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  • Bitcoin and Diversity

    The Bitcoin community is in a bit of a civil war; I hope readers whose eyes glaze over at the crypto-currency’s mention will bear with me as I explain what is going on, and why some of the fundamental ideas in question matter broadly.

    The Block Size Debate

    Briefly — and let me say up front, I am both simplifying and not taking sides — Satoshi Nakamoto, the mysterious creator of Bitcoin, added a 1MB size limitation to “blocks”, which, if you think of the Bitcoin blockchain as a ledger, are individual pages. This, as you might expect, limits the number of transactions that can be verified per block (there is a new block created about every ten minutes or so).

    The current “war” is about whether or not this transaction size should be increased in the near future. Bitcoin Classic supporters are, contra their implementation’s name, advocating a “hard fork” of Bitcoin that would simply double the block size limit to 2MB; it’s called a “hard fork” because it is not backwards compatible. Meanwhile, Bitcoin Core supporters, which, naturally, include the core developers of Bitcoin, advocate a solution called “Segregated Witness” that would be a “soft fork”, i.e. backwards compatible, although it would take more development work not only for the core but for many other companies in the Bitcoin ecosystem.

    What makes this brouhaha so interesting is there in the word “fork”: after all, the solution to a dispute in most open-source communities like, say, Linux, is to simply fork the project and build your own version. That is why there are a seemingly endless number of Linux distributions with names like Mint, Debian, and Ubuntu.1 And indeed, there are scores of Bitcoin-like crypto-currencies like Ethereum, Ripple, and Dogecoin.

    Unitary Bitcoin

    Crucially, though, none of these “forks” work with Bitcoin; unlike an effectively self-contained Linux distribution that uses widely accepted protocols to communicate with other computers, Bitcoin is the network and all the component pieces of that network. This is why, even if a Bitcoin alternative may be technically superior, Bitcoin’s “market cap”2 is more than 8x that of the next most valuable crypto-currency: Satoshi’s creation benefits from the network effects of hundreds of thousands3 of Bitcoin owners, miners, node operators, wallet providers, exchanges, etc.

    It is this quality that makes this current dispute so charged: the loser in the block size debate can’t simply up and start their own currency without giving up millions of dollars in collective value. In short, the outcome is zero sum: one side will win, and the other will lose.

    In this the debate about Bitcoin mirrors what it is that makes Bitcoin and the blockchain technology on which it is based so interesting: the entire idea is that there is one — and only one — record of all transactions; said record is added to by miners (incented by Bitcoin and transaction fees) and stored by nodes (wallet-holders, although the number of nodes is decreasing as people increasingly use centralized services), each of which, through a delicate balance of incentives, continually agrees on what is in the master ledger and what is not. And, when it comes to adding to the blockchain, only one block will win.

    There are other parallels between Bitcoin broadly and this debate in particular. For example, while everyone agrees that the idea of the blockchain is brilliant and a real breakthrough in computer science (digital scarcity was thought to be impossible), there is a lot of disagreement about exactly what blockchains generally and Bitcoin specifically are good for: currency is the most cited application, but things like smart contracts and micro-exchanges are just as (if not more) interesting.

    Similarly, there are a surprisingly wide array of opinions surrounding the block size debate, many of which are directly linked to underlying beliefs of what Bitcoin’s purpose is. Some want faster or more transactions, others are worried about ensuring nodes remain distributed (bigger blocks need more bandwidth), still others have security concerns. And, just as some Bitcoin adherents see a digital currency as a desirable alternative to traditional fiat currencies, some of those opposing a change are simply opposed to change period, at least to changing anything specifically designed by Satoshi.

    Appealing to “Rules”

    When the block size debate was first heating up last summer, Bitcoin Core developer Gregory Maxwell put his finger on the philosophy of Bitcoin issue:

    Fundamentally this question exposes ideological differences between people interested in Bitcoin. Is Bitcoin more of a digital gold or is it more of a competitor to Square? Is Bitcoin something that should improve personal and commercial autonomy from central banks? From commercial banks? Or from just the existing status-quo commercial banks? What are people’s fundamental rights with Bitcoin? Do participants have a right to mine? How much control should third parties have over their transactions? How much security must be provided? Is there a deadline for world domination or bust? Is Bitcoin only for the developed world? Must it be totally limited by the most impoverished parts of the world? Bitcoin exists at the intersection of many somewhat overlapping belief systems.

    What I found most interesting, though, was what Maxwell stated in the previous paragraph:

    We’re talking about tuning one of the fundamental scarcities of the Bitcoin Economy and cryptosystem — leaving the comfort of “rule by math” — and venturing into the space of political decisions.

    Maxwell has made similar comments elsewhere, including in this forum thread:

    The rules are Bitcoin. The stability of Bitcoin’s rules is the soundness of the currency. If the rules can be easily rewritten against the will of some users by others according to political whim then what can be trusted? Is the supply fixed? Will coins be confiscated and awarded to others? If that gate is crossed then there is almost always some excuses which is “good enough” — as was lamented in some of Bitcoin’s earliest announcements…

    I think governance is incredibly hard and that the development history of fiat currencies shows that mankind is ill-equipped to create a strong and sound system via human governance — not through lack of trying, but because mankind is fundamentally not cut out for it: there is always some excuse that makes people feel justified in compromising the property rights of some for the benefit of (potentially many) others. Bitcoin was specifically created and promoted to replace that kind of subjectivity with machines, but it can’t do it if we go around undermining it.

    I find this perspective fascinating,4 and for reasons that have nothing to do with the block size debate (which, again, I’m not stating an opinion on!). I can certainly see the allure of a system that seeks to take all decision-making authority out of the hands of individuals: it’s math!

    The problem, though, is that the consequence of embracing this sort of “Them’s the rules” philosophy is itself the sort of political statement that Maxwell is so eager to avoid. After all, in the case of the block size, the implication of not changing Satoshi’s “rules” is to limit the number of transactions and support the “Bitcoin is digital gold” worldview. If humans made the rules, then appealing to the rules can never be non-political. Indeed, it’s arguably worse, because an appeal to “rules” forecloses debate on the real world effects of said rules.

    The Diversity Blind Spot

    Today is International Women’s Day; I’m tempted to cynically pretend that it was my idea all along to use this fact as a segue, but the fact of the matter is I’m an oblivious male who found out via Facebook:

    FullSizeRender 2

    Facebook has over the last few years self-documented just how unrepresentative they are when it comes to demographic diversity: only 16% of technical jobs and only 23% of senior positions are held by women, and only 9% of the work-force is not white or Asian. Other Silicon Valley giants are barely better — women hold 20% of technical jobs at Apple, 17% at Google and LinkedIn — while Twitter is significantly worse: only 10% of technical employees are women.5

    It was Twitter that exposed me to fact that I, despite my expressed support for women and diversity, had my own blind spots. Last spring in Twitter Needs New Leadership I painstakingly laid out how the service’s minuscule growth and seeming inability to evolve the product were a significant problem necessitating change; the next day I was called out on Twitter for not even mentioning Twitter’s abuse problem.

    The criticism was absolutely fair: a platform that is inhospitable for 50% of the world’s population will by definition have a growth problem, and while I still don’t think it’s the primary reason Twitter’s growth has stalled, to not even acknowledge the effect of abuse was a pretty bad oversight on my part that falls uncomfortably close to my International Women’s Day observance: being a male I had to be hit over the head by it.

    You could certainly say the same thing about Twitter the company: Dick Costolo, the CEO I was criticizing, did finally admit Twitter had an abuse problem, and current CEO Jack Dorsey has taken some steps to address it, but said problem may be intractable thanks to decisions made in the earliest days of Twitter, particularly the allowance of anonymous accounts that can @-mention anyone on the service.6 Does it come as any surprise that, if Nick Bilton’s Hatching Twitter is to be believed, the internal Odeo team that first developed Twitter was all male, and the first female on the service had spent her first few months at work fending off Dorsey despite her repeated protestations that she had a boyfriend?

    This is why diversity matters — and it arguably matters even more at new companies that are right now creating the “rules” of their products that, should they be successful, will be all but impossible to change. For years Twitter ignored that it had a problem, insisting it represented the “free speech wing of the free speech party”, ignorant of just how much speech was being suppressed by allegedly neutral “rules” that, by virtue of who made them, were blind to the impact they would have on women.7

    There Is No Neutral

    The importance of understanding the inherently political nature of rules goes deeper than simply saying diversity is important; it also gets at how we as an industry should think about solutions. It is tempting to argue that companies should simply double-down on meritocracy and ensure they are selecting the best possible candidate; remove human judgment to the greatest degree possible. But then it must be asked, on what criteria would hiring decisions be made? Specifically, who would be making these neutral “rules”?

