Christopher Mims’ piece Uber’s $18.2B Valuation Is a Head Scratcher is getting a lot of play, and deservedly so: it’s a good encapsulation of many people’s objections to Uber’s recent round that valued the company at $18.2 billion.
Undervalues Uber’s ability to differentiate as a consumer product
Mistakes venture capital for public markets
I’ll take on each one-by-one
Uber Is More Than a Taxi Replacement
Last fall I proposed a new term in the business lexicon: Obsoletive
The context of the article was smartphones, and the point was to distinguish “obsoletive” from “disruptive”:
Of course the easy answer is to say “The iPhone disrupted cell phones.” Except, at least to my reading, that kind of misses the point of what disruption is…
Disruption is low-end; a disruptive product is worse than the incumbent technology on the vectors that the incumbent’s customers care about. But, it’s cheaper, and better on other vectors that different customers care about. And, eventually, as the new technology improves, it takes the incumbent’s market. This is not what happened in cell phones.
In 2006, the Nokia 1600 was the top-selling phone in the world, and the BlackBerry Pearl the best-selling smartphone. Both were only a year away from their doom, but that doom was not a cheaper, less-capable product, but in fact the exact opposite: a far more powerful, and fantastically more expensive product called the iPhone.
The jobs done by Nokia and BlackBerry were reduced to apps on the iPhone
The problem for Nokia and BlackBerry was that their specialties – calling, messaging, and email – were simply apps: one function on a general-purpose computer. A dedicated device that only did calls, or messages, or email, was simply obsolete.
Examples of obsoletive technologies include PCs, the Internet, search, and smartphones. All replaced multiples single-use tools with one (usually more expensive) single-purpose solution; more pertinently to this article, obsoletive technologies are huge opportunities, much greater in fact than disruptive ones (Read the original “Obsoletive” article here).
This, then, is the first thing that Mims gets wrong in his criticism of Uber. From the conclusion:
Even the most aggressive estimates of Uber’s value — let’s assume the company captures 50% of the world taxi market in 5 years — mean the company would still be worth less than $18.2 billion…It’s quite possible that investors have wildly overestimated the ultimate size of Uber’s potential revenue.
This is a relevant comparison today, but to my mind sells short Uber’s potential: the addition of technology to people driving cars does not make Uber a taxi competitor; rather, it makes Uber a taxi obsoleter. 1 Moving passengers around for money is but one small job that could be done by a nearly infinitely scalable logistics company, just as typing documents is one small job for a PC, or making phone calls one small job for a smartphone. In other words, to suggest that Uber’s ceiling is the size of the taxi industry is no different than suggesting typewriters are the ceiling for PCs.2 If you’re considering upside it’s far better to look at the market caps of UPS ($95 billion), Fedex ($42 billion), or even Toyota ($182 billion).3
Low Barriers to Entry Do Not Mean the End of Differentiation
This is Mims primary objection. From the article:
Uber’s larger vision, according to CEO Travis Kalanick, is to disrupt transportation and “make car ownership a thing of the past.”
That’s a worthy mission, but the wrinkle is that Uber is entering what is essentially a frictionless market (for both drivers and riders) in which its services are a commodity. The company’s phenomenal growth so far (we don’t know the actual numbers, but doubling in revenue every 6 months is what Kalanick claims) has been built on the back of low-hanging fruit — expansion into new cities, particularly where taxi availability is low — and levels of dissatisfaction among taxi drivers that may be temporal. (When I asked drivers who had a particular loyalty to Lyft why they liked the company, they said they felt it treated them better in general.)
In both respects, Uber’s growth is reminiscent of Groupon, and we know what happened to them.
Actually, what did happen to Groupon? Mims contention, as far as I can tell, is that Groupon lost its value because of competitors. But actually, Groupon’s competitors have largely disappeared! (LivingSocial exists, but barely; it’s a surprise it’s even a going concern at this point)
This was, in fact, what I predicted long before Groupon’s IPO: that while Daily Deals would be commoditized, there would always be an advantage that would accrue to the market leader based on brand and consumers’ willingness to tolerate managing multiple options (honestly, how many Daily Deals emails are too many?). After all, there are entire industries – consumer packaged goods, especially – built on the idea that, in the consumer market, commodities can be sustainably differentiated by brand, channel, distribution, etc. (Be right back – I’m going to snack on some Ritz crackers). Similarly, while the truly cost conscious may manage multiple ride-sharing apps, most will default to one, and in that case, the market and brand leader has a clear advantage (just like every branded item in your local grocery store).
