Apple (which makes money through selling hardware), I suspect the vast majority of profitable platforms will be primarily enterprise-focused.

Slack’s Opportunity

That said, it’s hard to see anyone — including Microsoft — having a bigger opportunity than Slack.4 The trend in every aspect of computing is higher and higher levels of abstraction, and that doesn’t apply just to things like programming languages. In the case of platforms, the operating system of the PC used to really matter, and then the Internet came along and it didn’t. Similarly, in mobile, the operating system, whether that be iOS or Android, used to really matter, but now it doesn’t. In the consumer space, Facebook or WeChat runs on both, and that is far more important to the day-to-day experience of the vast majority of people.

It turns out that “mobile” is not about devices, but rather, at a fundamental level, about computing anywhere; to differentiate between PCs or phones is an ultimately meaningless exercise. They are simply different form factors of effectively identical devices, the purpose of which is to connect us to the cloud (consumer or enterprise). And, by extension, if the device is simply an implementation detail, then the operating system that runs on that device is a detail of a detail.

What matters — what always matters! — is what actual users want to do, and what jobs they want to accomplish. And, whatever they want to do almost certainly involves communicating, which means Slack and its competitors are the best-placed to be the foundational platform of the cloud epoch. More broadly, humans are social creatures: why should we be surprised that social networks are primed to be the most important businesses of all?

  1. Whether or not this is a good thing is a subject for another article ↩

  2. Rather fortuitously, I posted that article exactly one day before Facebook shocked the world by buying WhatsApp ↩

  3. HipChat, Slack’s biggest competitor, actually beat Slack to the punch, having announced their development platform last month ↩

  4. Note that I said “opportunity”; opportunity means it’s possible, not that it’s necessarily going to happen ↩

Beyond Disruption

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I share Professor Clayton Christensen’s consternation about the overuse of the term “disruption.” In this month’s issue of the Harvard Business Review, Christensen and his co-authors Michael Raynor and Rory McDonald write:

Disruption theory is in danger of becoming a victim of its own success. Despite broad dissemination, the theory’s core concepts have been widely misunderstood and its basic tenets frequently misapplied…

As the article notes, disruption is a bottom-up process:

“Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price. Incumbents, chasing higher profitability in more-demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

In fact, many of technology’s most successful companies, both old and new, have started (or remain) at the high end — the opposite of a Christensen disruptor. Apple is the most famous example, and both the rise and durability of the iPhone in particular point to two big holes in the theory:

  • First, Christensen categorizes all innovations as being either “disruptive” or “sustaining”; according to disruption theory the former are ignored by incumbents, giving space for new companies to develop, while the latter are adopted by incumbents who eventually crush new entrants. This is why Christensen was infamously bearish on the iPhone: it was a superior product that Nokia et al would surely respond to.

    In reality, though, the iPhone was not disruptive nor sustaining: it was Obsoletive, a term I coined back in 2013:

    The problem for Nokia and BlackBerry was that their specialties – calling, messaging, and email – were simply apps: one function on a general-purpose computer. A dedicated device that only did calls, or messages, or email, was simply obsolete.

    An even cursory examination of tech history makes it clear that “obsoletion” – where a cheaper, single-purpose product is replaced by a more expensive, general purpose product – is just as common as “disruption” – even more so, in fact.

    Disruption is a bottom-up strategy; obsoletion is a top-down one.

  • Secondly, Christensen still thinks the iPhone is ultimately in trouble because it is an integrated offering competing against modular competitors. However, as I noted in What Clayton Christensen Got Wrong, it’s not clear that “good enough” always wins in consumer markets:

    Modularization incurs costs in the design and experience of using products that cannot be overcome, yet cannot be measured. Business buyers — and the analysts who study them — simply ignore them, but consumers don’t. Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.

    Indeed, eight years on the iPhone is stronger than its ever been; skeptics may be concerned about growth, but no one (rightly) expects Apple to lose customers to Android.