    I get the allure of simply declaring that from now on everything is equal: men and women will be treated the same, we will be color-blind, etc. It’s neat, like math.8 It’s also unserious: foreclosing on measures that address past injustices ensures the effects of those injustices become cemented in place; to be “color-blind” or “gender-neutral” is neutral in language but fundamentally political when it comes to its effect.

    Ultimately, I don’t know what will happen to Bitcoin, but I’m skeptical of folks who are attracted to it because it allegedly removes humans from the equation: that is and always has been an idea that only makes sense in the very narrowest view of a single Bitcoin transaction, as we are seeing all too clearly in the community’s inability to address a relatively minor issue.9

    More broadly, I hope that the fundamental humanity that goes into any decision — product, policy, or otherwise — is appreciated by everyone in tech. Just as products and companies are either growing or dying, so too efforts to make the technology industry more accurately reflect, and thus better serve (and better monetize!) the diversity of the human race, are either explicitly improving the status quo or implicitly embracing it. There are no neutral “rules.”

    1. There are theoretically thousands if not millions of distributions, and effectively hundreds that are actively maintained ↩

    2. The value of all of the Bitcoins in your fiat money of choice ↩

    3. Probably not millions  ↩

    4. To be clear, I completely disagree with it ↩

    5. Data from this article ↩

    6. I am aware that forcing real names has its own problems, including in cases of domestic abuse, stalkers, and more ↩

    7. This problem isn’t limited to GamerGate. Check out this story in Sports Illustrated about what women in the sports world have to deal with ↩

    8. I mean it when I say I sympathize with this position: in my younger years I used to write exactly that ↩

    9. And, I’d add, a relatively small number of miners actually have nearly complete power when it comes to deciding this ↩

  • The Voters Decide

    Stratechery is not a political blog, and this is not a political post. Rather, my focus is the business and strategy of technology, something that is inextricably linked with the effect technological change has and will have on society broadly — and that includes politics.

    To that end I read with interest Hans Noel’s op-ed in The New York Times on Tuesday. Noel is, along with Marty Cohen, David Karol and John Zaller, the author of the 2008 book The Party Decides, one of the most influential books in U.S. political science, and Noel opened his piece by summarizing the book’s central thesis:

    We argued that the leaders of party coalitions have great influence over the selection of a presidential nominee. Before [we wrote The Party Decides], the conventional wisdom was that such broad and diverse coalitions of politicians, activists and interest groups within parties were largely shut out of the nominating process by primaries and caucuses in the 1970s. This led to a free-for-all among narrowly factional candidates. In 1976, Jimmy Carter emerged from a crowded field to win the nomination despite having no connections to most leaders in the national party.

    We argued that since that 1976 contest, party leaders had been exerting influence by coordinating on their choice during the “invisible primary” — the period before any voting when the leaders observed, met with and vetted candidates — then supporting that candidate throughout the process. When party leaders work together, they nearly always win, we said…

    This year’s election has not followed our script. Mr. Trump is the clear front-runner, but is loathed by the party establishment.

    To Noel’s credit, the reason for writing the op-ed is to self-critically examine what he and his co-authors may have gotten wrong; he has three potential theses (beyond noting that the Republican establishment may yet rally, and that Democrats have largely fallen into line):

    • Maybe the political environment has changed
    • Maybe the party is falling apart
    • Maybe Mr. Trump just got in the way

    I think Noel’s scope is too narrow: politics is just the latest industry to be transformed by the Internet.

    The Evolution of Politics and the Web

    A few weeks ago Clay Shirky wrote a tweetstorm that is worth reading in full; for this post, though, I wanted to highlight the parts describing how the Internet has, election-by-election, fundamentally reshaped presidential campaigns:

    Social media is breaking the political ‘Overton Window’ — the ability of elites to determine the outside edges of acceptable conversation (link). These limits were enforced by party discipline, and mass media whose economics meant political centrism was the best way to make money (link). This was BC: Before Cable. One or two newspapers per town, three TV stations; all centrist, white, pro-business, respectful of authority (link). Cable changed things, allowing outsiders to campaign more easily. In ’92, Ross Perot, 3rd party candidate, campaigned through infomercials (link).

    After Cable but Before Web lasted only a dozen years. Cable added a new stream of media access. The web added a torrent (link). This started with Howard Dean (the OG) in ’03. Poverty was the mother of invention; Dean didn’t have enough $ to buy ads, even on cable (link) but his team had Meetup & blogs… (link). After webifying Perot’s media tactics, Dean pioneered online fundraising. Unfortunately for him, his Get Out The Vote operation didn’t (link). That took Obama. Obama was less of an outsider than Dean (though still regarded as unelectable in ’07) but used most of Dean’s playbook (link). And then there was vote-getting. Facebook and MyBarackObama let the Obama campaign run their own vote-getting machine out of Chicago (link).

    The new scale Facebook introduces into politics is this: all registered American voters, ~150M people, are now a medium-sized group (link). Reaching & persuading even a fraction of the electorate used to be so daunting that only two national orgs could do it. Now dozens can (link). This set up the current catastrophe for the parties. They no longer control any essential resource, and can no longer censor wedge issues (link)

    There are a few key concepts at the foundation of this analysis:

    • Previously information was gated by newspapers and TV stations with geographic monopolies; this began to break down with cable and was completely swept away by the web
    • The Internet made it possible to connect directly with voters to share information, collect money, and drive get-out-the-vote (GOTV) efforts
    • All of those voters are reachable via just a handful of platforms, especially Facebook

    Long-time readers should recognize the tell-tale signs of Aggregation Theory.

    Aggregation Theory Redux

    Facebook and newspapers is an excellent example of how Aggregation Theory plays out:

    • Previously newspapers integrated editorial and advertising copy into a bundle that was delivered to a geographically captive audience. Said newspapers’ market dominance was secured by their control of production and distribution, but their growth was capped by the challenges of scaling said production and distribution beyond said geographic area.
    • Facebook (like Google before it) built a powerful relationship directly with users by delivering content users cared the most about. This, then, made Facebook the front door to the Internet for most users.
    • Facebook’s direct connection with users was a double-whammy for newspapers: first, Facebook is better-positioned to serve advertising, and second, users increasingly find all their news and entertainment via Facebook

    Screen Shot 2016-03-03 at 12.35.22 AM

    The end result of this process is that newspapers have been modularized and commoditized into effective Facebook-filler, competing on an equal basis with everything from new media startups like BuzzFeed to personal blog posts to pictures of your cousin’s new baby. It’s hard for publishers to break through with content, and publisher-centric advertising is dying: better for ad buyers to get as close to the customer as possible and buy space on the service that has aggregated users on one side and leveraged that into commoditizing and modularizing suppliers on the other.

    There certainly is room for all the ads: thanks to the Internet reality of zero distribution costs and zero transaction costs, an aggregator can scale nearly perfectly to effectively every user on Earth, as we’ve seen with Google, Facebook, Amazon, and increasingly Netflix and Uber.

    Parties and Voters

    For a moment, though, step back to the world as it was: the one where newspapers (and TV stations, etc.) were gatekeepers thanks to their ownership of production and distribution. In this world any viable political campaign had to play nicely with those who ran the press in the hopes of gaining positive earned media, endorsements, etc. Just as important, though, was the need to buy advertising, as that was the only way to reach voters at scale. And advertising required lots of money, which meant donors. And then, once the actual election rolled around, a campaign needed an effective GOTV effort, which took not only money but also the sort of manpower that could only be rustled up by organizations like labor unions, churches, etc.

    It is all these disparate pieces: partisan media members, advertisers, donors, large associations, plus consultants and specialists to manage them that, along with traditional politicians, made up the “party” in The Party Decides. Noel and company asked in Chapter 1:

    Why tie parties so closely to party leadership as such? Why not view parties as larger coalitions that include not only top leaders but activists, fund-raisers, interest groups, campaign technicians, and others? Certainly the larger set of actors has great influence on party behavior. We therefore propose to theorize parties, and to study them in practice, as coalitions of the larger set of actors. Politicians will be important but not necessarily dominant; interest groups, activists, and other policy demanders will be permitted large roles in party decisions. Our theory will focus on why diverse political actors might attempt to form parties and what kinds of candidates they might seek to nominate.

