Stratechery by Ben Thompson On the business, strategy, and impact of technology.

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Posted onTuesday, September 22, 2020Wednesday, September 23, 2020 Author by Ben Thompson Manage your Stratechery subscription.If the famous Jim Barksdale quote is to be believed — the one about there only being two ways to make money in business, bundling and unbundling — then I am long past due for a follow-up to 2017 s The Great Unbundling. I wrote in the introduction: To say that the Internet has changed the media business is so obvious it barely bears writing; the media business, though, is massive in scope, ranging from this site to The Walt Disney Company, with a multitude of formats, categories, and business models in between. And, it turns out that the impact of the Internet — and the outlook for the future — differs considerably depending on what part of the media industry you look at.That article focused on three types of media: print, music, and TV (both broadcast and cable).Print was completely unbundled and commoditized by the Google and Facebook Super Aggregators.Music labels, thanks to the importance of their back catalogs, have been able to maintain their place — and profits — in the value chain, even as Apple and Spotify have grown their revenues.TV has seen the jobs it has traditionally done become unbundled, with information going to Google, education to YouTube, story-telling to streaming, and escapism to everything from TikTok to video games to Netflix; sports, meanwhile, is well on its way to being the only reason to keep the traditional bundle.What is critical to understand about Barksdale s famous quote is that bundling and unbundling happen on different dimensions, and at different points in the value chain, often because of the transformative nature of technology. Netflix is an obvious example:When the constraint on viewing video was the combination of time and having a dedicated cable or satellite dish, the bundle that emerged was a collection of independent networks (which could show different content at the same time) delivered over channels sold by the distributor that owned said cable or dish.Streaming removed the constraint on time, which meant one single network — Netflix — could, at least in theory, contain all of the content. Therefore Netflix doesn t contain different channels or networks, but rather a huge number of shows, some produced in house, some bought, and others rented from traditional networks.In this case Netflix helped unbundle traditional TV, even as it created a new bundle of its own.Looking at just TV, though, is insufficient when it comes to thinking about entertainment bundles broadly. Just listen to Netflix CEO Reed Hastings, who wrote in the company s 2018 Q4 letter to shareholders: In the US, we earn around 10% of television screen time and less than that of mobile screen time. In 2 other countries, we earn a lower percentage of screen time due to lower penetration of our service. We earn consumer screen time, both mobile and television, away from a very broad set of competitors. We compete with (and lose to) Fortnite more than HBO. When YouTube went down globally for a few minutes in October, our viewing and signups spiked for that time. Hulu is small compared to YouTube for viewing time, and they are successful in the US, but non-existent in Canada, which creates a comparison point: our penetration in the two countries is pretty similar. There are thousands of competitors in this highly-fragmented market vying to entertain consumers and low barriers to entry for those with great experiences. Our growth is based on how good our experience is, compared to all the other screen time experiences from which consumers choose. Our focus is not on Disney+, Amazon or others, but on how we can improve our experience for our members.It it tempting to dismiss Hastings assertion as being self-serving, particularly as Netflix is viewed as a dominant force in Hollywood, but what is striking about the bundles that have emerged over the last couple of years — and over the last couple of weeks! — is the degree to which they span different types of media, often with widely varying business goals.Netflix: Bundle as Business ModelI already explained how Netflix s bundle is a reorganization of the TV value chain enabled by the removal of linear time as a constraint (I first wrote about this in 2015 s Netflix and the Conservation of Attractive Profits). What is also worth highlighting, particularly for purposes of comparison below, is Netflix s business model.This one is quite straightforward: Netflix makes money by selling subscriptions to its bundle. Of course the execution of this strategy is considerably more complex. For example, Netflix focuses on evergreen content because that means that ever more content increases the attractiveness of Netflix to new subscribers, reducing customer acquisition costs. Netflix is also focused on quantity as much as quality, recognizing that people sometimes just want something to watch, and that there is value in being the default choice.For purposes of this article, though, Netflix is straightforward:Netflix bundles individual showsNetflix s business model is selling subscriptions to that bundle.Other bundles are much less straightforward.Disney+: Bundle as CRMAt first glance, Disney+ seems a lot like Netflix: pay a monthly price, and get access to a bunch of different shows. However differences quickly become apparent:Disney+ only has Disney (and Disney-owned 21st Century) content, whereas Netflix has both its own content and content from other networks.Disney+ is significantly cheaper than Netflix ($6.99 versus $12.99).Disney+ does not necessarily include everything on Disney+; for example, last month Disney released Mulan on Disney+ for an additional $29.99.These differences make sense when you realize that Disney+ is not simply about earning subscription revenue; rather, it is a direct-to-consumer touchpoint for Disney s entire business. I explained in Disney and the Future of TV: While obviously Disney+ will compete with Netflix for consumer attention, the goals of the two services are very different: for Netflix, streaming is its entire business, the sole driver of revenue and profit. Disney, meanwhile, obviously plans for Disney+ to be profitable — the company projects that the service will achieve profitability in 2024, and that includes transfer payments to Disney’s studios — but the larger project is Disney itself. By controlling distribution of its content and going direct-to-consumer, Disney can deepen its already strong connections with customers in a way that benefits all parts of the business: movies can beget original content on Disney+ which begets new attractions at theme parks which begets merchandising opportunities which begets new movies, all building on each other like a cinematic universe in real life. Indeed, it is a testament to just how lucrative the traditional TV model is that it took so long for Disney to shift to this approach: it is a far better fit for their business in the long run than simply spreading content around to the highest bidder. This is also why Disney is comfortable being so aggressive in price: the company could have easily tried charging $9.99/month or Netflix’s $12.99/month — the road to profitability for Disney+ would have surely been shorter. The outcome for Disney as a whole, though, would be worse: a higher price means fewer customers, and given the multitude of ways that Disney has to monetize customers throughout their entire lives that would have been a poor trade-off to make.The Mulan strategy fits this model. While Disney s hand was certainly forced by the COVID pandemic, the company s overall goal is to maximize revenue per customer via its highly differentiated IP; to that end, just as Disney+ is a way to connect with customers and lure them to Disney World or a Disney Cruise, it is equally effective at serving as a platform for shifting the theater window to customers living rooms.Amazon: Bundle as Churn ManagementIt took me a long time to figure out what exactly Amazon was trying to accomplish with Amazon Prime Video, its now 14 year-old streaming service. The most obvious explanation is that it was a way to acquire customers for Amazon Prime, the then-2-day shipping service with which it was bundled. But then Amazon started offering Prime Video subscriptions on its own — was it a Netflix competitor? Or was Prime Video a loss leader for Amazon Channels, where Amazon made money selling other streaming services? Meanwhile, Amazon Prime keeps adding on more and more disparate services: delivery, video, music, video games, photo storage, a clothing service, books, magazines — the Prime benefits page has 28 different items listed!To some extent, the answer is all of the above , but it is notable that many customers only find out about many of these features after they are subscribers; Amazon may tell you about the book benefits when you buy an e-book for example, Amazon Music when you set up an Echo, or remind you about Prime Video when you checkout. The most valuable impact in these cases is giving you yet another reason to not churn.This makes sense when you remember that the business model for the Amazon Prime bundle is less subscription revenue than it is increasing usage of Amazon.com. Back in 2015 Prime customers were estimated to spend an average of $1,500/year on Amazon, compared to $625 for non-Prime customers; according to eMarketer earlier this year, 80% of Prime subscribers start their product search on Amazon, and only 12% on Google, while that split is 50/50 for non-Prime subscribers.To that end, simply keeping Amazon Prime subscribers is the biggest possible win for Amazon broadly. Thus the continuous drive to add more and more features; sure, you may find 90% of them useless, along with everyone else, but as anyone who has managed a feature-rich product knows, the 10% that are considered useful vary considerably!Microsoft: Bundle as Market ExpansionOne of the most interesting stories to watch over the coming few years will be the competition between the PS5 and Xbox Series X and Series S. Last Thursday I explained why the companies are heading in very different directions: In short, Sony is treating the PS5 like a console, and gamers like gamers, just as they did last generation. It is an overall aligned strategy that makes a lot of sense… Microsoft is seeking to get out of the traditional console business, with its loss-leading hardware and fight over exclusives, and into the services business broadly; that’s why Xbox Game Pass, the