The problem with Groupon was the entire premise of their business; in short, daily deals were a terrible deal for small businesses, which meant the cost of getting more daily deals eventually became prohibitive (Groupon’s sales force costs were through the roof). In this respect, Uber stands in stark contrast: drivers are getting a great deal with Uber (and Lyft and all the other competitors). In other words, I believe Groupon lost most of its valuation because it had a crappy value proposition for its core constituency, not because it faced too much competition. If I’m right, and Uber v Lyft plays out the same way as Groupon v LivingSocial, then only Uber will be left standing (a la Groupon), but standing on top of a much healthier industry (unlike Groupon).
Venture Round Valuations Do Not Equal Public Market Valuations
At this point Mims could justifiably argue that Uber as logistical network or differentiated brand are simply pie-in-the-sky fantasies that pale in reality to today’s market. And that would be a fair thing to say if Uber were a public company and $18.2 billion were their market cap.
But, in fact, $18.2 billion is a valuation used in a venture round, and that has entirely different implications. Venture capitalists are not buying stock per se, but rather mis-priced optionality. In the case of Uber, $18.2 billion valuation is the result of a $1.2 billion investment; for the investors ponying up the cash, their downside is capped at $1.2 billion (and likely much less, given that Uber’s valuation will never go to zero, and that investors get preferential treatment in a below valuation exit). The upside, though, is by definition infinite, because Uber’s valuation has no theoretical limit (again, the bottom limit is $0).
The truth is that whenever Uber goes public, they are not an $18 billion company. They are either a $4 billion company, like Groupon, or a $180 billion (or more) company befitting their status as an obsoletor. While I think the latter is more likely, just for the sake of argument I’ll say the downside position has a 90% chance, and the upside position a 10% percent change. That means this investment round has an expected return as follows:
Again, in an extremely pessimistic scenario in which Uber has only a 10% chance of realizing its potential, investors in this latest round will still make their money back. There isn’t that much downside, and the upside is enormous. Opportunities like this investment round are the entire premise of venture capital, and the valuations that result just aren’t that analogous to public market valuations, at least in the short term.
I don’t particularly like picking on individual writers or articles, and there’s a non-zero chance that Mims ends up being right – I still have friends giving me grief for being bullish on Groupon. However, even there I think my reasoning was sound: you can differentiate in consumer markets with low barriers to entry. Add that to the obsoletive nature of Uber’s product, along with an understanding of how venture valuations work, and $18.2 billion ends up looking downright reasonable.
Between a feature-by-feature review (members only) and an analysis of strategic underpinnings, I’ve written nearly three thousand words about Apple’s WWDC announcements. Still, though, it feels like I haven’t written about what is perhaps the most important takeaway.
It’s a takeaway I’ve resisted, even as writer after blogger after Twitterer has said the same thing: Apple is different, things have changed, they are opening up. My instinctual reaction has been to assume that it is all hyperbole, that nothing has changed, everything is expected. And yet, I have to admit the conclusion from Josh Topolsky’s piece Meet the New Apple rings true:
But the big story — and the big picture — is that Apple seems to have come out of deep freeze. It feels light, like it’s moving forward. Like the cobwebs have brushed aside, and things are going to get fun again. Everything we saw at WWDC’s keynote points to a very interesting next few months for Apple — a period that will undoubtedly come into deep focus around the fall, when the company tends to roll out its major hardware updates. But unlike previous events, which have felt painfully predictable and iterative in the past couple of years, the next move Apple makes should be surprising. If the software and platform work that we saw at the keynote on Monday is any indication, the kind of apps and hardware that follow it aren’t just going to be business as usual.
Indeed, there was an undeniable lightness and confidence in both the content and the style of Apple’s presentation. What’s more interesting is to consider why. Topolsky chalks it up to a post-Steve Jobs hangover:
In recent years — and let’s be honest, probably since just after Steve Jobs’ death in 2011 — there has been a sense of hesitation, of standoffishness, and maybe even a little bit of fear in the tone of Apple events. That tone has carried over to the company’s approach to the outside world, and has left a lot of people wondering just whether there’s been a plan at all. You could feel a palpable sense of Apple being closed off, in a huddle, trying to figure out what kind of company it wants to be (and can be) in a post-Jobs world. Because whether you agreed with his style, decisions, or philosophies, it’s impossible to deny that Jobs was the voice of Apple and the holder of the keys to the company roadmap.
I don’t think this is quite right. Topolsky is right about the fear, but wrong about the timing. What is critical to understand about Steve Jobs’ Apple was how much it was rooted in fear. Not fear of Jobs, but rather, the abject terror of the company ever finding itself in a similar situation to the one Jobs stepped into in 1997. A company bankrupt technically, and on the verge of being bankrupt financially, deserted by the partner it had made into a powerhouse (Adobe), and forced to accept a loan from its oldest and most bitter rival Microsoft. Jobs, and all of those closest to him, swore never again.