    What is critical to understand when it comes to this more broad-based definition of a “party” is that its goals are not necessarily aligned with a majority of voters. The authors explain in Chapter 2 (emphasis mine):

    The most important party business is the nomination and election of office seekers who will serve the interests of the party’s intense policy demanders. The italicized phrase marks the key difference between our theory and most other contemporary theorizing about parties. In our theory, parties — that is, the groups that constitute parties — do not care about winning for the sake of winning office. They care about the policy gains. And they make those gains not simply by the election of someone nominally affiliated with their party. They make them by the election of someone committed to the maximum feasible achievement of group goals…

    It is natural to think of parties in a two-party system as majoritarian. Ours, however, are not. They want to win elections, but they do not necessarily wish to represent a majority of voters. As a by-product of their wish to govern, parties must offer a degree — perhaps a large degree — of responsiveness to popular majorities, but responsiveness to voters is not why parties exist. They exist to achieve the intense policy demands of their constituent groups. One might criticize parties for lack of deference to majority will, but their groups would not much care. Intense policy demanders nearly always believe their demands are just and that it is their duty to work for these demands whether or not most voters agree with them.

    To summarize: parties are not just politicians, but coalitions of actors who care intensely about certain policy outcomes. These actors work together to get politicians elected who will serve their interests; voter interests are a means, not an ends. And, according to Noel and company, such parties succeed because they control all of the apparatus necessary to win elections.

    Aggregation and Politics

    This brings us back to today’s world, and admittedly, the leap from a description of Facebook and Aggregation Theory to politics is not an obvious one: I’m not proposing that Donald Trump or anyone else is an aggregator. Indeed, given their power over what users see Facebook could, if it chose, be the most potent political force in the world. Until, of course, said meddling was uncovered, at which point the service, having so significantly betrayed trust, would lose a substantial number of users and thus its lucrative and privileged place in advertising, leading to a plunge in market value. In short, there are no incentives for Facebook to explicitly favor any type of content beyond that which drives deeper engagement; all evidence suggests that is exactly what the service does.

    Said reticence, though, creates a curious dynamic in politics in particular: there is no one dominant force when it comes to the dispersal of political information, and that includes the parties described in the previous section. Remember, in a Facebook world, information suppliers are modularized and commoditized as most people get their news from their feed. This has two implications:

    • All news sources are competing on an equal footing; those controlled or bought by a party are not inherently privileged
    • The likelihood any particular message will “break out” is based not on who is propagating said message but on how many users are receptive to hearing it. The power has shifted from the supply side to the demand side

    Screen Shot 2016-03-03 at 12.35.04 AM

    This is a big problem for the parties as described in The Party Decides. Remember, in Noel and company’s description party actors care more about their policy preferences than they do voter preferences, but in an aggregated world it is voters aka users who decide which issues get traction and which don’t. And, by extension, the most successful politicians in an aggregated world are not those who serve the party but rather those who tell voters what they most want to hear.

    In my initial description of Aggregation Theory I noted:

    This has fundamentally changed the plane of competition: no longer do distributors compete based upon exclusive supplier relationships, with consumers/users an afterthought. Instead, suppliers can be aggregated at scale leaving consumers/users as a first order priority. By extension, this means that the most important factor determining success is the user experience: the best distributors/aggregators/market-makers win by providing the best experience, which earns them the most consumers/users, which attracts the most suppliers, which enhances the user experience in a virtuous cycle.

    The term “user experience” obviously refers to a product; in the case of politics it is, apparently, at least in the case of some substantial number of Republican voters, “telling it like it is”, aka what voters, not parties, believe.1

    From The New York Times
    From The New York Times

    And so, without any of the apparatus traditionally provided by parties, much of it obsoleted by the Internet, and thanks to the ability to connect directly with voters (because of aggregation), Donald Trump is marching on in direct defiance of the Republican Party’s decision.2

    Voters (and users) decide.

    1. Note that this too is why the media covers Trump to such a significant degree: they are just as subservient to what their viewers want ↩

    2. And yes, Trump primarily communicates via Twitter, but he is dominating Facebook ↩

  • Apple, the FBI, and Security

    The dispute between Apple and the FBI is a much closer question than it is being framed as in most of the tech press. In large part this is because the dispute itself is being serially mischaracterized by both Apple supporters and detractors.

    Apple supporters are, in my estimation, too easily conflating the security issues at hand with the more fundamental debate about encryption; detractors are trivializing the significance of the FBI’s request by suggesting they simply want Apple to unlock the phone.

    My goal with this piece is to, in as plain language as possible, lay out the issues at hand, give a framework to think about them, and explain why I am ultimately supporting Apple’s decision.

    Three Debates

    The first thing to understand about the issue at hand is that there are three separate debates going on: the issue at hand, the encryption debate, and the PR battle. To understand the issue it is necessary to separate them, but to figure out which side may win it is equally critical to understand how they relate to each other.

    The Issue At Hand

    As I laid out last week, iPhones running iOS 8 or later have all of their contents encrypted on-disk with very strong encryption that is practically unbreakable. Therefore, the most realistic way to get access to the contents of the iPhone in question in this case is to brute force — i.e. try every possible combination — the passcode on the device. This passcode, in conjunction with the iPhone’s unique ID key (UID) that is embedded at manufacture and unknown by Apple, forms a “key” that unlocks the contents of the drive.

    Given that this is an obvious way to break into an iPhone, Apple has instituted a number of software-based protections against brute force attacks, specifically a (user-selected) option to delete the contents of the disk after 10 failed passcode entries1 and a five-second delay between passcode entries. In addition, the passcode must be entered on the device’s touchscreen.

    The FBI is asking Apple to remove these limitations: allow more than 10 passcode tries, remove the five-second delay (there would still be an 80-millisecond delay if the computation is done on the device due to a hardware limitation), and allow passcodes to be entered by a separate device instead of a human finger. The FBI cannot do this themselves because removing this limitation would require the installation of a new version of iOS, which itself requires its own key that is known only to Apple.

    Moreover, the FBI is insisting that this is a one-time ask for one device: Apple would be able to use the device’s Unique Device Identifier (UDID), which is different than the aforementioned UID and is known to Apple (and anyone else with the device), to ensure the custom version of iOS could only run on the device in question. In fact, the FBI is even offering to let Apple install the custom version of iOS themselves to ensure it does not leave Apple’s campus.

    The Encryption Debate

    What the FBI is not asking in this case is that Apple defeat the device’s on-disk encryption, and for good reason: as I noted above the iPhone’s on-disk encryption is practically unbreakable. Small wonder that when, in 2014 with the debut of iOS 8, Apple extended this encryption to all of an iPhone’s data, law enforcement agencies everywhere were aghast. FBI Director James Comey, in an October 2014 speech at the Brookings Institute stated:

    Encryption isn’t just a technical feature; it’s a marketing pitch. But it will have very serious consequences for law enforcement and national security agencies at all levels. Sophisticated criminals will come to count on these means of evading detection. It’s the equivalent of a closet that can’t be opened. A safe that can’t be cracked. And my question is, at what cost?…

    Cyber adversaries will exploit any vulnerability they find. But it makes more sense to address any security risks by developing intercept solutions during the design phase, rather than resorting to a patchwork solution when law enforcement comes knocking after the fact. And with sophisticated encryption, there might be no solution, leaving the government at a dead end—all in the name of privacy and network security.

    “Intercept solutions during the design phase” entail the creation of a so-called “golden key”: a built-in solution to an encryption algorithm that is independent of the user’s passcode. Basically, Comey has for a few years now been agitating for Apple’s on-disk encryption be designed like a TSA-compliant luggage lock: it opens with either the owner’s passcode or with a universal key owned by a government agency.

    This is an unacceptable outcome that has to date been rightly rejected by Congress. While a “golden key” can not, contrary to conventional wisdom, be guessed, it can be stolen (much like the TSA luggage key has been). Worse, once said key is stolen, every single device governed by said key would be vulnerable without anyone knowing any better: that includes not only devices that hold personal details, but also corporate secrets, classified information, in short, nearly everything of value that underpins the United States economy. And no one would know when and if the data was being stolen.

    Again, though, while Comey and the FBI have been the most outspoken advocates of this destructive golden key, that is not an issue in this current case. If it were, my support of Apple would be unequivocal, because a golden key is an issue where there is simply no compromise.