cloud streaming service that is available not only on Xbox and PC but also on Android phones (Apple has blocked it from iOS for business model reasons), is included. In Microsoft’s view of the world the Xbox is just a specialized device for accessing their game service, which, if they play their cards right, you will stay subscribed to for years to come.Sony is following the traditional razor and blades model that has long characterized consoles: try and not lose too much money on the consoles, and make up the difference in game licenses, its online service, and in-game purchases. It s a model that gamers are familiar with, even if it ends up being a pricey one: this generation games are expected to hit the $70 mark, plus more for additional downloadable content that may or may not be necessary to the core experience.Microsoft is taking a different approach: with Xbox Game Pass you not only get access to over 100 games, along with all of the other usual online services you might expect, but for an additional $10/month, you can get an Xbox Series S as well ($20/month for the more capable Series X)! Notice the framing there, which is the opposite of how I put it on Thursday: given the fact that consoles have always been an up-front purchase, the natural way to think about Microsoft s monthly pricing option is that it is a 24-month installment plan for the $299 Series S or the $499 Series X, with Xbox Game Pass added on top. Given that Microsoft s strategy is all about subscriptions, though, it makes sense to consider the console itself as the bundled benefit.What is compelling about Microsoft s approach is its potential for expanding the gaming market. Traditional gamers will still be attracted to Sony s model and its exclusives, but for folks whose last console was the Wii (for which they only ever bought Wii Sports), the $25/month Xbox bundle is a pretty attractive way to not only get a console, but over 100 games; if Microsoft pulls this bundle off, its overall revenue and especially profit could surpass Sony s more traditional approach, particularly in the long run.Apple: Bundle as Money-MakerAll of this is a long way of explaining why I was relatively underwhelmed by last week s announcement of Apple One. Apple One includes Apple Music, Apple TV+, Apple Arcade, and iCloud storage, for either individuals or families; Apple Premier adds on Apple News+ and Apple Fitness+.Some of the aforementioned bundle strategies are applicable to Apple One, others less so:While Apple s primary business model remains selling hardware at a profit, the company has a longstanding goal of increasing services revenue; selling a bundle potentially helps in that regard.Apple doesn t really need any help connecting to its customers, although iCloud Storage does make for a better overall Apple experience.Apple One may reduce churn, particularly if customers are attached to the Apple-only services like Apple Arcade, Apple News+, and Apple Fitness+, but the truth is that Apple’s churn is already quite lowOn the flipside, Apple One doesn t really make an iPhone any more accessible, particularly since Apple is competing against Android, as opposed to non-consumption.To me the biggest hangup is the first one: the degree to which a bundle is compelling is the degree to which it is integrated with and contributes to a company’s core business model, and, in contrast to these other four companies, it s a bit of a stretch to see how Apple One really move the needle when it comes to buying an iPhone or not.To that end, what would be much more compelling is attaching Apple One to the iPhone explicitly. I thought this might be coming after last year s iPhone announcement: It does feel like there is one more shoe yet to drop when it comes to Apple’s strategic shift. The fact that Apple is bundling a for-pay service (Apple TV+) with a product purchase is interesting, but what if Apple started including products with paid subscriptions? That may be closer than it seems. It seemed strange yesterday’s keynote included an Apple Retail update at the very end of the keynote, but I think this slide explained why: Not only can you get a new iPhone for less if you trade in your old one, you can also pay for it on a monthly basis (this applies to phones without a trade-in as well). So, in the case of this slide, you can get an iPhone 11 and Apple TV+ for $17/month. Apple also adjusted their AppleCare+ terms yesterday: now you can subscribe monthly and AppleCare+ will carry on until you cancel, just as other Apple services like Apple Music or Apple Arcade do. The company already has the iPhone Upgrade Program, that bundles a yearly iPhone and AppleCare+, but this shift for AppleCare+ purchased on its own is another step towards assuming that Apple’s relationship with its customers will be a subscription-based one. To that end, how long until there is a variant of the iPhone Upgrade Program that is simply an all-up Apple subscription? Pay one monthly fee, and get everything Apple has to offer. Indeed, nothing would show that Apple is a Services company more than making the iPhone itself a service, at least as far as the customer relationship goes.The problem is that Apple s financing programs — both the one pictured above, and also the iPhone Upgrade Program — continue to be funded by 3rd-parties; Apple is making it easier to buy an iPhone, but is still focused on getting its money right away. And, as long as it sticks with this approach, its Apple One bundle feels more like a money-grab, and less like a strategic driver of the business.1Microsoft and ZeniMaxStepping back, what is notable about all of these examples is that only Netflix is a pure content play. Disney, Amazon, Microsoft, and Apple are all using content to differentiate something in physical space. This makes logical sense: content, with its zero marginal costs and zero distribution costs2 is non-rivalrous, which makes it challenging to monetize directly. Indeed, this is why bundling is so important to Netflix: its value is always having something to watch, as opposed to having the one thing you have to have.At the same time, content is highly differentiated, while goods in physical space are rivalrous but subject to commoditization. The former, delivered in a bundle with the latter, makes it possible to charge a premium for or drive increased usage of the product as a whole, whether that be a theme park or cruise ship, a cardboard box or console.What is interesting is that the same forces that broke up the old distribution-based bundles and reduced content to a differentiator for physical goods and experiences, have also made content directly monetizable through business models like subscriptions. This, in turn, has made content-only bundles that much more difficult to create: the higher the bar there is for any individual content creator to join a bundle, the more necessary it is to have an orthogonal business model that justifies clearing that bar.This also explains Microsoft s purchase of ZeniMax, the publisher for Elder Scrolls, Doom, Fallout, and many other popular games. Going forward Microsoft can ensure those games are available from day one on Xbox Game Pass (and not on PS53), using content to differentiate their service. However, given that ZeniMax s alternative was continuing to sell games directly, Microsoft has to pay $7.5 billion in cash for the opportunity.What is even more interesting about the ZeniMax acquisition, though, are the implications for Steam, the PC gaming service. Steam, like Netflix, is a content-only play, although it is a marketplace, not a subscription service. Microsoft will probably leave ZeniMax games on Steam, but if those same games are available on Xbox Game Pass for $15/month, how many folks will be willing to pay full price? In short, Microsoft could potentially wield the content-differentiated bundle it is building across services and devices not only against Sony, its console competitor, but Steam, its services competitor.This also gives insight as to why Apple s bundle is underwhelming: PS5 and Steam are real competitors — Microsoft is arguably an underdog to both — which means the Xbox maker has to be creative. Apple, meanwhile, simply wants to make a bit more money on an audience that doesn t have anywhere else to go. Perhaps the best way to make money is to not need a bundle at all.Moreover, Apple runs the risk of actually cannibalizing itself, as its most ardent customers happily take a discount for services they would have subscribed to anyways. [ ]On a marginal basis, to be clear; obviously Netflix s bandwidth bills are massive [ ]Microsoft will honor current PS5 deals, and handle future games on a case-by-case basis. [ ] Posted onTuesday, September 15, 2020Tuesday, September 15, 2020 Author by Ben Thompson Manage your Stratechery subscription.Back in 2010, Kyle Conroy wrote a blogpost entitled, What if I had bought Apple stock instead?: Currently, Apple s stock is at an all time high. A share today is worth over 40 times its value seven years ago. So, how much would you have today if you purchased stock instead of an Apple product? See for yourself in the table below.Conroy kept the post up-to-date until April 1, 2012; at that point, my first Apple computer, a 2003 12 iBook, which cost $1,099 on October 22, 2003, would have been worth $57,900. Today it would be worth $311,973.I thought of this meme, which pops up every time Apple s stock hits a new all-time high, while considering the price Apple paid for P.A. Semi back in 2008; for a mere $278 million the company acquired the talent and IP foundation that would undergird its A-series of chips, which have powered every iPad and every iPhone since 2010, and, before the end of the year, at least one Mac (the rest of the line will follow within two years).So I was curious: what would $278 million in 2008 Apple stock look like today? The answer is $5.5 billion, which, honestly, is still an absolute bargain, and a reminder that the size of an acquisition is not necessarily correlated with its impact.Nvidia Acquires ARMOver the weekend Nvidia consummated the biggest chip deal in history when it acquired Arm1 from Softbank for around $40 billion in stock and cash. Nvidia founder and CEO Jensen Huang wrote in a letter to Nvidia employees: We are joining arms with Arm to create the leading computing company for the age of AI. AI is the most powerful technology force of our time. Learning from data, AI supercomputers can write software no human can. Amazingly, AI software can perceive its environment, infer the best plan, and act intelligently. This new form of software will expand computing to every corner