And so, Apple hoarded cash like a depression-era grandma; every new Apple product was locked down to the fullest extent possible, with limitations removed grudgingly at best. This absolutely extended to developers: not only were apps originally banned from the iPhone, and later on subject to seemingly arbitrary limitations and restrictions, but even today it’s unclear if non-game apps can be the foundation of sustainable businesses because of Apple’s restrictions.
The values Jobs insisted Apple embody – quality, simplicity, the “feel” of something – are actually not that difficult to understand. There is no magic formula, just the incredibly difficult work of making choices and executing in a way that ensures those values come through in the products…
In other words, I think Apple is fine. My long-term worry is about what happens when all of the old guard leave, and those in charge have only ever known success. But that’s still a ways off.
In fact, it wasn’t a ways off at all. Just compare the executive pages from 2010 and 2014 – nearly 60% of the 2010 team is gone.
Jobs, of course, is the biggest absence, but also gone is his protégé Scott Forstall. Both were ardent proponents of uncompromising Apple control, and, I think it’s safe to say, both would have been concerned with both the tenor and content of this week’s announcements. It was Forstall, remember, who dominated the most depressing post-Jobs keynote at WWDC 2012 (when iOS 6 was announced). That keynote is memorable largely for the introduction of Apple Maps, the moment when Apple’s insistence on control crossed the line from justifiable caution to injuriousness to the end-user experience.
Interestingly, Craig Federighi, whose enthusiastic joviality is a stark contrast from Forstall’s certitude, was also at Apple in 1997, having been a part of the NeXT acquisition. Crucially, though, he left in 1999 for eight years, meaning he witnessed the first part of Apple’s incredible run from afar. And perhaps that perspective helped him to move on in a way Forstall and others in the old guard could not. Again, by “moving-on” I don’t mean moving-on from Jobs’ death, but rather moving-on from the darkest parts of Apple’s past. Apple is not about to go bankrupt, they hold the power in every partnership they enter, developers around the world desperately want to work with them. It is not 1997, and to make decisions with a 1997 mindset simply doesn’t make sense.
In short, perhaps my fears for Apple’s future were precisely backwards: Apple didn’t need to always remember 1997; in fact, they needed to forget. And so they have.
In the end, as with many of Apple strategies, much of what transpired in Monday’s WWDC keynote was telegraphed many months ago, at least from a strategic perspective. Consider the thinking behind iOS 7. As Jony Ive told USA Today:
When we sat down last November (to work on iOS 7), we understood that people had already become comfortable with touching glass, they didn’t need physical buttons, they understood the benefits…So there was an incredible liberty in not having to reference the physical world so literally. We were trying to create an environment that was less specific. It got design out of the way.
Implicit in that statement – “people had already become comfortable with touching glass” – is the acknowledgment that smartphones have reached the saturation point, especially in the premium segment that Apple has chosen to focus on. However, as I wrote in Why Apple is Buying Beats, this is problematic because Apple needs to grow.
There are two ways to do so: steal share from competitors and sell more to existing users. While the sheer number of announcements at Monday’s WWDC keynote was almost overwhelming, much of what was announced slotted neatly into one of these two strategies.
Steal Share: Winning Android Customers
Steal share is just what it sounds like: get more of your competitors’ customers to switch to you than you lose to your competitor. The first part of that equation is largely a marketing effort. To that end Apple spent several minutes in the keynote talking about Android security problems and how few phones are upgraded, and also emphasized that Apple was very concerned about privacy at several different points in the presentation. It will be very interesting to see if Apple starts to incorporate this messaging into more of their outbound marketing.
The second way Apple has gone about stealing share is through increasing iPhone distribution. Many premium Android phones have been sold on networks that did not offer the iPhone; beyond the big ones like China Mobile and NTT DoCoMo, there are scores of smaller carriers like US Cellular that did not offer the iPhone until very recently. Simply being available is half the battle, and it’s one Apple is fighting on ever more carriers around the world, increasing their carrier base by 15% in the last 8 months alone.
Finally, there is a product component to winning Android customers: addressing specific reasons why someone might prefer an Android phone. One such reason is the availability of 3rd-party keyboards. Well, that’s only an advantage for the next three months or so. Much more importantly, many prefer larger screens, which have been Android-only; I strongly suspect that advantage is disappearing in three months as well.
Steal Share: Retain iPhone Customers
Many of the new technologies Apple announced Monday, especially HealthKit and HomeKit, have the potentially to serve as very powerful iOS lock-ins. It’s one thing to leave behind a few dollars’ worth of apps in order to get a larger screen or a lower price; it’s quite another to abandon expensive devices and home appliances that are designed to work with only iOS.