Still, neither critique is incompatible with disruption theory; they were, and are, presented as ways the theory could be made better, part of an endeavor Christensen himself has been engaged in for the last twenty years. However, understanding the success of Uber, the company at the center of Christensen’s latest article, is another matter entirely.

Disruption: A One Way Street

As noted, disruption is a bottom-up process, and from The Innovator’s Dilemma on Christensen has made clear disruption always starts on the low-end. Christensen wrote in a chapter entitled “What Goes Up, Can’t Go Down”:

Three factors — the promise of upmarket margins, the simultaneous upmarket movement of many of a company’s customers, and the difficulty of cutting costs to move downmarket profitably — together create powerful barriers to downward mobility. In the internal debates about resource allocation for new product development, therefore, proposals to pursue disruptive technologies generally lose out to proposals to move upmarket. In fact, cultivating a systematic approach to weeding out new product development initiatives that would likely lower profits is one of the most important achievements of any well-managed company.

Indeed, for all that the iPhone has done to confound Christensen’s theory, it has, as predicted, never gone down-market. Christensen makes the same critique about Uber, claiming the company is not disruptive because it didn’t start out by undercutting taxis:

A disruptive innovation, by definition, [originates in low-end or new-market footholds] footholds. But Uber did not originate in either one. It is difficult to claim that the company found a low-end opportunity: That would have meant taxi service providers had overshot the needs of a material number of customers by making cabs too plentiful, too easy to use, and too clean. Neither did Uber primarily target nonconsumers—people who found the existing alternatives so expensive or inconvenient that they took public transit or drove themselves instead: Uber was launched in San Francisco (a well-served taxi market), and Uber’s customers were generally people already in the habit of hiring rides.1

In fact, Christensen understates his case: Uber started by offering black car service at a price significantly higher than taxis; it was only with the introduction of UberX a full three years after the company was founded that the service became competitive with taxis on a price basis. Now, though, UberX is not only often cheaper, UberPool always is; the company is actually moving in the exact opposite direction of a disruptor, which means Christensen is quite justified in claiming that Uber is not disruptive.

And yet, the devastating impact Uber is having on the industries it is competing with looks an awful lot like disruption’s aftermath: the market for ride-sharing is far larger than the taxi-market ever was (a la new market disruption), and incumbents are not only losing riders but are also seeing the value of their most prized assets (taxi medallions) plummeting. To simply say that Uber is a sustaining innovation is to dramatically undersell what is happening.

Top-Down Aggregation

Disruptive Technologies: Catching the Wave, the Harvard Business Review article where Christensen first laid out disruption theory, came out 20 years ago; it was, in my estimation, the pinnacle of management theory. Christensen’s core insight was that the managers of disrupted companies were not stupid, but rather exceedingly rational:

Using the rational, analytical investment processes that most well-managed companies have developed, it is nearly impossible to build a cogent case for diverting resources from known customer needs in established markets to markets and customers that seem insignificant or do not yet exist. After all, meeting the needs of established customers and fending off competitors takes all the resources a company has, and then some.

A manager’s calculus looked something like this:

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Every additional customer accrued a cost, whether that be the marginal cost of serving them or the opportunity cost of not serving a different customer. Given that, it was, as Christensen noted, perfectly rational to focus on the most profitable ones.

However, something else momentous happened around 20 years ago: the emergence of the Internet. As I’ve written repeatedly, including two weeks ago in Selling Feelings and this summer in Aggregation Theory, the Internet has completely transformed business by making both distribution and transaction costs effectively free. In turn, this has completely changed the calculus when it comes to adding new customers: specifically, it is now possible to build businesses where every incremental customer has both zero marginal costs and zero opportunity costs.

This has profound implications: instead of some companies serving the high end of a market with a superior experience while others serve the low-end with a “good-enough” offering, one company can serve everyone. And, given the choice between a superior experience and one that is “good-enough,” of course the superior experience will win.