of the globe. Someday, trillions of computers running AI will create a new internet — the internet-of-things — thousands of times bigger than today’s internet-of-people. Uniting NVIDIA’s AI computing with the vast reach of Arm’s CPU, we will engage the giant AI opportunity ahead and advance computing from the cloud, smartphones, PCs, self-driving cars, robotics, 5G, and IoT.These are big ambitions for a big purchase, and Wall Street apparently agrees; yesterday Nvidia s market cap increased by $17.5 billion, nearly covering the $21.5 billion in shares Nvidia will give Softbank in the deal. Indeed, it is Nvidia s stock that is probably the single most important factor in this deal. Back in 2016, when Softbank acquired Arm, Nvidia was worth about $34 billion; after yesterday s run-up, the company s marketcap was $318 billion.The first takeaway is that selling Arm for $32 billion means that the company was yet another terrible investment by Softbank; simply buying Nvidia shares — or, for that matter, an S P 500 index fund, which is up 55% since then — would have provided a much better return than the ~5% Softbank earned from Arm.The second takeaway is the inverse: Nvidia is acquiring a company that was its marketcap peer four years ago for a relative pittance. Granted, Nvidia s stock may not stay at its current lofty height — the company has a price-to-earnings ratio of over 67, well above the industry average of 27 — but that is precisely why a majority-stock acquisition makes sense; Nvidia s stock may retreat, but Arm will still be theirs.Nvidia s IntegrationBeginning my analysis with stock prices is not normally what I do; I m generally more concerned with the strategies and business models of which stock price is a result, not a driver. The truth, though, is that once you start digging into the details of Nvidia and ARM, it is rather difficult to see what strategy might be driving this acquisition.Start with Nvidia: the company is perhaps the shining example of the industry transformation wrought by TSMC; freed of the need to manufacture its own chips, Nvidia was focused from the beginning on graphics. Its TNT cards, released in the late 1990s, provided 3D graphics for games while also powering Windows (previously hardware 3D graphics were only available via add-on cards); its GeForce line, released in 1999, put Nvidia firmly at the forefront of the industry, a position it retains today.It was in 2001 that Nvidia released the GeForce 3, which had the first pixel shader; instead of a hard-coded GPU that could only execute a pre-defined list of commands, a shader was software, which meant it could be programmed on the fly. This increased level of abstraction meant the underlying graphics processing unit could be much simpler, which meant that a graphics chip could have many more of them. The most advanced versions of Nvidia s just-announced GeForce RTX 30 Series, for example, has an incredible 10,496 cores.This level of scalability makes sense for video cards because graphics processing is embarrassingly parallel: a screen can be divided up into an arbitrary number of sections, and each section computed individually, all at the same time. This means that performance scales horizontally, which is to say that every additional core increases performance.It turns out, though, that graphics are not the only embarrassingly parallel problem in computing. Another obvious example is encryption: brute forcing a key entails running the exact same calculation over-and-over again; the chips doing the calculation don t need to be complex, they simply need as many cores as possible (this is why graphics cards are very popular for blockchain applications; miners are basically endlessly brute-forcing encryption keys).What is most enticing for Nvidia, though, is machine learning. Training on large datasets is an embarrassingly parallel problem, which means it is well-suited for graphics cards. The trick, though, is in decomposing a machine learning algorithm into pieces that can be run in parallel; graphics cards were designed for, well, graphics, which meant that programmers had to work in graphics programming languages like OpenGL.This is why Nvidia transformed itself from a modular component maker to an integrated maker of hardware and software; the former were its video cards, and the latter was a platform called CUDA. The CUDA platform allows programmers to access the parallel processing power of Nvidia s video cards via a wide number of languages, without needing to understand how to program graphics.Here the kicker: CUDA is free, but that is because the integration is so tight. CUDA only works with Nvidia video cards, in large part because many of the routines are hand-tuned and optimized. It is a tremendous investment that has paid off in a major way: CUDA is dominant in machine learning, and Nvidia graphics cards cost hundreds of dollars ($1500 in the case of the aforementioned RTX 3090). Apple isn t the only company that understands the power of differentiating premium hardware with software.Arm s NeutralityArm s business model could not be more different. The company, founded in 1990 as a joint venture between Acorn Computers, Apple, and VLSI Technology, doesn t sell any chips of its own; rather, it licenses chip designs to companies which actually manufacture ARM chips. Except even that isn t quite right: most ARM licensees actually contract with manufacturers like TSMC to make physical chips, which are then sold to OEMs. The entire ecosystem is extremely modular; consider an Oppo smartphone, with a MediaTek chip:Arm chips appear in many more devices than smartphones — most micro-controllers in embedded systems are Arm designs — and Arm designs more than CPUs; the company s catalog includes everything from GPUs to AI accelerator chips. It also licenses less than full designs: Apple, for example, designs its own chips, but uses the ARM Instruction Set Architecture (ISA) to communicate with them. The ARM ISA is the platform that ties this entire ecosystem together; programs written for one ARM chip will run on all ARM chips, and each of those chips results in a licensing fee for Arm.What makes Arm s privileged position viable is the same one that undergirds TSMC s: neutrality. I wrote about the latter in Intel and the Danger of Integration: In 1987, Morris Chang founded Taiwan Semiconductor Manufacturing Company (TSMC) promising “Integrity, commitment, innovation, and customer trust”. Integrity and customer trust referred to Chang’s commitment that TSMC would never compete with its customers with its own designs: the company would focus on nothing but manufacturing. This was a completely novel idea: at that time all chip manufacturing was integrated a la Intel; the few firms that were only focused on chip design had to scrap for excess capacity at Integrated Device Manufacturers (IDMs) who were liable to steal designs and cut off production in favor of their own chips if demand rose. Now TSMC offered a much more attractive alternative, even if their manufacturing capabilities were behind. In time, though, TSMC got better, in large part because it had no choice: soon its manufacturing capabilities were only one step behind industry standards, and within a decade had caught-up (although Intel remained ahead of everyone). Meanwhile, the fact that TSMC existed created the conditions for an explosion in “fabless” chip companies that focused on nothing but design. For example, in the late 1990s there was an explosion in companies focused on dedicated graphics chips: nearly all of them were manufactured by TSMC. And, all along, the increased business let TSMC invest even more in its manufacturing capabilities.That article was about TSMC overtaking Intel in fabrication, but a similar story can be told about Arm overtaking Intel in mobile. Intel was relentlessly focused on performance, but smartphones needed to balance performance with battery concerns. Arm, which had been spending years designing highly efficient processors for embedded applications, had both the experience and the business model flexibility to make mobile a priority.The end result made everyone a winner (except Intel): nearly every smartphone in the world runs on an ARM-derived chip (either directly or, in the case of companies like Apple, the ARM ISA), which is to say that Arm makes money when everyone else in the mobile ecosystem makes money.The Nvidia-ARM MismatchNotice that an ARM license, unlike the CUDA platform, is not free. That makes sense, though: CUDA is a complement to Nvidia s proprietary graphics cards, which command huge margins. ARM license fees, on the other hand, can and are paid by everyone in the ecosystem, and in return everyone in the ecosystem gets equal access to Arm s designs and ISA. It s not free, but it is neutral.That neutrality is gone under Nvidia ownership, at least in theory: now Nvidia has early access to ARM designs, and the ability to push changes in the ARM ISA; to put it another way, Nvidia is now a supplier for many of the companies it competes with, which is a particular problem given Nvidia s reputation for both pushing up prices and being difficult to partner with. Here again Apple works as an analogy: the iPhone maker is notorious for holding the line on margins, prioritizing its own interests, and being litigious about intellectual property; Nvidia has the same sort of reputation. So does Intel, for that matter; the common characteristic is being vertically integrated.Of course Nvidia is insistent that ARM licensees have nothing to worry about. Huang noted in that letter to Nvidia employees: Arm’s business model is brilliant. We will maintain its open-licensing model and customer neutrality, serving customers in any industry, across the world, and further expand Arm’s IP licensing portfolio with NVIDIA’s world-leading GPU and AI technology.Notice that last bit: Huang is not only arguing that Nvidia will serve Arm customers neutrally, but that Nvidia itself will adopt Arm s business model, licensing its IP to competitive chip-makers. It s as if this is an acquisition in reverse: the $318 billion acquirer is fitting itself into a world defined by its $40 billion acquisition.Color me skeptical; not only is Nvidia s entire business predicated on selling high margin chips differentiated by highly integrated software, but Nvidia s entire approach to the market is about doing what is best for Nvidia, without much concern for partners or, frankly customers. It is a luxury afforded those that are clearly best in class, which by extension means that sharing is anathema; why trade high margins at the top of the market for low