    The PR Battle

    Before I engage in such consideration, it’s important to acknowledge the PR aspect of this case: this is where details like the fact Apple helped the FBI bypass the passcode on non-encrypted iPhones goes, along with the fact that San Bernardino County, under direction from the FBI, reset the iCloud password associated with the iPhone in question. That’s not to say that PR doesn’t matter, but none of the surrounding details have anything to do with the substance of the question at hand: is Apple right to resist the FBI’s request to weaken software-based security measures (which do not entail breaking encryption)?

    Three Contexts

    As is the case with many contentious questions, the correct answer depends on the context with which you evaluate the problem.

    The Technology Industry’s Perspective

    Apple’s opposition to the FBI’s request, and the support they have received from most major technology companies, is completely understandable.

    First off, complying with this order would be a burden (the degree of said burden will be the critical factor on which the court’s decision will turn). Apple would need to design a new version of iOS, figure out a way to secure said version to ensure it doesn’t become widely available, and develop an infrastructure to deal with the inevitable flood of requests from law enforcement agencies seeking similar assistance to the FBI. It is not simply an issue of “unlocking” an iPhone: it is far more complex and dangerous than that.

    Secondly, Apple’s ability to resist government pressure in foreign countries — particularly China — will be severely compromised should Apple be forced to acquiesce in this case.

    Third, as much as it clearly irked Apple when the FBI framed the company’s opposition as a “marketing stunt,” there is no disputing the fact that the company has made privacy and security a core part of the iPhone value proposition. Forcing the company to actively undo its own security measures certainly works against that proposition.

    The FBI’s Perspective

    All that said, technologists do their case a disservice by dismissing the FBI’s position out of hand. The fact of the matter is that privacy of information is not an absolute: the Fourth Amendment both prohibits “unreasonable searches and seizures” and affirms an exception for warrants “upon probable cause”. Needless to say, the FBI has pretty damn compelling probable cause in this case,2 and I don’t doubt that future requests along these lines will be accompanied by warrants as well.

    Moreover, while it’s true the FBI and other law enforcement agencies have access to more information than ever before, both thanks to cloud services and also the expansion of the Communications Assistance for Law Enforcement Act (CALEA), which compels carriers and ISPs to provide the government with the capability to intercept communications, there very well may be information on devices that are never transmitted (or that is encrypted upon transmission).

    More broadly, while I argued an absolutists’ position above with regards to encryption, that is because absolutism is the only option: data is either securely encrypted or it’s not.3 Given that, one can certainly make the argument that given the inescapable reality that some amount of data will be “dark” because of encryption, it behooves the technology industry to cooperate on all requests that don’t entail compromising on something (encryption) that, by definition, cannot be compromised on. To put it another way, I can sympathize with law enforcement’s irritation that the position of companies like Apple when it comes to security leaves no room for the FBI’s enforcement of a different type of security: that of the public at large.

    The U.S. Perspective

    That noted, the FBI’s position itself is more limited than they themselves likely realize: the FBI is primarily concerned with domestic crimes, and their perspective is that of an investigator seeking to uncover a secret.

    However, the United States does not exist in a vacuum: there are plenty of entities that would like nothing more than to uncover American secrets, whether those be on the individual level (compromising information, identity, credit cards, etc.), corporate level (trade secrets, financial information, strategic documents, etc.), or government level (military information, government communications, counter-espionage, etc.). Moreover, given the fact the United States is the richest country in the world with the largest economy, powered by corporations overwhelmingly based on intellectual property, defended by the largest and most sophisticated military in the world, the United States collectively has by far the most to gain from strong security. This is why people like Michael Hayden, former director of the NSA — no civil liberties ideologue, to say the least! — say the FBI is wrong. From USA Today:

    “Look, I used to run the NSA, OK?” Hayden told USA TODAY’s weekly video newsmaker series. “Back doors are good. Please, please, Lord, put back doors in, because I and a whole bunch of other talented security services around the world — even though that back door was not intended for me — that back door will make it easier for me to do what I want to do, which is to penetrate.

    “But when you step back and look at the whole question of American security and safety writ large, we are a safer, more secure nation without back doors,” he says. With them, “a lot of other people would take advantage of it.”

    The fact that weaker security helps the FBI doesn’t change the fact that the United States has more to lose from weaker security than any other country on earth. By far.

    Winning the Security Game

    There’s one more way to look at the question of security in the context of the United States broadly. Consider a sports analogy: in a game like basketball you need to play both defense and offense; the FBI, given their responsibilities, is primarily concerned with offense — uncovering secrets. However, the agency’s haste to score buckets has the effect of weakening the United States’ defense.

    This is particularly unnecessary because the United States already has the best offense in the world! Consider the iPhone in question: the fact of the matter is that the data could be extracted without Apple’s help.

    • The first potential method would be to leverage a zero-day exploit that would allow the device to run code that is not signed by Apple;4 in other words, it is almost certainly possible that someone other than Apple could install the necessary software to bypass the 10 passcode entry limitation (the National Security Agency [NSA] is widely thought to possess several zero day exploits)
    • The second potential method would be to extract the data from the memory chips, and then de-cap the phone’s processor to uncover the device’s unknown UID and the algorithm used to encrypt the data, and then conduct a brute force attack on the passcode using a separate computer designed to do just that5

    Both of these processes are hugely difficult and expensive, which means they can only realistically be done by agencies with massive resources. Like, for example, the NSA — which is a big advantage for the United States. If there is strong security everywhere (i.e. everyone has the same defensive capability), then the country with the biggest advantage is the country with the most resources to overcome that security (i.e. not everyone has the same offensive capability). To lower the bar when it comes to defense is to give up one of the United States’ biggest strategic advantages.

    Note what I have not discussed in this article: privacy. In fact, I do agree that there are significant privacy concerns around the FBI’s insistence that Apple explicitly weaken iPhone security, and I would personally lean towards the privacy side of the debate when it comes to the privacy-security tradeoff.

    That said, as I articulated above, I understand the FBI’s concerns about going dark, and the agency could hardly have picked a more compelling example to make their case for tech company cooperation.6 I am not surprised that a majority of Americans say Apple “Should unlock the terror suspect’s iPhone.”

    That is why it is critical to make the argument that the FBI’s request weakens security by compelling something much deeper than merely “unlocking an iPhone.” In other words, given the context of the United States as a whole, an argument for privacy and an argument for security are not a tradeoff at all, but rather two paths to the same outcome: stronger, not weaker iPhones.7

    1. Specifically, the “key” for the disk is deleted, meaning the content is encrypted forever ↩

    2. Not to mention the explicit permission of San Bernardino County, the owner of the phone in question ↩

    3. It’s math: just as 2 + 2 can only equal 4, data is secure from everyone or no one ↩

    4. We know these exist: they are the foundation of jailbreaks ↩

    5. Which, thanks to Bitcoin, are cheaper than ever before ↩

    6. That this case is being leveraged is certainly not an accident  ↩

    7. One final point: Apple may lose, and that will be ok. This case is a close one, and such an outcome — facilitated brute force attacks — may prove to be the compromise that brings law enforcement to peace with encryption. That would be the hope anyways, because legislation limiting encryption would be a devastating outcome for everyone. One hopes Apple’s resistance in this case doesn’t lay the groundwork for an even worse outcome in the future ↩

  • Zenefits and Regulation

    From BuzzFeed:

    Parker Conrad has resigned as CEO of Zenefits, following a number of regulatory compliance failures at the richly valued human resources startup he co-founded, according to an email sent to employees on Monday.

    David Sacks, the chief operating officer, who formerly was an executive at PayPal and Yammer, is taking over as CEO. Zenefits also named Joshua Stein, a former federal prosecutor who is a vice president of legal affairs at the company, as its chief compliance officer. Sacks attributed Conrad’s departure to compliance failures by the startup.

    “The fact is that many of our internal processes, controls, and actions around compliance have been inadequate, and some decisions have just been plain wrong,” Sacks said in the email. “As a result, Parker has resigned.”

    I haven’t written about Zenefits before now, although the business model certainly is intriguing: the startup offers HR software-as-a-service for free and makes money by acting as an insurance broker for some number of companies using its service. In other words, the product is effectively a lead generation tool.