To be sure, it takes time to scale such a company, but given the end game of owning the entire market, the rational approach is not to start on the low-end, but rather the exact opposite. After all, while marginal costs may be zero, providing a superior experience in the age of the Internet entails significant upfront (fixed) costs, and while those fixed costs are minimized on a per-customer basis at scale, they can have a significant impact with a small customer base. Therefore, it makes sense to start at the high-end with customers who have a greater willingness-to-pay, and from there scale downwards, decreasing your price along with the decrease in your per-customer cost base (because of scale) as you go (and again, without accruing material marginal costs).

IMG_0011

This is exactly what Uber has done: the company spent its early years building its core technology and delivering a high-end experience with significantly higher prices than incumbent taxi companies. Eventually, though, the exact same technology was deployed to deliver an lower-priced experience to a significantly broader customer base; said customer base was brought on board at zero marginal cost (to be sure, there is more to Uber’s success than that; I laid out in Why Uber Fights how Uber’s aggregation of riders gives them leverage in bringing drivers onto their platform in a virtuous cycle).

Disrupting Disruption

I stated above that disruption was the pinnacle of management theory, and I chose my tense carefully: the truth is that Christensen’s attempt to demarcate what is and isn’t disruption perhaps has far deeper implications for the theory than he realized. Many of the most important new companies, including Google, Facebook, Amazon, Netflix, Snapchat, Uber, Airbnb and more are winning not by giving good-enough solutions to over-served low-end customers, but rather by delivering a superior experience that begins at the top of a market and works its way down until they have aggregated consumers, giving them leverage over their suppliers and the potential to make outsized profits.

And, by extension, incumbent companies are actually in far more trouble than they were 20 years ago: the issue isn’t that they are constrained by the profit motive from going down-market, but rather that the distinction between up-market and down-market is, from a cost basis anyways, increasingly non-existent. All that matters is the quality of the experience and the ability to scale, two skills that companies founded on controlling distribution and segmenting customers are fundamentally deficient in.

That’s not to say that disruption theory doesn’t still have its place: while the iPhone may not have been disruptive to phones (it obsoleted them), Christensen has noted that the iPhone did in fact disrupt the PC. Similarly, while I agree that Uber is not disruptive to taxis (it is winning through aggregation), what could potentially happen to the personal automobile industry happily fits the theory perfectly.

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

  1. Note: I think that calling San Francisco a “well-served taxi market” is overstating things, but that actually strengthens the point that Uber was a superior offering ↩

Exponent Podcast: Fashion in PC Gaming

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On Exponent, the weekly podcast I host with James Allworth, we discuss PC Gaming and the fascinating way in which it monetizes, leading to a wide-ranging discussion about how business has changed because of the Internet.

Listen to it here.

Selling Feelings

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One of the more famous marketing frameworks is the Marketing Mix, also known as “The Four P’s.” According to the framework there are four key components to a marketing plan:

  • Product (what is actually sold)
  • Price (how much the product is sold for)
  • Promotion (how customers find out about the product)
  • Place (where the product can be found)

Of these four the most difficult and expensive — and thus, the greatest barrier to entry (i.e. the biggest moat) — was place. Actually getting your product in front of customers required relationships with wholesales and retailers, not to mention significant investments in logistics. Indeed, the companies who controlled distribution were often the most profitable of all.

Consider the media industry: broadcast networks had rights to the airwaves, cable networks needed to get carriage (which itself was offered by private companies, earning them tremendous profits), newspapers owned printing presses and delivery trucks, music companies printed albums and got them into stores, publishers did the same with books. From a business-model perspective all of these companies were similar: by controlling distribution they collected rents on what was actually distributed.

It’s not just media, though. Selling anything — clothes, shoes, pots and pans — depended on actually getting your product on the shelves, which meant dealing with wholesalers, retailers, shippers, etc., all of whom extracted their chunk of flesh. Your typical manufacturer would be lucky to get 40% of the retail price of an item, and often far less — and that is if said manufacturer could get their item in a store in the first place.