margins and the headache of serving everyone?In short, this deal feels like the inverse of the P.A. Semi deal not simply in terms of the price tag, but in its overall impact on the acquirer. I have a hard time believing that Nvidia is going to change its approach.Or maybe that s the entire point.Huang s DreamBy far the best articulation of the upside of this deal came, unsurprisingly, from Huang. What was notable about said articulation, though, was that it came 46 minutes into the investor call about the acquisition, and only then in response to a fairly obvious question: why does Nvidia need to own ARM, instead of simply license it (like Apple, which has a perpetual license to the ARM ISA, and is not affected by this acquisition)?What was so striking about Huang s answer was not simply its expansiveness — I ve transcribed the entire answer below — but also the way in which he delivered it; unlike the rest of the call, Huang s voice was halting and uncertain, as if he were scared of his own ambition. I know this excerpt is long, but it s essential: We were delightful licensees of ARM. As you know we used ARM in one of our most important new initiatives, the Bluefield GPU. We used it for the Nintendo Switch — it s going to be the most popular and success game console in the history of game consoles. So we are enthusiastic ARM licensees. There are three reasons why we should buy this company, and we should buy it as soon as we can. Number one is this: as you know, we would love to take Nvidia s IP through ARM s network. Unless we were one company, I think the ability for us to do that and to do that with all of our might, is very challenging. I don t take other people s products through my channel! I don t expose my ecosystem to to other company s products. The ecosystem is hard-earned — it took 30 years for Arm to get here — and so we have an opportunity to offer that whole network, that vast ecosystem of partners and customers Nvidia s IP. You can do some simple math and the economics there should be very exciting. Number two, we would like to lean in very hard into the ARM CPU datacenter platform. There s a fundamental difference between a datacenter CPU core and a datacenter CPU chip and a datacenter CPU platform. We last year decided we would adopt and support the ARM architecture for the full Nvidia stack, and that was a giant commitment. The day we decided to do that we realized this was for as long as we shall live. The reason for that is that once you start supporting the ecosystem you can t back out. For all the same reasons, when you re a computing platform company, people depend on you, you have to support them for as long as you shall live, and we do, and we take that promise very seriously. And so we are about to put the entire might of our company behind this architecture, from the CPU core, to the CPU chips from all of these different customers, all of these different partners, from Ampere or Marvell or Amazon or Fujitsu, the number of companies out there that are considering building ARM CPUs out of their ARM CPU cores is really exciting. The investments that Simon and the team have made in the last four years, while they were out of the public market, has proven to be incredibly valuable, and now we want to lean hard into that, and make ARM a first-class data center platform, from the chips to the GPUs to the DPUs to the software stack, system stack, to all the application stack on top, we want to make it a full out first-class data center platform. Well, before we do that, it would be great to own it. We re going to accrue so much value to this architecture in the world of data centers, before we make that gigantic investment and gigantic focus, why don t we own it. That s the second reason. Third reason, we want to go invent the future of cloud to edge. The future of computing where all of these autonomous systems are powered by AI and powered by accelerated computing, all of the things we have been talking about, that future is being invented as we speak, and there are so many great opportunities there. Edge data centers — 5G edge data centers — autonomous machines of all sizes and shapes, autonomous factories, Nvidia has built a lot of software as you guys have seen — Metropolis, Clara, Isaac, Drive, Jarvis, Aerial — all of these platforms are built on top of ARM, and before we go and see the inflection point, wouldn t it be great if we were one company. And so the timing is really quite important. We ve invested so much across all of these different areas, that we felt that we really had to take the opportunity to own the company and collaborate deeply as we invent the future. That s the answer.It turns out this is very much an Nvidia vision after all. Nvidia is not setting out to be a partner, someone that gets along with everyone in exchange for a couple of pennies in licensing fees. Quite the opposite: Huang wants to own it all.In this vision Nvidia s IP is the CUDA to its graphics chips — the complement to its grander ambitions. Huang has his sights set firmly on Intel, but while Intel has leveraged its integration of design and manufacturing, Nvidia is going to leverage its integration of chip design and software. Huang s argument is that it is the lack of software — a platform, as opposed to simply a chip or a core — that is limiting ARM in the data center, and that Nvidia intends to build that software.On one hand, this is exciting for ARM licensees, particularly companies like Amazon that have invested in ARM chips for the data center; note, though, that Nvidia isn t doing this out of charity. Huang twice mentioned the importance of capturing the upside he believes Nvidia will generate, which ultimately means increased license fees. Sure, Nvidia will be able to make more changes to ARM to suit the data center than they could have as licensor, but the real goal is to tie ARM into an Nvidia software platform until licensees have no choice but to pay what will undoubtedly be ever-increasing licensing fees (which, it should be noted, will still result in chips that less expensive than Intel s).I don t know if it will work; data centers are about the density of processing power, which is related to but still different than performance-per-watt, ARM s traditional advantage relative to Intel, and there are a huge amount of 3rd-parties involved in such a transition. There is a lot about this vision that is out of Nvidia s control — it s more of a dream. What is comforting in a way, though, is just how true this dream is to what makes Nvidia unique: this isn t about adopting ARM s approach, it s about co-opting it for a vision of integration that makes Nvidia an object of inevitability, not affection.And, to return to the beginning, it is a bet that is a relatively free one. If Nvidia s stock is over-priced, then it is buying Arm for an even bigger discount than it seems; the vision Huang laid out, though, is a reason to believe Nvidia s stock price is actually correct. Might as well roll the dice on a P.A. Semi-type outcome.Three additional notes about this transaction:As I noted above, Apple has a perpetual license to ARM. The specific details of this license are unknown — we now know that Apple can extend the ISA for its own uses — but my understanding is that the terms are locked in. That is why Apple didn t feel any motivation to acquire ARM itself, even if Nvidia, a company that Apple does not get along with, was the alternative suitor.This vision of Arm s future is in many ways incompatible with ARM s neutral past, but the truth is Arm is already facing disruption of its own. RISC-V is an open-source ISA that is increasingly popular for embedded controllers in particular, in large part because it not only gets rid of Arm control, but also Arm license fees. I would expect investment in RISC-V to accelerate on this news, but it s worth noting that it is just that — an acceleration of what was inevitable in the long run.One of the biggest regulatory questions around this acquisition is China. On one hand, China has reason to fear an American company — which is subject to U.S. export controls — acquiring more processor technology. On the other hand, Arm China is actually a joint venture, the CEO of which has gone rogue; it s not clear if Arm is actually in control. It s possible that this acquisition happens without China s approval and without ARM China, which is 20% of Arm s sales. Huang s dream, though, is perhaps enough to justify this nightmare.Throughout this article I will write Arm when I am referring to the company, and ARM when I am referring to said company s IP [ ] Posted onTuesday, August 25, 2020Wednesday, August 26, 2020 Author by Ben Thompson Manage your Stratechery subscription.It seems appropriate that the first ruling in Epic v. Apple was a split decision: Fortnite remains out of the App Store,1 but Epic may continue to use Apple s developer tools in order to support Unreal Engine.Apple v. EpicThe truth is that, from a philosophical perspective, both Epic and Apple make valid points. Epic CEO Tim Sweeney wrote in an email to Apple announcing that Epic was offering its own payment processor in Fortnite, that this case was about the freedom to use your smartphone in whatever way you wished: We choose to follow this path in the firm belief that history and law are on our side. Smartphones are essential computing devices that people use to live their lives and conduct their business. Apple s position that its manufacture of a device gives it free rein to control, restrict, and tax commerce by consumers and creative expression by developers is repugnant to the principles of a free society. Ending these restrictions will benefit consumers in the form of lower prices, increased product selection, and business model innovation… We hope that Apple will reflect on its platform restrictions and begin to make historic changes that bring to the world’s billion iOS consumers the rights and freedoms enjoyed on the world s leading open computing platforms including Windows and macOS.Apple Fellow Phil Schiller, in a declaration to the court, argued Apple s approach gave users a different sort of freedom, that of having entrusted Apple to deliver an excellent user experience: The App Store’s monetization model is rooted in Apple’s overall philosophy of putting the user and user experience first. This focus on user experience is reflected in Apple’s overall business model and offerings to consumers, which prioritize quality (e.g., distinctive design, innovative technology), security (e.g., protection from malware), and privacy (e.g., safeguarding of personal and payment data). This philosophy