Similar lock-in applies to iCloud Storage and everything else related to Apple’s cloud (this applies to developers too using Cloud Kit); once customers decide to buy an iPhone, Apple wants to ensure that customer only ever considers an iPhone from that point forward.
Upsell Existing Users: Sell Macs
The iPhone’s “bad” news – the fact that only about 20% of the worldwide smartphone market is premium – is great news for Apple’s other platforms, especially the Mac. Ever since the days of the iPod Apple has talked about the “halo” effect – the idea that the experience of owning one Apple product will make you more likely to purchase other Apple products in other categories.
Many of Monday’s announcements, however, take this concept much further by making it very explicit that your iPhone experience can not be fully realized unless you also own a Mac (and, to a lesser extent, an iPad). Chief among these were the suite of features that made up Continuity. Answering phone calls on your computer, handing off documents or web pages, seamless SMS across devices, ad hoc hotspots – each of these is obviously useful to end users, yet only possible with a Mac. I would not be surprised to see Apple promote these features heavily in its marketing, with the intent of converting some portion of its non-Mac-owning iPhone base – which is huge – into Mac owners (And yes, it is rather incredible to think about a 30-year-old product being a growth story, but it absolutely is the case).
Upsell Existing Users: Sell More iPhones
The other way to think about upselling current iPhone customers is incentivizing them to sell iPhones to their friends and family. Just as many of Monday’s announcements only apply if you also have a Mac, others only apply if those you communicate with regularly also have an iPhone.
The biggest example here are the raft of updates to Messages. The “blue” versus “green” bubble color has long-served as a pro-iPhone status symbol, even though the actual experience of chatting via iMessage versus SMS was identical. Now, though, there are a great many additional functions that are only possible if both users have iPhones. To be sure, almost all of the additional Messaging features Apple announced are also available in 3rd-party messaging apps, but the most critical feature of any messaging service is who else is using it. Apple is betting some percentage of users would rather convince their friends to get an iPhone than understand and convince their network to make a wholesale shift to an alternate messaging service.
Family Sharing also fits in with this story. Shared calendars, photo albums, etc. are significant pain points, and if Apple is able to successfully enable these features out of the box it is absolutely a reason for parents to not only buy iPhones for themselves, but for their children as well.
The other important growth story for iOS is the enterprise. Apple went beyond its usual boilerplate about 98% of the Fortune 500 using iOS and actually spent meaningful time detailing new features that had been developed specifically for enterprises, including new security features, enhanced Mail and Calendar, and better device management. Equally meaningful are app extensions, which will not only make power users happy, but also better enable corporations to create and meaningfully use proprietary line-of-business applications.
All-in-all, it’s hard to imagine how Monday’s announcements could have been more impressive. It’s not just that Apple delivered an incredible number of new features and genuine surprises, but also the strategic clarity with which they did so. The big decisions have been made: Apple (and thus the iPhone) is a premium product company that won’t go downmarket; what is left is to execute, and they are doing just that.
Beyond the usual updates of iOS and OS X, there are two significant rumors about what Apple might unveil next week at WWDC.
The first is Healthbook, as detailed by Mark Gurman here and here. The second is Apple’s plan for a smart home, first reported by The Financial Times. I’m considering them together because at a high level they are actually quite similar: both will likely rely primarily on 3rd-party hardware that is integrated at a software level on iOS. It’s a strategy that makes a lot of sense both at a theoretical level and at a strategic level for Apple specifically, which leads me to believe that both reports are mostly correct.
Right now the health-monitoring and smart home markets are in their infancy; as Clay Christensen first laid out in The Innovator’s Solution, in immature markets nothing is “good enough,” meaning functionality is prioritized over price, giving the advantage to integrated solutions (in mature markets, everything is good enough, meaning price is prioritized over functionality; I discussed the extent to which this applies to the consumer market here).
What Apple is rumored to be proposing for both health monitoring and smart homes is, unsurprisingly, an integrated solution: a series of devices and appliances that rely on one central interface for all of their functionality and interaction. It’s a similar model to the old digital hub, where your digital devices were spokes surrounding your Mac; in the future Apple allegedly envisions your home and personal accessories to be spokes around your iPhone:
Contrast this to Android@Home and Android Wear. Just as Android was developed from the beginning to be a standalone device that relied on the cloud, not a computer, Android@Home and Android Wear are at their heart meant to enable standalone devices that connect with all types of other devices through the cloud.
The cloud as a hub connecting many disparate pieces
This is a modular world, and while it is ideal for a mature market (as noted above), in immature markets it leads to a landscape like this:
“Making Sense of the Internet of Things” – TechCrunch
Lots of devices that use Android@Home and Android Wear may be sold, but the majority will be like cheap Android: smart in name, but not in actual usage. It will only be over time, as devices and appliances become more capable and as standards develop that functionality will become “good enough” such that the more integrated solution would be seriously challenged.