The Good Old Days

In short, starting a new business in any industry was really, really hard: simply getting your foot in the door required not just a great product but also a massive investment in getting that product in front of customers, and we haven’t even gotten to promotion (much less a price that pays for it all).

This ultimately benefited the largest players: Proctor & Gamble, for example, could leverage its relationships with retailers who already sold Tide laundry detergent and Pampers diapers to get shelf space for a new product line. Big department store chains could demand exclusivity for new apparel or drive down the price. Media companies could pick and choose who to feature, and on their terms. The payoff for actually getting a business off the ground was that once you made it things got a lot easier:

FullSizeRender 3

This is what the “good old days” looked like: pre-existing businesses at best competed with a known set of peer companies, or as was often the case, dominated individual markets, limited only by their ability to scale. Of course things weren’t so good for the folks who couldn’t manage to get distribution: at best they could throw their product over the wall and hope for whatever crumbs got tossed back for their trouble, while customers had to settle for products that tended to serve the lowest common denominator.

The Connection Between Price and Place

This context is why I tend to roll my eyes at, for example, complaints about the 30% commission charged by app stores. It used to be that publishing a piece of software was only partially about creating said software: just as important, if not more, was getting said software onto shelves where customers could actually pick them up, and a publisher was lucky to keep 30% of the retail cost for the privilege.

App stores changed everything: now anyone with a developer account could publish an app on the exact same terms as anyone else; Apple and Google could afford to do that because the Internet made shelf space effectively infinite. The wall was gone!

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The problem, as App Store developers have increasingly realized, is that the existence of that old distribution wall was directly tied to the existence of profits on the other side: when anyone can sell software — when the place is open to all — no one can make a profit, because the price goes to zero.

The Problem With Selling Apps

I’ve been a longstanding critic of Apple’s approach to the App Store, most recently in From Products to Platforms. Specifically, I think the App Store’s refusal to support trials makes it difficult for superior products to differentiate themselves and thus charge a higher price, and the absence of upgrade pricing and customer data makes it difficult to get more money from a developer’s existing user base.

Still, I’ve long been cognizant that even were Apple to change its policies developers would be rolling the proverbial rock uphill. Back in 2013 I noted in Open Source Apps:

What makes the software market so fascinating from an economic perspective is that the marginal cost of software is $0. After all, software is simply bits on a drive, replicated at the blink of an eye. Again, it doesn’t matter how much effort was needed to create said software; that’s a sunk cost. All that matters is how much it costs to make one more copy: $0.

The implication for apps is clear: any undifferentiated software product, such as your garden variety app, will inevitably be free. This is why the market for paid apps has largely evaporated. Over time substitutes have entered the market at ever lower prices, ultimately landing at their marginal cost of production: $0.

Still, that doesn’t mean it’s impossible to make money.

Differentiated Games

Note the key adjective there: “undifferentiated.” What does it mean to be differentiated? There’s no question it has something to do with that first ‘P’, product. A differentiated product is “better” in some way, but all too often putting your finger on exactly what is better is a frustrating exercise. It just “feels” better, or, to switch that around, it’s about how it makes you feel. I’ve written extensively about the importance of the user experience and this gets at the same point: delivering an experience is less about features than it is the entirety of the experience, including approachability, usability, and even things like status or fitting in.

Consider the one app category that continues to succeed wildly on the App Store: free-to-play games like Candy Crush or Clash of Clans. Critics complain that they are manipulative, extracting money from culpable players in exchange for a worthless digital good that delivers little more than a sense of accomplishment to the buyer — a shot of dopamine, basically. But, if I may put on my contrarian hat, so what? Is said shot of dopamine any different than that obtained by any number of other means, many of which cost money? If differentiation is more about how something makes you feel and less about features then why the special bias simply because one particular something happens to be created in software? And, I’d add, digital dopamine results in a far more equitable business model for the developer: the more a user plays the more money a developer earns.