can also be seen in Apple’s strategy of integrating its proprietary hardware, software, and services across the range of its products to ensure a high quality user experience, in contrast to many of its competitors.Schiller s declaration included a letter from Apple s Associate General Counsel that explained how this approach benefited developers, including Epic: Because of Apple’s rules and efforts, iOS and the App Store are widely recognized as providing the most secure consumer technology on the planet. And as a result, consumers can download and pay for an app and in-app content without worrying that it might break their device, steal their information, or rip them off. This level of security benefits developers by providing them with an active and engaged marketplace for their apps.As I noted last week, there is a lot of credence to Apple s claims, particularly when it comes to the size of the app market; while the convenience and accessibility of smartphones are the more important reason why iOS and Android are far larger markets than the Windows and macOS platforms Sweeney wishes iOS would emulate, the confidence users have in installing smartphone apps far exceeds the confidence they have doing the same on traditional PCs. That confidence, it should be noted, is well placed: the likelihood of installing malware or performance-destroying applications on your smartphone is far less than on even modern Windows and macOS computers, much less those back in the 2000s when the App Store first launched.This was something that former Apple CEO Steve Jobs was very focused on; he told the New York Times in 2007: “We define everything that is on the phone,” he said. “You don’t want your phone to be like a PC. The last thing you want is to have loaded three apps on your phone and then you go to make a call and it doesn’t work anymore. These are more like iPods than they are like computers”… “These are devices that need to work, and you can’t do that if you load any software on them,” he said. “That doesn’t mean there’s not going to be software to buy that you can load on them coming from us. It doesn’t mean we have to write it all, but it means it has to be more of a controlled environment.”At the same time, everything is a trade-off, and the fact that iOS is so much more important in 2020 than it was in 2008 raises the costs inherent in Apple s model. Smartphones are not adjuncts to computers, like iPods were; they are the primary computer for nearly everyone, including those that might invent the future. Francisco Tolmasky, who was on the original iPhone team, noted on Twitter:But here’s the kicker: think of all the other amazing ideas that haven’t gotten a chance to be invented because they aren’t allowed on mobile devices. Mosaic happened less than 10 years after the Macintosh. We very well might have already had a browser-caliber invention by now. Francisco Tolmasky (@tolmasky) August 22, 2020This is the chief reason why, if I had to choose a victor in this case, I would choose Epic; Apple is a brilliant company, but they hardly have a monopoly on invention and innovation. My overriding concern is that their monopoly on iOS (and duopoly with Google, which copies many of their App Store practices) will prevent the invention and innovation of others.The problem for Epic — and, I suppose, for me — is that to this observer it seems exceedingly likely that Apple is going to win this case, last night s decision notwithstanding. Current Supreme Court jurisprudence is very clear that businesses — including monopolies — have no duty to deal with third parties,2 and if they do choose to deal with them (or are even compelled to), that they can choose the terms on which to do so.3 The only exceptions are if the monopoly in question changes the rules in an unprofitable way with the express purpose of driving out a competitor4, or if any company — not even a monopoly — changes access to after-market parts and services5In short, what is needed are new laws built for the Internet, which is why it was encouraging that Congress is holding hearings about these issues, and also frustrating that Apple received relatively little attention.WordPress and HeyThe nature of the limited exceptions above are one reason Apple is at pains to emphasize that the App Store rules have been the same from the beginning; this is mostly correct, although the company has certainly tightened the limits around in-app purchasing over the years, to the extent that companies with cross-platform offerings can t even tell users that they can subscribe on the web. It also seems that the App Store is going further than that; consider last weekend s kerfuffle with the WordPress app:Automattic CEO Matt Mullenweg tweeted that Apple was refusing to allow updates to the WordPress app until it implemented in-app purchase for WordPress.com.The problem for Automattic is that the WordPress app is designed for not only WordPress.com, but also all open source WordPress sites (the app itself is distributed with the non-App-Store-compatible General Public License; Automattic has a special license from the WordPress Foundation, which owns the WordPress copyrights, to submit a version compatible with the App Store). This meant that Apple was demanding that an app meant to service all WordPress sites, including those on WordPress.com, add in-app purchases for just one of those sites.After 24 hours of confusion and outcry (including from me), Apple reversed its decision and apologized for any confusion that [they] caused .It seems likely that the dual nature of the WordPress app — both adjunct to the for-profit WordPress.com and tool for the open-source WordPress.org project — was the reason Apple reversed its decision (that or bad press); said reasoning, though, means that Apple very much intended to make Automattic add in-app purchase functionality because it felt entitled to the company s revenue.This certainly appeared to be the case for Hey.com; while Apple s official position in its written communication to Basecamp was that the app had to add in-app purchase if it did not have free functionality, the final paragraph suggested the company felt it deserved a cut: Thank you for being an iOS app developer. We understand that Basecamp has developed a number of apps and many subsequent versions for the App Store for many years, and that the App Store has distributed millions of these apps to iOS users. These apps do not offer in-app purchase — and, consequently, have not contributed any revenue to the App Store over the last eight years. We are happy to continue to support you in your app business and offer you the solutions to provide your services for free — so long as you follow and respect the same App Store Review Guidelines and terms that all developers must follow.Ultimately Basecamp added free functionality (an email address that is only good for two weeks) and didn t add in-app purchase, and Apple approved the app; like the WordPress case, though, the question remained: how much did the massive amount of publicity around the case, particularly given the fact this blew up right before Apple s annual developer conference, matter?App Store AnecdotesFrom what I have seen, quite a bit. When the Hey.com rejection happened, I wondered on Twitter if Apple was blocking other developers from updating their apps unless they added in-app purchase, and was surprised at the response: twenty-one app developers who contacted me had added in-app purchase in the last twelve months, and all of the developers in that list with regular update schedules had significant gaps in their history of updates (for example, one app updated every two weeks, with a four-month interruption in the middle of 2019). Nine more had either committed to adding in-app purchase, still had their app in limbo, or had simply given up on the App Store.What was striking about all of these apps is that only three of them functioned primarily on an iPhone; in the vast majority of cases Apple was demanding in-app purchase offerings for functionality that was largely not dependent on an iPhone:14 of the apps were Companion Apps , many of them in the business-to-business category. Imagine, for example, there was a service that allowed you to track inventory, and that service had a mobile app that let you look up your inventory numbers from your phone; Apple held up updates until the iPhone app had an in-app purchase option for the entire service (this is a fake example, but is representative). There were also some apps that looked a lot like the WordPress app: easier access to a web service (like a blog) that could just as easily have used a web page.6 of the apps were Cross-platform Web Services in this case iPhone access was certainly essential, but only because said service had to work everywhere. Think Hey s email service, but, well, other email services, none of whom appear to have achieved Hey s favorable outcome.4 of the apps offered marketplace-type of functionality for things like classes, coaching, therapists, etc. Two examples are Airbnb and ClassPass, which the New York Times wrote about last month.3 of the apps were purely digital goods, 1 was a niche streaming video app (that for whatever reason did not fall under the reader exemption), and 1 was a hardware app.I have sat on these anecdotes for several months now, in part because this is all I can say: none of the developers were willing to go on the record for fear of angering Apple. What I think the WordPress and Hey episodes show, though, is that these are the exact sort of apps where Apple is getting things wrong, at least as far as popular opinion is concerned. Epic, what with its costumes and emotes that have zero marginal costs and only ever exist within the virtual world that Fornite created, is in many respects the worst possible agent for App Store change.Organizing PrinciplesHere is what I believe the App Store has fundamentally wrong: its current organizing principle is digital versus analog; anything that is digital has to have in-app purchase, while anything that is analog — i.e. connected to the real world — can monetize however it pleases. That is why Amazon or Uber can ask for your credit card, and Airbnb can do the same for rooms but not for digital experiences (according to Apple).The problem with this organizing principle is found in Reader app exception; from the App Store Guidelines: 3.1.3(a) “Reader” Apps: Apps may allow a user to access previously purchased content or content subscriptions (specifically: magazines, newspapers, books, audio, music, video, access to professional databases, VoIP, cloud storage, and approved services