    What Went Right — And Wrong

    It’s easy-to-see why the company was so attractive to venture capitalists: Conrad and team created a unique two-sided offering in which Zenefits had an asymmetric advantage in both markets it competed in. On the product side the company was competing with paid solutions with the price of free; on the brokerage size the company could both forego expensive professional agents on the ground in favor of a call center model and explore different marketing channels beyond the ultra-expensive market for insurance keywords on Google.

    However, even in a call center agents needed to be licensed, and Conrad’s resignation came on the heels of a series of BuzzFeed reports about the company’s failure to ensure that was the case. The event that reportedly led to Conrad’s effective firing was also about licensing, specifically the discovery of a Zenefits-created program that helped Zenefits’ brokers cheat on the California licensing process (which required a user to be logged in to the training program for 52 hours).

    However, the company’s troubles aren’t just regulatory: between August and September Zeneifts $4.5 billion valuation suffered a 48% markdown by Fidelity, mere months after the mutual-fund giant invested in the company, and in November the Wall Street Journal reported that the company was falling well short of its revenue goals and suffering from high turnover and poor morale. Andreessen Horowitz, which counts Zenefits as its largest investment, may have a stated preference for founder CEOs, but I suspect the venture firm wasn’t particularly broken up about having such a clear-cut rationale for showing Conrad the door.

    Zenefits Versus Uber

    In the wake of Conrad’s departure there has been a bit of a meme about Silicon Valley needing to clean up its “move fast and break things” mentality, with most such think-pieces tying Zenefits screwups to Uber’s well-documented run-ins with regulators.

    In fact, I made a connection between the two startups on Exponent over a year ago: at the time Uber was in hot water for comments made by Emil Michaels about threatening a journalist (which I condemned), but I noted that the ride-sharing company by necessity had a certain level of scrappiness given the challenges it faced with regulators on the ground. And, as an example of how regulation could run amok, I discussed the fact that Zenefits had been banned in Utah because of its practice of giving away software for free in order to drum up insurance business, which was deemed an illegal rebate (the Utah law was later changed).

    I think that Utah episode is a useful way to understand why it is that, despite my having compared Zenefits and Uber a year ago, I don’t think today’s Uber comparisons hold water: specifically, just as is the case with regulations themselves, the validity and viability of “violating” them all comes down to context.

    Thinking About Regulation

    Here’s how I would think about dealing with regulations, using Zenefits’ prior experience in Utah, along with Uber, as an example:

    • Is the regulation unambiguous? Utah claimed that Zenefits’ offering of free software was the same thing as an insurance broker offering a rebate, which is absolutely not clear and would need to be litigated. Similarly, while Uber competes with taxis, the vast majority of laws deal with cars that are hailed from the street or from a central dispatcher, not coordination between two independent actors via an app.

    • Is the regulation business-critical? Zenefits entire model depends on offering the software for free, which makes it worth the risk of litigating the regulation; same thing with Uber’s skirting of taxi-specific regulations.

    • Is there a user-benefit to testing the regulation? The entire point of Zenefits’ model is that it provides significant consumer surplus to its users and thus places the company in a superior position to sell insurance. Similarly, Uber provides a superior experience with much better liquidity than taxis.

    • Is there recourse to adverse regulatory action? When Zenefits was banned in Utah the startup, in large part thanks to support from the active Twitter accounts of Andreessen Horowitz, mobilized much of the startup community in protest; this was particularly effective given Utah’s preexisting efforts to position itself as a startup-friendly state. Uber is especially effective on this point: the company famously mobilizes its users to put political pressure on regulators and elected officials (or, in the case of China, appeals to the leadership’s stated goals of fostering innovation)

    • Is it right? This is the fuzziest yet most important question, and frankly, it’s hard for any startup to answer honestly. Still, these examples are helpful: Zenefits arguably helps small businesses get started by offering a critical product for free; similarly, Uber takes cars off the road, reduces drunk driving, driver discrimination, etc.

    In contrast, note how Zenefits’ recent licensing violations fail every single test:

    • The regulations around needing a license to sell insurance are unambiguous
    • Zenefits’ core value proposition would not be affected by ensuring its salespeople were licensed
    • Users did not benefit from Zenefits’ violating these regulations
    • Zenefits’ has no recourse should regulators sanction these violations
    • It very well may be the case that licensing regulations are busywork, but not by abiding them isn’t “right”; it’s pure convenience

    In other words, these recent Zenefits’ violations are straight up bad business and emblematic of bad judgment; add on the company’s poor performance and internal strife and it seems clear Conrad’s exit was justified.

    Incentives

    It seems likely the aforementioned poor performance and these violations were interconnected: a company missing its revenue targets is one that is much more tempted to break the rules, and the creation of a tool specifically designed to skirt an unambiguous regulation speaks to the warping effect of Zenefits’ growth imperative.

    Moreover, Zenefits was primed to get this wrong: as clever as Zenefits’ model may have been on paper, it is always problematic when a company’s money-making apparatus is misaligned with its product focus. Either executives are focused on the product and provide too little oversight to the money-making side of things, leading to a bending of the rules in the drive to reach arbitrary goals, or executives focus too much on making money, and the product suffers.

    This incentive problem is especially problematic for companies operating in regulatory gray areas: it requires a lot of judgment to determine that pushing the limits in Utah is worth the risk but blatantly breaking licensing rules isn’t, but incentives have a funny way of ensuring that judgment calls always come down on one side or the other.

    The Problem with Regulations

    I know that some of you think this argument is gibberish: companies should follow the law as plainly understood and try to change regulation through the legislature, city council, etc. Making judgment calls based on context is a recipe for anarchy.

    I (unsurprisingly) disagree for several reasons:

    • Regulations are one of the most effective moats incumbents have because they already have the infrastructure and revenue streams to deal with them
    • Regulatory capture, in which incumbents have overdue influence on what the regulations actually say and do, is very much a real thing and inevitable the longer a regulation is on the books
    • Politicians and regulators respond to political pressure, which comes from mobilized constituents; this, by extension, requires an actual product providing actual consumer benefit, not a powerpoint presentation

    We are living in a time when technologies like the smartphone and the Internet are fundamentally changing what is possible, what is dangerous (or not), and incumbents in industries everywhere are threatened and heavily incentivized to exercise their influence on governments struggling to keep up with the pace of change. The last thing we need is companies voluntarily tying their own hands about something that is “right” simply because it’s legally gray.

    But, on the flip side, regulatory risk is a real thing, and companies operating in this area must have more judgement and better execution and only choose battles worth fighting. Conrad failed on all three counts, and I suspect it may ultimately doom the company he started.

  • The Reality of Missing Out

    When it comes to ad-supported services, pundits everywhere are fond of the adage “If you’re not the customer you’re the product”. It’s interesting, though, how quickly that adage is forgotten when it comes to evaluating the viability of said services.

    Twitter is a perfect example. In response to my piece How Facebook Squashed Twitter I got a whole host of responses along the lines of this from John Gruber:1

    I have argued for years that the fundamental problem is that Twitter is compared to Facebook, and it shouldn’t be. Facebook appeals to billions of people. “Most people”, it’s fair to say. Twitter appeals to hundreds of millions of people. That’s amazing, and there’s tremendous value in that — but it’s no Facebook. Cramming extra features into Twitter will never make it as popular as Facebook — it will only dilute what it is that makes Twitter as popular and useful as it is.

    From a user’s perspective, I completely agree. But remember the adage: it’s the customers that matter, and from an advertiser’s perspective Facebook and Twitter are absolutely comparable, which is the root of the problem for the latter. Digital advertising is becoming a rather simple proposition: Facebook, Google, or don’t bother.

    Consumer Service Carnage

    Last Friday LinkedIn suffered one of the worst days the stock market has ever seen, plummeting 40% despite the fact the company beat expectations for both revenue and adjusted earnings; the slide was prompted by significantly lower guidance than investors expected.

    The issue for LinkedIn is that a company’s stock price is not a scorecard;2 rather it is the market’s estimate of a company’s future earnings, and the ratio to which the stock price varies from current earnings is the degree to which investors expect said earnings to grow. In the case of LinkedIn, the company’s relatively mature core business serving recruiters continues to do well; that’s why the company beat estimates. That market, though, has a natural limit, which means growth must be found elsewhere, and LinkedIn hoped that elsewhere would be in advertising. The lower-than-expected estimates and shuttering of Lead Accelerator, LinkedIn’s off-site advertising program (which follows on the heels of LinkedIn’s previous decision to end display advertising), suggested that said growth may not materialize.