I believe the iPhone will be Apple’s chief revenue driver for at least the next five years. Something like the iWatch may be interesting, but it’s unrealistic to expect it or any other product category to drive Apple’s growth in a meaningful way, at least in the short term. So Apple needs lots of small revenue drivers in place of one big one. And that means accessories.
To that end, there are two rumored products in Apple’s pipeline that fit this vision: the iWatch (to go with Healthbook) and an enhanced AppleTV (to go with the smart home). While I don’t expect iWatch news next week, I am hopeful for news about the AppleTV. Regardless, I expect both to be Apple’s next priorities on the hardware front.
Perhaps more interesting is to consider how Apple might go about integrating 3rd-party devices and appliances into their vision. There will certainly be some sort of licensing program similar to the “Made for iPod” program, and the price of inclusion could be steep, particularly for big ticket items like home appliances or specialized medical devices (when “Made for iPod” launched Apple reportedly charged the greater of $10 or 10% of the retail price, although this dropped over time). This could absolutely be a material revenue stream sooner rather than later.
More significantly, though, each item purchased that is “Made for iPhone” further locks a consumer into the Apple ecosystem; Apple will likely long struggle to generate significant growth from such a massive base, but making it even harder for people to leave would cheer investors who tend to discount AAPL based on the perceived fragility of their position.
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Justifying Beats
One side effect of how long it took to announce the Beats deal is that it gave analysts and pundits plenty of time to come to grips with Apple’s possible rationale. Philip Elmer-DeWitt has a roundup of analyst reactions, but I think M.G. Siegler summed it up best:
Honestly, I’ve been confused as to why others have been so confused by this deal. In buying Beats, Apple gets three key things:
A music streaming service that can be run fully separate from iTunes, meaning it won’t entirely kill the download business…
Jimmy Iovine, who has long supported Apple in the music business and was instrumental in helping to get iTunes off the ground in the first place…
The headphone business, which happens to make quite a bit of money…
The only real argument I see is with the $3 billion price. But $3 billion to you or me is not $3 billion to Apple. Or to any other company, for that matter. Apple makes roughly that amount in profit a month.
This is basically the argument I made after the deal was first rumored: from a strictly business perspective, this deal is eminently justifiable. To my mind the most valid and justifiable criticism is much more difficult to articulate, and has to do with culture and executive focus (which this episode of Exponent gets into).
That said, you can make another positive argument from a similarly intangible position. Note that Beats Music is going to be operated independently from iTunes (which is clearly being disrupted by streaming services, including YouTube); according to Clay Christensen, the best way to respond to disruption is to set up a separate division that is insulated from the main company and its tendency to kill alternative business models in the crib (such as a business model that entails having apps on Android and Windows Phone). Perhaps accidentally, but more likely intentionally, Apple is doing just what the Doctor (of Business Administration) ordered.
Note: After I wrote this I discovered this great article by Michael Vakulenko suggesting that Apple might make Beats into a platform for artists akin to the app store. It’s a fascinating idea, not just for Beats, but also for what it might mean for the App Store, which itself is desperately in need of curation.
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This episode surprised us; through a discussion of who is at fault in the latest series of new vs old-world spats, we realized that not only has the Internet fundamentally changed winners-and-losers, but also the very nature of economic competition and the type of regulation that is required.
Ay, we must die an everlasting death.
What doctrine call you this, Che sera, sera,
What will be, shall be? Divinity, adieu!
– The Tragical History of Doctor Faustus, Christopher Marlowe
To evoke Faust as allegory for the ongoing dispute between Amazon and book publishers is appropriate on two levels, the first being the nature of the original story.
Faust was the protagonist of a German legend, who, dissatisfied with his life as a scholar, sold his soul to the devil in exchange for infinite knowledge and the full array of worldly pleasures. Said legend has been appropriated by multiple authors for variations on the same theme, including Christopher Marlowe’s The Tragical History of Doctor Faustus, Johann Wolfgang von Goethe’s Faust, and a host of other plays, operas, books, and symphonies. Indeed, most of you reading this have likely uttered the phrase “Make a deal with the devil,” and so have adopted the original idea and made it your own, without paying a cent to anyone.
Ideas have always been free, but their closest cousin, words, have long been a bit more problematic. The publishers would have you believe that their words, written by authors of course, but blessed by them, are worth a premium, and certainly ought not be shared freely. And, for centuries, that was mostly true. Books – and newspapers and magazines, for that matter – were sold for a price.