such as classroom management apps), provided that you agree not to directly or indirectly target iOS users to use a purchasing method other than in-app purchase, and your general communications about other purchasing methods are not designed to discourage use of in-app purchase.This is how you end up with Netflix or Spotify or Kindle having apps that open to a login screen with zero indication about how to sign up for an account; most users probably figure out to go to their websites, but it is hardly a good experience from anyone s perspective, and lesser known apps are likely to simply lose potential customers. At the same time, though, you can understand why Reader apps don t really have a choice: Kindle has to pay publishers for books, and Spotify music labels; layering on 30% simply isn t feasible.The better organizing principle is whether or not the app developer has marginal costs. If every incremental sale costs the developer money, then Apple should not only not charge 30%, but should in fact compete for that purchase. Consider, for example, the ClassPass example in that New York Times article: ClassPass built its business on helping people book exercise classes at local gyms. So when the pandemic forced gyms across the United States to close, the company shifted to virtual classes. Then ClassPass received a concerning message from Apple. Because the classes it sold on its iPhone app were now virtual, Apple said it was entitled to 30 percent of the sales, up from no fee previously, according to a person close to ClassPass who spoke on the condition of anonymity for fear of upsetting Apple. The iPhone maker said it was merely enforcing a decade-old rule… With gyms shut down, ClassPass dropped its typical commission on virtual classes, passing along 100 percent of sales to gyms, the person close to the company said. That meant Apple would have taken its cut from hundreds of struggling independent fitness centers, yoga studios and boxing gyms.In this case, Apple should both allow ClassPass to sell its classes via a webview (i.e. loading a webpage within its app), and also offer in-app purchases for, say, 10%; yes, that s more expensive than credit card processing fees (which are ~$0.30+2.5%~2.9%, or around 6% of a $10 purchase), but the superiority of the user experience may convert enough customers that ClassPass would consider it worth the expense. This should also apply to all of the apps in the Reader category.Fortnite, on the other hand, like most games, is selling purely virtual goods that have zero marginal cost; a costume or emote are bits in a database. Epic may be right that Apple s 30% take is higher than it would be if the App Store had competition, but ultimately the cost of Fortnite s V-Bucks is a completely arbitrary one (that is why, for example, Fortnite was willing to cut the price of V-Bucks on consoles to make their App Store point, even though they were still paying 30% to Sony, Microsoft, and Nintendo). To the extent that the App Store tax must exist — and to be clear, this is all predicated on the assumption that it isn t going anywhere — purely digital goods, particularly those that are only usable on Apple s platform, are the least objectionable.This does, I should note, apply to more categories of apps than games. Many productivity apps are zero marginal cost — they are simply infinitely replicable software — and Apple s take is reducing profitability, as opposed to making individual sales unviable. Indeed, I have always been less concerned about the 30% take for productivity apps and more focused on the lack of traditional trials and paid updates.There is also a distinction worth drawing between experiences that primarily happen on an iPhone, and those that are primarily on the web, or cross-platform. The latter should be allowed the current Reader exception: simply present a login, because, by definition, the user is already using the application in question elsewhere. It is absolutely bizarre that Apple is going after these apps to demand in-app purchase; the fact these developers bothered to make an iPhone app as an add-on is the real win, and punishing them is counter-productive.Distinguishing apps according to their iPhone-centricity and marginal costs results in a landscape that looks like this:iPhone-focused experiences with zero marginal cost goods pay the full in-app purchase tax, while cross-platform experiences are allowed only a login. Apps with marginal costs, meanwhile, can either offer their own payment solution via a webview, or take advantage of the App Store s superior in-app purchase experience at a competitive rate.A New App Store ApproachI know this Article has been wide-ranging, but there is a reason:First, while I recognize there are good reasons for Apple s approach to the App Store, in a vacuum I would prefer far more openness and freedom, primarily for the sake of increased innovation.Second, under current law, I expect Apple to retain total control of the App Store.Third, I believe that Apple s current approach to the App Store is bad for developers, bad for innovation, and ultimately bad for Apple.All of these points are important; it is tempting to write a screed about the App Store that ignores point two, for example, which means the screed doesn t matter; at the same time, I am concerned that Apple itself will ignore point three, and miss an opportunity to rethink its approach.That, then, is the spirit of my proposals: if we accept the fact that Apple is determined to make a significant amount of money off of the App Store, and that they have the right to do so, what is a better approach? For this I will incorporate all of the above, and also draw on the distinctions I made to discrete App Store functionality last week (and again, let me be very clear: this isn t my preferred outcome, but rather one that I hope is plausible).App Installation: Apple should stop using App Installation to stifle new business models like Google Stadia or Xbox Game Pass. This is, admittedly, one of my weaker arguments in terms of getting Apple s buy-in: I believe Apple should allow these because innovation is important, and cloud gaming is exactly that. At the same time, cloud gaming is a direct challenge to Apple s App Store control, so I understand why 30% is not enough from Apple s perspective.Payment Processing: This is where the marginal cost/cross-platform distinction comes into play:If your app experience is contained to the iPhone and has zero marginal costs, you can only use in-app purchase at Apple s rate (30% currently).If your app experience is cross-platform and has zero marginal costs, your app can simply be a login page at launch, with the assumption you are paying elsewhere; if you wish to offer payments, you have to offer in-app purchase at Apple s rate.If your app experience has marginal costs, then you can offer either a webview for purchase or an in-app purchase at a new Apple rate (~10%) (keep in mind that marginal costs means something discrete; simply needing some indeterminate amount of more server capacity doesn t suffice).There will still be edge cases here, particularly when it comes to determining what is an iPhone-only experience, as opposed to a cross-platform one; Fortnite, for example, can be played cross-platform, but I would still classify it as an iPhone-only experience (I would be okay with simply assuming that all games are iPhone-only experiences). What makes these edge cases far more tolerable, though, is that they are arguing about who gets what share of zero marginal cost goods, as opposed to driving folks who need to pay for what they provide out of business.In addition, I will never rest in my call for traditional trials and upgrade pricing (and go ahead Apple, take your 30%); it s a better model for productivity apps than subscriptions, particularly small-scale apps, and it genuinely bums me out that this doesn t yet exist. Indeed, this is the strongest possible argument as to why one company having a monopoly over payment processing is such a terrible idea.Customer Management: Here Apple both gives and takes. The taking is clear: by virtue of controlling payment, Apple controls the customer relationship. That is a reason for a developer to try and consummate the payment on their own.At the same time, the App Store is itself a marketing channel. I do believe that Apple massively overstates its importance — sure, it is nice to for an app to be featured, but you can t build a business model around that like you can targeted advertising — but it is a potential value-add. What Apple should do is make discovery in the App Store contingent on using in-app purchase. If you want to be featured or show up in charts use in-app purchase; if you don t, then customers have to search for your app directly.The odds are that Apple isn t going to change anything; the App Store is extremely profitable, and Apple is probably going to win its court case. Why give up a single dime? At the same time, the constant wave of controversies have to be wearing on the company, from a morale perspective if nothing else. Apple can be legitimately accused of profiteering off of COVID-19!To that end, I hope the company will at least consider the possibility that this isn t the 1990s, they re not about to go out of business, and that being perceived as an asset to developers and not a tax opens up the possibility of growing the pie, not simply taking their slice. If that is the outcome of this summer of App Store turmoil, it will be a win for everyone: developers, Apple, and the users that want both security and innovation.I wrote a follow-up to this article in this Daily Update.Fortnite still works if you have previously downloaded it; the judge s order does suggest that Apple could render Fortnite (and only Fortnite) completely unplayable if it chose to [ ]See Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP. [ ]See Pacific Bell Telephone Co. v. linkLine Communications, Inc.. [ ]See Aspen Skiing v. Aspen Highlands Skiing; this case may apply to Apple s removal of parental control apps that leveraged mobile device management capabilities. [ ]See Eastman Kodak Co. v. Image Technical Services, Inc., of which the dissent is the de facto controlling precedent. [ ] Posted onMonday, August 17, 2020Tuesday, August 25, 2020 Author by Ben Thompson Manage your Stratechery subscription.Circuit Judge Consuelo M. Callahan, in last week s decision by the Court of Appeals for the Ninth Circuit, reversing the District Court s ruling that Qualcomm was guilty of antitrust violations, opened her opinion thusly: This case asks us to draw the line between anticompetitive