    Yelp, meanwhile, was only down 11% yesterday after releasing earnings (and issuing guidance) that weren’t that terrible.3 The company’s big hit came last summer when the stock plummeted 28% in a single day on, you guessed it, a lower-than-expected forecast, based in part on Yelp’s decision to end its brand advertising program.

    Yahoo’s core business, meanwhile, is practically worthless as revenues and earnings continue to decline, and the aforementioned Twitter has seen its valuation slump below $10 billion; both are in stark contrast to the companies each has traditionally been associated with: Google is worth $460 billion (and was briefly the most valuable company in the world) and Facebook is worth $267 billion.

    The reason for such a stark bifurcation is, ultimately, all about the “customer”: the advertiser actually buying the ads that underlie all of these “free” consumer services.

    A Brief History of Analog Advertising

    Newspapers are the oldest tool in the advertiser’s chest, and were for many years the only one. This wasn’t a problem because newspapers had the magical ability to expand or contract based on how much advertising was sold for a particular day; from a business perspective, editorial has always been filler.

    For the first half of the 20th century, U.S. aggregate newspaper revenue growth roughly tracked GDP, which is what you would expect given that advertising has always been around 1.2% of economic activity for as long as such things have been tracked. In the second half of the century, though, the rate of growth for newspapers slowed just a bit, thanks to the advent of first radio and then television.

    Both radio and television advertising had distinct advantages relative to newspaper advertising, both in terms of storytelling and especially their effectiveness in capturing potential consumers’ attention. Still, while newspapers were no longer capturing all of the advertising dollars, they still grew nicely because both radio and television had three important limitations:

    • Because both radio and television were programmed temporally, there was limited advertising inventory; thus, as you would expect in any situation where supply is scarce, prices were significantly higher
    • It was much more expensive to produce an effective radio or television advertising slot relative to a newspaper ad
    • It was difficult to measure the return-on-investment of radio and television advertising; newspapers weren’t that much better, although things like coupons could be tracked more closely

    Ultimately, advertisers (known as “brand managers” in the consumer-packaged goods industry, which pioneered these techniques) developed strategies that leveraged all three mediums, plus on-the-spot promotions at retailers, to move customers “down the funnel”:

    stratechery Year One - 269

    TV and radio were particularly effective at building awareness — making customers aware that your product existed — and also at building brand affinity — the subconscious preference for your product over a competing product at the moment of purchase. Newspapers, meanwhile, were useful when it came to “consideration”: helping consumers decide to buy the product they were now aware of (coupons were very useful here). Finally, brand managers spent a lot of time and money on their relationships with retailers to help pull consumers through the funnel to conversion, with the vague hope that said consumers would prove to be loyal.

    Digital Advertising 1.0

    The first wave of digital advertising took square aim at the bottom of the funnel: the fact that computers log everything made it easy to demonstrate when an advertisement led directly to a purchase (or a click), and no company benefitted more than Google. Search ads were so effective because consumers were entering the purchase funnel already at the bottom: they already wanted insurance, or to travel, or a lawyer, so Google could charge a lot of money for the right to put an ad for precisely those services right in front of a guaranteed lead and collect every time said lead clicked.

    Efforts to implement digital advertising further up the funnel were more mixed; retargeting ads that displayed items you looked at previously were the most blunt and probably most effective attempt to move customers through the consideration phase, even though said bluntness creeped a lot of people out. The top of the funnel, though, never really took off: it really wasn’t clear how to build awareness in a cost effective way on digital.

    stratechery Year One - 270

    There were two big problems with brand advertising on the Internet: first, there simply weren’t any good ad units. Banner ads were pale imitations of print ads, which themselves were inferior to more immersive media like radio and especially TV. Secondly, given the more speculative nature of brand advertising, it was much more cost effective to spread your bets over the maximum number of customers; in other words, it remained a better idea to spend your money on an immersive TV commercial that could be broadly targeted based on programming to a whole bunch of potential consumers at a single moment as opposed to spending much more time — which is money! — creating a whole bunch of banner ads that could be more finely targeted.

    Today, though, that is beginning to change.

    Digital Advertising 2.0

    Facebook COO Sheryl Sandberg relayed a fascinating anecdote on Facebook’s most recent earnings call:

    Leading up to Black Friday, Shop Direct, the UK’s second largest online retailer teased upcoming sales with a cinemagraph video to build awareness. They then retargeted people who saw the video with one day only deals. On Black Friday, they used our carousel and DPA ads to promote products people had shown interest in. They saw 20 times return on ad spend from this campaign, helping them achieve their biggest Black Friday and their most successful sales day ever.

    What Sandberg is detailing here is really quite extraordinary: Facebook helped Shop Direct move customers through every part of the funnel: from awareness through Instagram video ads to consideration through retargeting and finally to conversion with dynamic product ads on Facebook (and, in the not too distant future, a direct customer relationship to build loyalty via Messenger).

    stratechery Year One - 271

    Google is promising something similar: awareness via properties like YouTube, consideration via DoubleClick, and conversion via AdSense.4 Just as importantly, both companies are promising that leveraging their respective platforms will provide benefits on both sides of the ROI equation: the return will be better given the two companies superior targeting capabilities and ability to measure conversion, and the investment will be smaller because you can manage your entire funnel from a single ad-buying interface.

    Here’s the kicker, though, and the big difference from the era of analog advertising: the Facebook and Google platforms turn TV and radio’s disadvantages on their head:

    • Facebook and Google have the most inventory and are still growing in terms of both users and ad-load; there is no temporal limitation that works to the benefit of other properties (and Facebook in particular is ramping up efforts to advertise using Facebook data on non-Facebook properties)
    • It is cheaper to produce ads for only Facebook and Google instead of making something custom for every potential advertising platform
    • Facebook and Google have the best tracking, extending not only to digital purchases but increasingly to off-line purchases as well

    Both companies, particularly Facebook, have dominant strategic positions; they are superior to other digital platforms on every single vector: effectiveness, reach, and ROI. Small wonder that the smaller players I listed above — LinkedIn, Yelp, Yahoo, Twitter — are all struggling.

    The Implications of Winner-Takes-All

    I have been arguing for a while that in the aggregate the tech sector is fine, and the state of advertising-based services is a perfect example of what I mean: taken as a basket the six companies in this article (Google, Facebook, Yahoo, Twitter, LinkedIn, and Yelp) are up 19% over the last year, even though the latter four companies are down a collective 53%; the fact that Google and Facebook are up a combined 31% more than makes up for it.

    This makes sense: while advertising as a whole is a zero-sum game, there is a secular shift from not just print but also radio and TV to digital, which is why this basket of digital advertising companies is up. Digital, though, is subject to the effects of Aggregation Theory, a key component of which is winner-take-all dynamics, and Facebook and Google are indeed taking it all.

    I expect this trend to accelerate: first, in digital advertising, it is exceptionally difficult to see anyone outside of Facebook and Google achieving meaningful growth, with the possible exception of Snapchat, which just signed a deal with Viacom that is very much inline with my analysis of the company in Old-Fashioned Snapchat and has a hold on the powerful teen demographic).5 Everyone else will have an uphill battle to show why they are worth advertisers’ time.

    More broadly, the winner-take-all dynamics described by Aggregation Theory have inspired a powerful sense of FOMO (the Fear of Missing Out) amongst investors resulting in a host of unicorns intent on owning their respective industries; I think the recent chill in valuations and fundraising are about coming to terms with the fact that a lot of those unicorns are in the same boat as Facebook and Google’s advertising competitors: they have already missed out to the dominant player in their field (or, that their field was never viable to begin with).

    In some respects it is tech’s own inequality story: the average and median company and startup will increasingly bifurcate. It’s not a bubble, it’s a rebalancing, and the winners are poised to be bigger and richer than anything we have seen before.

    1. Gruber wasn’t responding to my piece directly, but his writing is so concise I couldn’t help but use his response to a recent Walt Mossberg piece on Twitter; it’s perfectly representative of those responses I alluded to ↩

    2. A point consistently missed by far too many AAPL stockholders, at least the ones on Twitter and in my mailbox ↩

    3. The company missed on earnings but revenue beat and guidance was in-line ↩

    4. I’m more bullish on Facebook for reasons I explained in Peak Google and The Facebook Epoch and reiterated yesterday  ↩

    5. This piece about how teens use Snapchat is great ↩

  • How Facebook Squashed Twitter

    The idea of a “smartphone” that could connect to the Internet and run applications was around long before 2007; Apple, though, was the first to put the entire package together, including the device, user interface, and interaction paradigm, which is why the first iPhone is considered the start date of the mobile revolution.