The problem, though, as newspapers and magazines have long since discovered to their peril, is that no one was ever paying for the words. Rather, it was the difficulty in distributing words that demanded a premium, whether that be the paper, the printing, the shipping, or the distributing. With the Internet, each of these proved unnecessary, leaving only the writing, editing, and publishing, and the market has dictated exactly what those are worth, all things being equal: $0.
The issue is that writing, editing, and publishing are all fixed costs; they are accrued before an article or book is published, and increasing the distribution of said article or book is, relative to these costs, completely free. The costs the Internet obviated, on the other hand, such as paper, ink, shipping, and retail space, were all variable costs; to create one additional book (or newspaper or magazine) required money. To put it another way, before the Internet free was not an option, and once customers were already paying something, it was a whole lot easier to get them to pay just a little bit more. And, with that little bit more, publishers could cover their fixed costs, and perhaps even turn a tidy profit.
On the Internet, though, words are much more like the mythical story of Faust, available to anyone and everyone for zero marginal cost. Each of you reading this article is creating a new version of this site on your computer, and it’s not costing anyone a cent.1 Unfortunately for those accruing those fixed costs, it’s much more difficult to convince customers to move from $0 to even $0.01 than it is to go move from $1 to $2 (or $10 to $20).
This reality, unsurprisingly, terrifies the publishers, which is where we return to Faust: just as the doctor made a deal with the devil, so have publishers, but in this case the devil is Amazon, and Mephistophilis, the devil’s agent, is DRM.
Unlike newspapers, which quickly placed all their content on the Internet in the 90s, massively increasing readership but ultimately hollowing out their revenue base, publishers approached the digital era much more gingerly. It’s not that the idea of ebooks was unknown – the first ebook reader launched in 1998 – but rather that publishers, having seen what happened to music with the release of Napster, were rightly terrified of a world in which books were accessible to anyone, at any time, for free. Over the next several years different publishers dabbled with different ebook readers, but it wasn’t until Amazon, with its longstanding relationship with publishers, launched the Kindle in 2007 that the publishers fully got on board, and key to the publishers embrace of the Kindle was its proprietary DRM. Over time the publishers would also launch their titles on other companies ebook readers, such as the Nook and iBooks, but always with DRM.
The problem with DRM, as Nook owners now know all too well, is that it ties your books to a single company. If you start buying Kindle books, you will always buy Kindle books, because your books will only ever work on a Kindle. The result is that anyone who has bought Kindle books is now more loyal to Amazon than they are to any of the publishers. Not that they were ever loyal to publishers, of course; said loyalty is reserved for specific authors. And that right there is the root of the publishers’ Faustian bargain: unloved by consumers, yet unwilling to give up their position as middleperson, publishers traded away infinite distribution and the truly free exchange of ideas for the yoke of another, infinitely more powerful middleperson – Amazon.
And now, Amazon is demanding its payment. While the specifics are unclear, publishers Hachette and Bonnier are to give up more control and money when it comes to ebooks, and to help them remember their end of the deal, Amazon is “forgetting” to keep many of their physical books in stock.
Let me be perfectly clear here: I think what Amazon is doing is ugly and I don’t like it. And, were this 1985, I would absolutely be raising antitrust alarms around Amazon’s monopsonistic position in printed books (i.e. their position as by far the largest buyer of books gives them undue power). However, it’s not 1985; it’s 2014, and a huge percentage of the population has at least one device capable of reading ebooks. In fact, publishers could break the back of the Amazon monopsony today were they to start selling all of their books without DRM. Can’t find the book you want on Amazon? How about you simply visit the publisher’s site and buy it there. Or, as is more likely, visit the site of your favorite author.
Ah, but that’s the rub. The publishers need Amazon because they need the Kindle’s DRM, because they know without that artificial friction their contribution to a book’s fixed costs would become untenable. As George Packer recounted in his anti-Amazon article Cheap Words:
Amazon executives considered publishing people “antediluvian losers with rotary phones and inventory systems designed in 1968 and warehouses full of crap.” Publishers kept no data on customers, making their bets on books a matter of instinct rather than metrics. They were full of inefficiences, starting with overpriced Manhattan offices.
I’ve worked with publishers, and here’s the thing: Amazon is right. It’s not that publishers don’t add value,2 but rather that their economics are wholly incompatible with the reality of the Internet. If publishers are to have a future free of Amazon, that future will be as a service with upside directly tied to a book’s success. Specifically:
Authors will hire publishers from a competitive marketplace based on reputation, quality of service, and price
Fees will likely be some sort of fixed price up-front, with a percentage of revenues
Books will be published without DRM and marketed primarily by the authors themselves, likely at lower price points but with significant upside for breakthrough works
Some sort of DRM remains an option in this new world, but it must be controlled by the author (or, if he chooses, his publisher) directly. DRM is artificial scarcity, and whoever controls it controls the entire market (I myself have chosen to not make all my content here on Stratechery available to everyone, but I control the means by which it is distributed). The problem with publishers is that, due to their own incompetence and (understandable) unwillingness to change, they gave the keys to the castle to Amazon, and it’s no surprise they are now paying the price; the devil always has its due.