behavior, which is illegal under federal antitrust law, and hypercompetitive behavior, which is not.This is, admittedly, a distinction I have not seen before, but it is perhaps a useful one, for the simple reason that being a successful business by definition means being anticompetitive: without some sort of differentiation and/or superior cost structure any sort of margin a business has will be competed away, and so preserving that differentiation and/or cost structure — being anticompetitive — should be the goal of any business. The distinction Callahan was drawing, though, is necessary if you interpret anticompetitive as being illegal : businesses should compete, but they should not break the law along the way.What makes this distinction particularly challenging is that the question as to what is anticompetitive and what is simply good business changes as a business scales. A small business can generally be as anticompetitive as it wants to be, while a much larger business is much more constrained in how anticompetitively it can act (as a quick aside, for the first part of this essay I am painting in broad strokes as far as questions of specific legality go). The specific case of Apple and the iPhone raises an additional angle: should the importance of the market in the question make a difference as well?Apple s Vertical IntegrationApple s business model, which uses software to differentiate hardware, is designed to be anticompetitive. The company has traditionally made its money by selling physical devices which run Apple s proprietary operating systems; its device-manufacturing competitors, meanwhile, have had to rely on an operating system that they could license, primarily Windows for PCs, and Android for mobile devices. They cannot license macOS or iOS.What is funny about calling this strategy anticompetitive is that it wasn t that long ago that most pundits were sure Apple was anti-competing themselves into the ground. When Stratechery started in 2013, the media was filled with predictions of the iPhone s imminent demise at the hands of Android: there were simply too many other manufacturers making too many smartphones at too many price points that Apple could not or would not match, which would inevitably lead to developers fleeing iOS and Apple fighting for its life.The problem with these predictions, as I wrote in What Clayton Christensen Got Wrong, is that they drastically undervalued the experience of using Apple s integrated products. The business buyer, famously, does not care about the user experience. They are not the user, and so items that change how a product feels or that eliminate small annoyances simply don’t make it into their rational decision making process. Again, though, Christensen’s research is tilted towards business buyers. Critically, this includes the PC. For the most of its history, the vast majority of PC purchasers have been businesses, who have bought PCs on speeds, feeds, and ultimately, price…I attributed Apple s ability to eliminate many of those small annoyances to its vertical integration, which had long been out of fashion: The traditional business theory about vertical integration rests on the costs and controls…The issue I have with this analysis of vertical integration…is that the only considered costs are financial. But there are other, more difficult to quantify costs. Modularization incurs costs in the design and experience of using products that cannot be overcome, yet cannot be measured. Business buyers — and the analysts who study them — simply ignore them, but consumers don’t. Some consumers inherently know and value quality, look-and-feel, and attention to detail, and are willing to pay a premium that far exceeds the financial costs of being vertically integrated.One thing that is worth noting is that Apple has only ever integrated part of its value chain, particularly once it started manufacturing in China. A Mac, for example, looks something like this:In this view Apple integrates hardware made with industry-standard components and macOS, providing a platform for even more app developers. Of course, this view of the Mac will soon be obsolete: Apple computers will soon come with Apple s own chips, which is to say that the company is backward-integrating into one of its most important components. This is, as far as I can tell, seen as a good thing: Apple has both demonstrated its ability to build fast chips and to integrate those chips with its operating system; no one feels especially bad for Intel, particularly since the company had its own near-monopoly for decades.App Store IntegrationOf course iPhones have already been using Apple s own chips for a decade; what has always made the iPhone different than the Mac, though, is the degree to which Apple has forward-integrated into the app ecosystem. What is critical to understand is that this integration proceeded in parts, and that those parts build on each other.App Store Part One: InstallationStart with app installation: because Apple controls the operating system, it controls what apps can or cannot be installed on the device. iOS will only run apps that have permission from Apple (this permission is ultimately enforced by Apple s hardware), and Apple grants this permission via the App Store. To put it in the context of the value chain, Apple leverages its integration of hardware and software to control app installation:It is essential to note that this forward integration has had huge benefits for everyone involved. While Apple pretends like the Internet never existed as a distribution channel, the truth is it was a channel that wasn t great for a lot of users: people were scared to install apps, convinced they would mess up their computers, get ripped off, or accidentally install a virus.The App Store changed all of that: Apple effectively extended the trust it had earned with users over the years to all developers in the App Store. Users could install whatever they wanted, confident the app would not mess up their phone, rip them off, or be a virus. This by extension meant that the addressable market was far larger for app developers than the PC was, even though it would be several years before smartphones had a larger installed base than PCs. And this, of course, brought benefits to Apple:This was the combination of integration and modularity at its absolute best: Apple leveraged its control to create a better market that benefited everyone.App Store Part Two: Payment ProcessingGiven the fact that Apple controlled app installation, it was a natural extension into payment processing, particularly since the App Store was built on the same infrastructure as iTunes.Unsurprisingly, like iTunes at the time, payment processing functionality was limited to up-front purchases. Suppose you wanted Super Monkey Ball: you had to pay $9.99 to even download the app; there were no trials or in-app purchases:From the beginning Apple kept 30% of every purchase; that was similar to the rate the company kept for iTunes purchases, and perhaps more pertinently, just barely covered credit card processing fees for a $0.99 app.1This gets at why this was another great deal for everyone involved: most users had already trusted Apple with their credit card information, and again, Apple was extending that trust to every developer in its App Store, making it far more likely that developers would earn money on their apps than if they had to drive downloads and purchases on their own. And once again, this circled back to Apple s benefit, both in terms of the ecosystem broadly and, as the App Store reached scale (and added in-app purchasing), real profits.App Store Part Three: Customer ManagementThat Apple has controlled app installation and payment processing from the beginning is an obvious point; what is less appreciated is that Apple leveraged its control of payment processing, which was based on its control of app installation, which was based on its control of the operating system, into complete ownership of the customer relationship.Users didn t pay developers, they paid Apple, who paid developers. Users didn t get receipts from developers, they got receipts from Apple, who kept their email addresses for themselves. This did have some user benefits, particularly in terms of ensuring their data was not sold to unscrupulous data brokers, but the benefit to developers was much less clear cut. There remains no means to offer refunds, for example, and for many years developers could not respond to negative reviews in the App Store.What was most frustrating for developers, though, was that the lack of a customer relationship, in conjunction with the lack of functionality for upgrade pricing, made it difficult to build sustainable businesses in product spaces that did not have an obvious service component (which might require a subscription) or consumables (which could be bought with in-app purchases). The App Store was about transactions, not relationships, and Apple liked it that way.These three distinct integrations, each of which built on the previous, were present in the App Store from Day One — and Steve Jobs knew it. He articulated what just took me 700 words in a crisp five minutes and seven seconds:2Everything about this video was exceptional at the time, and just as critically, nothing was objectionable. After all, the iPhone was still a small business; from a developer perspective, the App Store was (almost) all upside. It would be users who would vote with their wallets in favor of Apple s approach.App Store ProblemsThere is a bit of a running joke in tech that the mainstream media believes that every tech company is ridiculously over-valued right up until the day that the exact same company is a juggernaut that is killing industries; in the case of Apple, the company s strategy was doomed right up until it was illegal, or so it seems with the App Store.In truth, though, while many of the issues surrounding the App Store are about Apple being a whole lot bigger than they were in 2008, the company has, particularly over the last few years, extended its control further and further away from the core integration that undergirds its business.Last year, for example, the company required that apps that utilize third-party login services also utilize Sign in with Apple .3 This, by extension, meant that cross-platform apps and services had to integrate Sign in with Apple into their Android and web apps. This was in part a further assumption of customer management, and also an extension of control beyond the iPhone.Apple s control of the customer relationship has also helped sustain its control of payment processing; after Amazon