    Similarly, the idea of a feed of information developed over many years; blogs were based on the format, and RSS allowed users to compile multiple news sources into a single stream. However, the introduction of Twitter in March of 2006, along with the Facebook News Feed, in September 2006, were the two seminal products that brought all the essential components together: users, content, and a place to read. I would argue it’s a date that is just as significant.

    Today, having a feed that users willingly return to day-after-day is the foundation of successful mobile advertising companies, especially Facebook. As I noted back in 2013 the feed allows for an advertising unit that is actually superior to anything found on the desktop: users have no choice but to at least visually engage with whatever is dominating the screen of the mobile device that is the center of their lives.

    In fact, I would argue that the feed is so important that its development — or lack thereof — is the core reason why Facebook has soared over the last ten years, while Twitter has slumped after a beginning that suggested the exact opposite sort of outcome.

    Twitter’s 2009 Slowdown

    In their 2013 S-1 Twitter released user numbers that only went back to Q1 2010; the best estimate of growth between 2006 and 2010 is found by looking at 3rd-party services reports on traffic to Twitter.com. The numbers, at least for the first three years, are very impressive. This is from comScore:1

    Screen Shot 2016-01-26 at 7.08.36 PM

    However, later that year something surprising happened: Twitter’s growth dramatically decelerated. Here’s a chart of Nielsen data:23

    Screen Shot 2016-01-26 at 7.13.46 PM

    That summer produced the first set of stories that have since come to dominate the Twitter narrative: Twitter’s Phenomenal Growth Suddenly Stops, Has Twitter Peaked?, Is Twitter in Trouble, Twitter’s Growth: Has It Peaked?, Twitter’s Global Growth Flattens. In retrospect, the answer is yes: as noted, Twitter reported user numbers starting in 2010 that never came close to the hockey stick growth the company enjoyed from 2006 to 2009.

    So what happened?

    Facebook Versus Twitter

    The counterpoint to Twitter’s declining growth numbers was, as noted, Facebook. While the company always had a big head start on the desktop, the story was quite a bit different in mobile. In the first quarter of 2009 Facebook only had 35 million active users on mobile, barely more than Twitter’s 30 million active user base (which was predominantly mobile) a year later. However, the trajectory from those starting points couldn’t be more different:

    Screen Shot 2016-01-26 at 9.10.49 PM

    I suspect the dramatic difference in Facebook and Twitter’s growth was due to three factors:

    • Facebook always had an inherent advantage over Twitter in that its network, at least in the beginning, was based on networks that already existed in the offline world, namely, people you already knew. That made the service immediately approachable and useful for basically everyone. Twitter, on the other hand, was more about following people you didn’t know based on your interests. This theoretically applied to everyone as well, but uncovering those interests and building an appropriate list of people to follow had to be done from scratch.

    • As any product moves down the diffusion curve from early adopters to the mass market, the marginal willingness of each new user to go through the effort of introducing said product into their daily life decreases: early adopters will jump through all kinds of hoops to take advantage of the product’s utility, but the 100 millionth user, to pick a number, is a lot less willing to go through the trouble. In retrospect it seems clear that in 2009 Twitter reached that marginal user: the service had tremendous visibility, but it was simply not worth the effort to get started for an increasing number of people.

    • Facebook, meanwhile, continued to add to the variety of posts available to their algorithmically generated feed.4 Yes, the early adopters who had gone to the trouble to tune their feed complained, but the real beneficiaries were users who didn’t want to go to the trouble of making sure they saw something interesting — whether related to friends and family or not — whenever they visited Facebook. And, starting in 2009, those users had even less motivation to get Twitter working: Facebook was good enough.

    It’s easy to pontificate on how Twitter and Facebook are fundamentally different services, or to argue that Twitter’s interest graph is potentially more valuable than Facebook’s social graph. Ultimately, though, the two services, along with every other form of media, are competing for the same scarce resource: attention. And, as of 2009, not only was it easier to get started with Facebook, but it was also more likely that the service had enough interesting content to ensure most users had no desire to look for something better.

    The rise of mobile accentuated this difference. I wrote in 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.

    When it comes to “the empty spaces” most people don’t want to do work, but work is exactly what Twitter required. You had to know what you were interested in, know who to follow based on those interests, and then, to top it all off, you had to pick out the parts that you were interested in from a stream of unfiltered tweets; Facebook, in contrast, did the work for you.

    The Attention Market

    I have been a fierce critic of Twitter the company ever since they released their S-1, writing at the time that the service had strong monetization prospects but a real user growth problem. Accordingly, I criticized the service for what I perceived as a failure to evolve the product, culminating in a call for a change in leadership last spring; a few months later, consistent with my belief that evolving the product was the key to growth, I made the case for Jack Dorsey to be CEO.

    When that happened, and when Twitter released a new product — Moments — that finally abandoned the chronological timeline, I was thrilled, exulting in Twitter’s Moment:

    I think, though, it’s time for a new prediction: that the summer of 2015 will be seen as the low point for Twitter, and that this week in particular will mark the start of something new and valuable. Crucially, the reasons why are directly related to why I was bearish for so long: the product, the CEO, and the stock.

    Quite clearly that was wrong: the stock is down 38.38% since I wrote that article, including a 4.6% drop yesterday in the wake of a significant shake-up in the executive suite. As I wrote in the Stratechery Daily Update yesterday, I actually don’t think said shake-up is particularly surprising: if the point of bringing in Dorsey was to overhaul the product then it’s hardly a shock that the head of product and engineering from the previous regime are headed out the door. Still, there’s no question that the company is at an even lower point than they were last fall, but, perhaps there is still room for optimism?

    I don’t think so.5 Unfortunately for Twitter the attention market of 2016 is far different than it was back in 2009. When Dorsey states that he wants Twitter to “become the first thing everyone in the world checks to start their day and the first thing people turn to when they want to share ideas, commentary, or simply what’s happening”, he is no longer trying to capture an entirely new market, but rather to steal that market from well-established competitors, particularly Facebook, but also services like Snapchat, Instagram, and the messaging services, all of which have feeds of their own. And Facebook in particular has undergone its own evolution. I wrote in Facebook and the Feed:

    Facebook is compelling for the content it surfaces, regardless of who surfaces it. And, if the latter is the case, then Facebook’s engagement moat is less its network effects than it is that for almost a billion users Facebook is their most essential digital habit: their door to the Internet.

    Or, to put it in Twitter terms, Facebook has developed its own interest graph that is far more powerful and effective and easier-to-use than Twitter’s ever was. Yes, Twitter still owns niches like NBA Twitter, and news hounds like myself (and most of you reading this article) will continue to find it essential, but for nearly everyone else in the world6 it is Facebook that is the first thing people check, not just in the morning but in all of the empty spaces of their lives. In short, it’s not simply that Twitter needs to convince users to give the service a second-chance, something that is already far more difficult than getting users to sign up for the first time; it’s that even if the service magically had the perfect on-boarding experience leading to the perfect algorithmically-driven feed, it’s not clear why the users it needs7 would bother looking up from their Facebook feeds.

    In other words, my error last fall was not a misguided belief that Moments was a step in the right direction, or that Dorsey was the right person to overhaul Twitter’s product. Rather, I failed to appreciate not just then but in every single post I’ve written about Twitter that anything the company might do can’t make up for the failure to evolve in those critical few years when the attention unlocked by mobile was up for grabs.8

    1. Via Business Insider  ↩

    2. via The Daily Mail  ↩

    3. The number of visitors reported aren’t very consistent between the various 3rd-party services, but the trends are the same for all of them ↩

    4. This originally stated: “Facebook, meanwhile, in 2009 made perhaps the most significant change to their service since the introduction of the News Feed, and I don’t think it’s a coincidence that said change is roughly correlated with Twitter’s slowdown in growth: the News Feed added items beyond friends and family status updates, and it switched from being chronological to being algorithmic.” In fact, Facebook’s feed was algorithmically based from the beginning ↩

    5. With the caveat that I am wary of over-reacting in an attempt to compensate for getting this one wrong ↩

    6. Outside of China ↩

    7. I explained why Twitter needs more users here and here  ↩

    8. So what should Twitter do now? Well, there is value there: Twitter occupies outsized influence when it comes to news in particular, and also specific niches like live events, African Americans, Japan (especially relative to Facebook), etc. That is certainly worth something to someone, but it’s hard to see the growth opportunities. The company’s user base is likely what it is, and any evaluations should be based on estimates of just how much revenue the company can extract from said user base (and, it should be noted, Twitter has done an excellent job of exactly that.