OK, fine, the bandwidth and electricity cost something, but you know what I mean ↩
Forbes seem to think that Hachette is a producer and Amazon is a distributor. This isn’t quite true. I am a producer. From my perspective, Hachette is a value-added wholesale distributor: they supply editorial, production, packaging, marketing, accounting, and sales services and pay me a percentage of the revenue. (I could do this myself, and self-publish, but I don’t want to be a publisher, I want to be a writer: we have this thing called “the division of labour”, and it suits me quite well to out-source that side of the job to specialists at Hachette, or Penguin, or Macmillan.)
Unfortunately for Stross, a division of labor neatly isolated from the market success of his work is one of those inefficiencies ruthlessly culled by the Internet; of course he thinks this is a loss to consumers, but that ignores the fact that most would-be authors never actually even had a chance. ↩
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Good morning,
Ah, the American holiday hangover. Not much news; instead some extended thoughts on two of my favorite topics: the iPad and Intel. Oh, and Rap Genius.
On to the update:
Apple’s New iPad Ads
From Recode:
Here are two new ads from Apple, which wants you to know that the iPad can help you conduct a symphony or travel around the world.
The two spots, featuring Finnish conductor/composer Esa-Pekka Salonen and travel blogger Chérie King, are designed as answers to the “What Will Your Verse Be” spot that Apple debuted in January…Like many Apple ads, these two are particularly interested in promoting the notion that Work Can Be Done On An iPad.
I have written extensively about Apple’s iPad marketing (my three-part series from last year starts here), arguing they should position the iPad not as a PC-replacement, but rather as an enabler of all kinds of new activities. Even as recently as a month ago I urged people, Don’t Give Up on the iPad. That said, I do think it is very valid to wonder where do tablet sales broadly, and iPad sales specifically, go from here. These ads, despite fitting my proposed positioning, show why:
Orchestrating Sound absolutely shows scenarios that could only be done on a tablet (in fact, like many tablet-specific scenarios, the protagonist would likely benefit from an even larger screen). The problem, though, is that said protagonist is a famous conductor; how many people will truly relate to his story? In fact, this spot runs the risk of cementing the perception that an iPad is an expensive luxury, not truly necessary for the common person (i.e. the people who drive growth)
Exploring Without Limits has an inspiring and much more relatable protagonist (even though she is deaf) who uses the iPad in her travel adventures. However, nearly every use case could just as easily be accomplished with a phone, which, of course, would have the additional benefit of being much more portable (which is much more important to a traveler!)
Ultimately, I do think the iPad will unlock more and more new use cases, but that process is likely going to be long and drawn-out. Moreover, each of those use cases is likely going to be focused on specific niches, making them difficult to leverage in broadly-focused marketing. In the short-term, that means a continued slow-down in iPad growth. For Apple, the best strategy is to rework its App Store policies and promotional efforts to ensure developers who serve these niches can build thriving businesses, but even that will only show results over the long-run.
The more pessimistic take is that as phones increase in size (especially with the rumored large-screen iPhones coming this fall), they start to replace the use cases that tablets have already claimed, leading to not just slower growth, but an outright decline. I’m not fully in this camp yet, but I’m definitely moving in that direction; if Apple comes out with a larger-screen iPad it could be an admission they are concerned about the cannibalistic effects of the iPhone as well.
We’ll likely not know which of these scenarios is correct until next January’s earnings report (presuming larger screen iPhone come out this fall), but regardless, Apple itself is surely disappointed that the iPad isn’t nearly the growth driver they once hoped it was.
Intel’s Missed Opportunity
Beyond the fact we will both be panelists at the Postmodern Computing Summit, Jean-Louis Gassée and I share a certain fascination with Intel and their refusal to look reality in the eye. From Gassée’s latest Monday Note:
With no room to grow, PC players exit the game. Sony just did. Dell took itself private and is going through the surgery and financial bleeding a company can’t withstand in public. Hewlett-Packard, once the leading PC maker, now trails Lenovo. With no sign of turning its PC business around, HP will soon find itself in an untenable position.
Intel doesn’t have the luxury of leaving their game — they only have one. But I can’t imagine that Brian Krzanich, Intel’s new CEO, will look at Peak PC and be content with the prospect of increasingly difficult x86 iterations. There have been many discussions of Intel finally taking the plunge and becoming a “foundry” for someone else’s ARM-based SoC (System On a Chip) designs instead of owning x86 design and manufacturing decisions. Peak PC will force Intel CEO’s hand.