An even more extreme example is free-to-win games that are increasingly popular on the PC (yes, it’s still a thing!). Chris Dixon wrote a must-read post entitled Lessons From the PC Video Game Industry that described this business model:

The PC gaming world has taken the freemium model to the extreme. In contrast to smartphone games like Candy Crush that are “free-to-play,” PC games like Dota 2 are “free-to-win.” You can’t spend money to get better at the game — that would be seen as corrupting the spirit of fair competition. (PC gamers, like South Park, generally view the smartphone gaming business model as cynical and manipulative). The things you can buy are mostly cosmetic, like new outfits for your characters or new background soundtracks. League of Legends (the most popular PC game not on Steam) is estimated to have made over $1B last year selling these kinds of cosmetic items.

I know many of you are rolling your eyes — selling digital clothes for a digital avatar, and to the tune of a billion dollars? How silly must you be? Well, how silly must you be to carry a $5,000 handbag with far less functionality than another a fraction of the price, or wear a $10,000 watch or $200 necktie? What about flying first class or staying in a five-star hotel — you can’t take either with you! It’s completely irrational.

Or, rather, it’s irrational if you only look at features. The entire point is how these purchases make you feel, and it’s that feeling, whether it be an appreciation for craftsmanship, status, or simply being pampered, that provides the sort of differentiation that makes all of these products profitable. One could argue that an insistence on limiting the calculation of value to items that are permanent, physical, and easily listed on a spreadsheet is the real irrationality.

Make Your Market

In the case of those PC games, what the developers have done is actually exceptionally impressive, and something that should serve as a model for all sorts of businesses. Instead of trying to make money in a market — paid PC games — where making money is all but impossible thanks to the competition unleashed by the Internet, the developers effectively created an entirely new market — a virtual world filled with people lured in through free access and quality gameplay — and then leveraged their ownership of that market to fulfill the same sort of needs that fashion-focused businesses have been fulfilling forever. The need to look cool, or the need to stand out. The need to impress your friends, or simply to like how you look.

It doesn’t matter that it’s digital, by the way: any one person’s reality is ultimately wherever they choose to focus their attention and time, which makes games like League of Legends far more real to their inhabitants than the fashion boutiques in Paris would ever be — and far more exclusive. After all, there is only one seller.

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Plus, just as is the case with free-to-play games, the economics are all in alignment: creating the market is a fixed cost which means it has no impact on the marginal cost of one more player. Why not add the maximum number of players (by making it free) and then develop a different revenue stream that pays out continuously the longer a player plays the game, ensuring the developer captures value as it is realized? Sure, said value may only be captured from some, and in relatively tiny increments, but remember we’re dealing with the Internet: you can make it up in volume.

Moreover, I think the model is broadly applicable. I wrote two weeks ago about how the future of publishing will not be about monetizing pure words but rather about using words to gain fans that can be monetized through other harder-to-discover media. Time and attention remain precious commodities and earning trust in one area gives you the right to make money from it in another. Similarly, as I wrote last week, software generally should be seen as a lever to solutions that are much more meaningful to customers, and much more difficult to copy. After all, as noted above, software is infinitely copyable: better to use that quality to your advantage than to base your business model on fighting gravity.1

More broadly, the fact remains that business is difficult — it was difficult before the Internet, and it’s difficult now — but the nature of the difficulty has changed. Distribution used to be the hardest thing, but now that distribution is free the time and money saved must instead be invested in getting even closer to customers and more finely attuned to exactly why they are spending their money on you. Any sort of software — or writing, or music, or video, or clothing, or anything else — has never been purchased for its intrinsic value but rather because of what it did for the buyer — how it made them feel (informed, happy, relaxed, etc.). Create the conditions where the need might manifest itself and then meet that need, and not only will your business succeed, it will, in all likelihood, succeed to an even greater extent than the physically-limited lowest common denominator winners from the “good old days.”

  1. Like me… ↩