      In addition, there are very fundamental questions about the long-term viability of a public-oriented service that allows anonymity. Twitter abuse is a real issue that has driven away users. I address this issue here  ↩

  • The FANG Playbook

    Jim Cramer, who coined the “FANG” acronym as a descriptor for the high-flying Facebook, Amazon, Netflix, and Google group of tech stocks that have dramatically outperformed the market, made clear yesterday that his endorsement wasn’t necessarily connected to the underlying companies:

    A note on these stocks. I picked them largely because over the years they have become anointed by a group of go-go managers, meaning managers who like to be affiliated with the stocks of companies with the most momentum. I by no means have said “buy these stocks” because they represent great value. What I have been saying is that because of the scarcity of actual high-growth stocks these have become default names that managers naturally gravitate to.

    It’s not an unreasonable position: the demand for growth in a low-interest-rate environment flooded with capital, plus a healthy dose of FOMO (Fear of Missing Out) has certainly played a role in the rise of unicorns; it makes sense that the same dynamics would play out in the stock market as well. It’s also a position that has had the good fortune of being right: in 2015 the FANG group accounted for more than the entire return of the S&P 500.1

    In fact, though, Cramer was more right than he apparently knows: the performance of the FANG group is entirely justified because of the underlying companies, or, to be more precise, because the underlying companies are following the exact same playbook. Sometimes the market does get it right.2

    The State of FANG

    Each of the FANG companies is in a similar position in their respective industries: they haven’t so much disrupted incumbents as they have subsumed them:

    • Facebook: The late David Carr, who first broke the news about Facebook’s Instant Articles initiative back in 2014, worried that “media companies would essentially be serfs in a kingdom that Facebook owns.” However, as I noted in The Facebook Reckoning, publishers already are. Facebook’s status as the Internet’s home page means that publishers have no choice but to accommodate themselves to the social network, whether that be Instant Articles or an increased focus on video.

    • Amazon: While the biggest driver of Amazon’s increased valuation has almost certainly been AWS, the e-commerce side of the business continues to grow like gangbusters as well, taking over half of every additional dollar spent by U.S. consumers online, and a quarter of all retail growth online or off. The vast majority of those sales are actually from 3rd-party merchants using Amazon as a discovery and fulfillment platform, but these merchants’ market power relative to Amazon is not unlike publishers relative to Facebook, because Amazon.com is where the buyers are.

      From a certain perspective this paradigm applies to AWS as well: the reason why AWS’s profitability increases along with growth is that Amazon achieves economies of scale, which is another way to say that AWS’s suppliers have no choice but to be squeezed in order to indirectly serve the customers they used to sell to directly

    • Netflix: The Internet — and Netflix — made fun of an NBC executive who claimed that “The reports of our death have been greatly exaggerated.” Here’s the thing, though: he’s right, in part thanks to Netflix. According to this February 2015 list, 42 past and present NBC shows are streamable on Netflix, for which the latter is certainly paying a material amount. Indeed, perhaps the most fascinating aspect of Netflix’s meteoric rise is the fact that the same content producers who are ultimately threatened in the battle for attention are increasingly unable to stop themselves from selling their content to Netflix: the streaming company has too many customers adding to a pile of content money that is too big to ignore.

    • Google: Google’s position is similar to Facebook’s: any business that wants to be discovered by potential customers has no choice but to follow the search company’s directives, whether that be cleaning up dubious SEO strategies, making their pages mobile-friendly, or soon, adopting Accelerated Mobile Pages. Every now and then someone, usually a set of publishers, tries to defy the search engine’s influence, only to come crawling back within weeks once traffic craters. The reality is that most people find most web pages through Google, which means Google calls the shots — and sells the most expensive advertising of all.

    There is a clear pattern for all four companies: each controls, to varying degrees, the entry point for customers to the category in which they compete. This control of the customer entry point, by extension, gives each company power over the companies actually supplying what each company “sells”, whether that be content, goods, video, or life insurance.

    How FANG Started

    There are also striking similarities to how each FANG company started, particularly when it comes to the pre-existing resources each leveraged:

    • Facebook: Facebook didn’t launch to the world: it launched to Harvard only. In other words, Facebook started with a preexisting network and, for all intents and purposes, a preexisting infrastructure (Harvard-provided Internet access).3 What Zuckerberg added was an entry point that provided a much more effective and enjoyable way to tap into and connect with that network.

    • Amazon: Amazon’s roots were equally humble: the company sold only books and held no inventory; when an order was placed Amazon would order the book from pre-existing book distributors and then ship it on using pre-existing parcel shippers to the end user. What Jeff Bezos and team added was an entry point to a far more extensive selection of books than any offline bookstore could provide and lower prices to boot. Once you bought from Amazon, why would you buy anywhere else?

    • Netflix: Netflix’s also began with pre-existing assets: off-the-shelf DVDs and the U.S. Postal Service, providing a benefit similar to Amazon’s — a wide selection and delivery to your doorstep. It took a year to figure out the subscription model, which meant lower prices for heavy users and less stress about things like late fees for everyone, and Netflix slowly became the gateway to entertainment for more and more customers.

    • Google: Google didn’t create any of the pages accessible through its search engine, nor the means of accessing those pages (the browser). Rather, by basing its algorithm on the link (instead of content) it offered a dramatically more effective way to find exactly what you were looking for, making it the natural first stop for anyone looking for anything on the Internet.

    None of the FANG companies created what most considered the most valuable pieces of their respective ecosystems; they simply made those pieces easier for consumers to access, so consumers increasingly discovered said pieces via the FANG home pages. And, given that Internet made distribution free, that meant the FANG companies were well on their way to having far more power and monetization potential than anyone realized.

    FANG and Aggregation Theory

    Last July I described the theoretical underpinning for this shift in power and monetization potential in Netflix and the Conservation of Attractive Profits. By owning the consumer entry point — the primary choke point — in each of their respective industries the FANG companies have been able to modularize and commoditize their suppliers, whether those be publishers, merchants and suppliers, content producers, or basically anyone who needs to be found on the Internet.

    Over time, each of the FANG companies has leveraged their ownership of the customer relationship to expand their arena of control, whether that be by expanding their offerings like Amazon or integrating backwards into the previously valuable components of their ecosystem (Facebook owns their network completely, Netflix creates their own content, and Google increasingly monetizes by keeping people on Google properties). All of those moves, though, were predicated on owning the customer relationship.

    Long-time readers know that I already summed up this phenomenon in Aggregation Theory, but in some respects I think my chosen name does this idea injustice: the word “theory” sounds abstract and disconnected from the real world, when in fact the elements of Aggregation Theory are not only very much real phenomena but also the connective tissue tying the FANG companies together.

    Moreover, understanding where these companies started and how they grew fleshes out the advice I gave at the end of last week’s article Cars and the Future:

    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.

    Each of the FANG companies was technically innovative in their own way (especially Google, the exception that proves the rule), but each of them — like Uber, which that paragraph referenced — also depended to an incredible degree on products and infrastructure that already existed. The key to their now or future dominance was their proximity to customers, superior user experience, and new business models that simply weren’t possible before the Internet.

    Note that none of these companies are “disruptors” in the Christensen sense. They are not offering low-margin good-enough products that appeal to customers who are over-served by incumbent companies. Rather, they are “aggregators” who start with the best customers and don’t really compete with incumbent companies, at least in the beginning. In fact, incumbents nearly universally benefit from the presence of aggregators, at least at first (publishers benefited from Facebook, merchants from Amazon, content makers from Netflix, web businesses of all types from Google). It is only when the aggregators’ consumer base becomes dominant that the inevitable squeeze on incumbents — specifically, on their profit margins — begins, and it is in the long-run irreversible.

    That, Mr. Cramer, represents incredible value.

    1. I.e. without these four stocks the S&P 500 would have been significantly more than barely down for the year ↩

    2. Actually, I think in the long run, it almost always does. As legendary investor Benjamin Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” ↩

    3. Facemash, the “hot-or-not” app that Mark Zuckerberg built even before Facebook, even included pre-existing content (photos of students)  ↩

  • Cars and the Future

    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

    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

    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!