I completely agree with Gassée long-term prognosis (see The Intel Opportunity) but am concerned that Intel has already missed their best opportunity to embrace their manufacturing future. Specifically, while Apple was at the height of its battle with Samsung the phone maker, they were completely enmeshed with Samsung the chip maker, who continues to make the A-series of processors inside Apple’s iOS devices.
According to most reports, Taiwan Semiconductor Manufacturing Company (TSMC) has finally gained the capability to manufacture at least some of the upcoming A8 chip, finally giving Apple an alternative to Samsung. Now imagine if Intel had been willing to step in even a year ago, preferably two. I think it is very reasonable to expect that Apple would have paid a significant premium not just for Intel’s superior technology, but also for the fact they weren’t Samsung. Would that have been worth an extra $5/chip? $10? Who knows, but I think it’s very fair to assume it would have been material.
Whenever Krzanich does finally do the inevitable and open Intel up to manufacturing non-Intel designed chips at scale, Intel will still hold a technological advantage. The strategic advantage with the largest chip buyer in the world, though, will be gone. And Intel has no one to blame but themselves and their unwillingness to look reality in the face.
Rap Genius co-founder Mahbod Moghadam has been fired from the annotation service after posting appalling comments on the memoir of mass murderer Elliot Rodger, who killed six people in a shooting spree earlier this week.
In now-removed annotations on the site on the sick 141-page manifesto, Moghadam added a tasteless series of comments, including “beautifully written” and also “MY GUESS: his sister is smokin hot.”
In a weird way, this is an interesting counterpoint to my post yesterday on why managers’ don’t prioritize security, and how I hoped Target’s CEO stepping down would have a positive effect; sometimes it takes a few heads rolling to get the attention of everyone else. In this case, the speed with which Rap Genius reacted is undoubtedly related to the terrible publicity GitHub endured when they dragged their feet in dealing with an allegedly insensitive co-founder.
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I was very honored to join Leo Laporte and friends on a special Memorial Day episode of This Week in Tech. We covered a wide range of issues, including the Surface Pro 3, the rumored Apple-Beats deal delayed, Amazon v Hachette, Metafilter v Google, Ebay’s security breach, and more.
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Lenovo Posts Strong Earnings
Lenovo had another good quarter, capping off a strong year. From Reuters:
China’s Lenovo Group Ltd, the world’s fourth-biggest smartphone vendor, saw net profit grow 29 percent for the business year ended March, as strong smartphone sales helped shore up weak growth in China.
Lenovo is expanding into smartphones to offset a decline in its once-mainstay personal computers (PC) as consumers switch to mobile devices, to the extent that it agreed in January to buy the Motorola Mobility smartphone unit of Google Inc for $2.9 billion.
Actually, it’s their PC sales I find most interesting – they were actually quite strong (as they have been for several years running). From the Lenovo press release:
Lenovo expanded its number one position in PCs, adding 2.1 points of market share to post a record 17.7 percent total share for the full-year, representing five percent year-over-year growth, compared to an overall industry decline of 8 percent during this same period. Even while China’s PC market slowed, Lenovo’s operating profit in China PC improved by 1 percentage point. Asia Pacific had record share of almost 15 percent, while improving profitability. For the first time, Lenovo’s EMEA revenue surpassed its China PC revenue in the quarter, while in the US, Lenovo surpassed Apple to take the number three position in PC shipments in the fourth quarter. With 20 consecutive quarters of outgrowing the PC market, Lenovo continued to show it can post rapid growth in absolute shipment and in relative market share metrics, even in difficult markets.
Lenovo is such an interesting company because their strategy is in many ways the exact opposite of most other manufacturers; the conventional wisdom is that you seek a growing market, because it’s easier to win new customers than it is to steal customers from your competitors. Lenovo, though, takes the opposite tack. They look for mature non-growth – or shrinking – markets, and specialize in stealing share from the incumbents.
What is particularly interesting is that they accomplish this strategy with a much more integrated model than many of said competitors. While it’s true they use 3rd-party OSs (which is great for them, because they have compatibility), they keep almost all design and manufacturing in-house, unlike companies like Dell or HP. This then enables Lenovo to focus on all kinds of innovative designs that fill particular niches (helping them to steal share), even as they use relentless discipline and mature technology to keep their costs low.
Lenovo is, in my opinion, absolutely the company to keep your eye on when it comes to smartphones; in many respects the smartphone marketplace is increasingly right in their sweet spot, and I expect them to seriously challenge Samsung for overall market share sooner rather than later.
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