advertised that Kindle books were available on all platforms Apple forced the bookseller to stop selling books in its app. Moreover, Amazon couldn t even tell users to visit Amazon.com, much less offer a link or, as Android allows, a webview of the store.What is troubling about this example, which also applies to Netflix, Spotify, and other so-called Reader apps, is that Apple s aggressive integration up the stack isn t really helping anyone. Users are confused, these big developers get fewer customers than they might have otherwise, while Apple s overall iPhone experience is degraded. The ones that really lose out, though, are smaller developers whose cost structures cannot support Apple s 30% cut, yet don t have the brand awareness to enable customers to find their websites. In this way Apple is actually making dominant companies even stronger (much like they are Facebook).Apple also appears to be making an effort to limit this exception; while Basecamp managed to drive Apple to a face-saving retreat from its insistence on in-app purchase for its Hey email service, I heard from many developers that App Store review had started rejecting apps that had been in the store for years because they only allowed users to subscribe on the web.What was particularly disappointing about these shakedowns, though, is that Apple itself admitted in a press release that it had been holding up bug fixes in App Review over guideline violations , many of which were about driving usage of its own payment processor. This is truly an inversion of the win-win-win dynamic that characterized the company s previous integration efforts: now users were being put at risk for bugs developers were liable for because of arbitrary reasons related to Apple s drive for Services revenue.Of course Apple had long put users at risk in other ways; the company had turned a blind eye to the search for digital whales who would spend huge amounts of money on games they could never win. This was, in retrospect, the canary in the coal mine about the corrupting power of the App Store: Apple had started out bragging how they would protect users, but the company seemed far more concerned about protecting its bottom line.And worst of all, while this was happening, App Store functionality, particularly around payments, was being left in the dust by companies like Stripe, Square, Shopify, and even PayPal. While these companies were making it radically easier for developers to accept payments, offer subscriptions, even get loans and manage their finances, Apple s payment solution took years to even support subscriptions (never mind that that solution is so difficult to use that a startup just raised $15 million to provide basic tracking functionality); in-app purchase still doesn t support traditional trials4 or upgrades, the importance of which I ve been writing about for years.For me this is the biggest disappointment. I have long believed that the Internet is going to fundamentally remake all aspects of society, including the economy, and that one area of immense promise is small-scale entrepreneurship. The App Store was, at least at the beginning, a wonderful example of this promise; as Jobs noted even the smallest developer could reach every iPhone on earth. Unfortunately, without even a whiff of competition, the App Store has now become a burden for most small developers, who instead of relying on the end-to-end functionality offered by, say, Stripe, have to support at least two payment solutions, the combined functionality of which is limited to the lowest common denominator, i.e. the App Store.All that noted, what does remain valuable is Apple s total control of the installation process. The iPhone is probably the most valuable target on earth for scams and hackers, and while vulnerabilities have been exploited, there is no denying the fact that users are safer on iOS than they are on other platforms, and that is valuable to everyone involved.The Epic LawsuitAll of this explains why I find Epic s lawsuit against Apple, which was filed last Thursday after the company updated Fortnite to include an alternate payment system, and was promptly kicked out of the store by Apple, such a bummer.Epic is attacking every level of the iPhone stack: the company doesn t just want a direct relationship with customers, and it doesn t just want to use its own payment processor; it is also demanding the right to run its own App Store. There is precedent on the PC: there Epic has built a rival to Steam that has benefited gamers most of all; at the same time, the PC has always been completely open, for better and for worse.My preferred outcome would see Apple maintaining its control of app installation. I treasure and depend on the openness of PCs and Macs, but I am also relieved that the iPhone is so dependable for those less technically savvy than me. What would be a far better outcome, at least from my perspective, would be Apple remembering that those same users that benefit from the iPhone being locked down should be the focus everywhere.That means, for example, allowing purchases via webviews, particularly for products and experiences that do not have zero marginal costs. Sure, that could mean less App Store revenue in the short run, but Apple would be well-served having to build more and better products to win developers over. At the end of the day, squeezing businesses that can stomach the cost of Apple development, both in terms of implementing in-app purchase and that 30%, by definition has less ultimate upside than growing the pie for everyone.This lawsuit is also a reminder that Apple has a lot to lose. While the most likely outcome is an Apple victory — the Supreme Court has been pretty consistent in holding that companies do not have a duty to deal — every decision the company makes that favors only itself, and not society generally, is an invitation to examine just how important the iPhone is to, well, everything.Indeed, this is the most frustrating aspect of this debate: Apple consistently acts like a company peeved it is not getting its fair share, somehow ignoring the fact it is worth nearly $2 trillion precisely because the iPhone matters more than anything. This is not a console you play on to entertain yourself, or even a PC for work: it is the foundation of modern life, which makes it all the more disappointing that Apple seems to care more about its short term bottom line than it does about the users and developers that used to share in its integration upside; if Apple doesn t change course, hyperessential will at some point trump hypercompetitive.I wrote a follow-up to this article in this Daily Update.Credit card processing fees generally consist of a fixed fee between $0.25 and $0.30 per transaction, plus 1.5%~3.0%; Apple of course would have had a significant volume discount. [ ]Although I can t help but note that 2:30 mark has a very rare Apple presentation error: the Backgammon game should be on the iPhone screen [ ]This previously stated that Sign in with Apple had to be at the top of the list, which as of the current version of the rules is not the case. [ ]You can trial a subscription only [ ] Posted onTuesday, August 4, 2020Wednesday, August 5, 2020 Author by Ben Thompson Manage your Stratechery subscription.The only thing more predictable than members of Congress using hearings to make statements instead of ask questions, and when they do ask questions, usually of the gotcha variety, refusing to allow witnesses to answer (even as those witnesses seek to run out the clock), is people watching said hearings and griping about how worthless the whole exercise is.There was, needless to say, all of the above last Wednesday, when the House Subcommittee on Antitrust, Commercial, and Administrative Law held a hearing featuring Tim Cook, CEO of Apple, Jeff Bezos, CEO of Amazon, Sundar Pichai, CEO of Google, and Mark Zuckerberg, CEO of Facebook. Statements were made, gotcha questions were asked, answers were interrupted, clocks were run out, and there was a whole lot of griping about what a waste of time it all was.To be sure, it does seem like there must be a better way to hold these hearings, particularly if the goal is to learn something new, but the reality is that genuine inquiry is much more likely to happen without the glare of the media spotlight that inevitably accompanies such a high profile hearing; what that glare will highlight is the politics of the topic in question: what do various politicians and parties actually care about, what do they think that their constituents care about, and how should those affected by said hearings respond.In that regard last Wednesday s hearing was a success: partisan priorities were made clear on the politician side, tech s collective position and impact on society came into view, even as each of the companies at the hearing revealed different strengths and vulnerabilities. This article will examine all of these points, but first a caveat: this post, even more than most on Stratechery, is meant as an analysis of the politics of this hearing in particular, not a statement of values; unless I say so explicitly, I am not necessarily endorsing or condemning any particular line of argument, simply pointing it out.The Political Effects of MonopolyLina Khan, who rose to prominence with her 2017 law review article Amazon s Antitrust Paradox, and who served as counsel for the antitrust subcommittee over the course of the investigation that culminated in Wednesday s hearings, summarized the New Brandeis Movement of antitrust in 2018: As the name suggests, this new movement traces its intellectual roots to Justice Louis Brandeis, who served on the Supreme Court between 1916 and 1939. Brandeis was a strong proponent of America’s Madisonian traditions—which aim at a democratic distribution of power and opportunity in the political economy. Early in the twentieth century, Brandeis successfully updated America’s antimonopoly regime, along Madisonian lines, for the industrial era, and his philosophy held sway well into the 1970s. As the ‘New Brandeis School gains prominence — even prompting two floor speeches by Senator Orrin Hatch (a Republican from Utah) — it’s worth understanding what this vision of antimonopoly does and does not represent.While the article is worth reading in full, it is no accident that Khan started with democracy : Brandeis and many of his contemporaries feared that concentration of economic power aids the concentration of political power, and that such private power can itself undermine and overwhelm public government. Dominant corporations wield outsized influence over political processes and outcomes, be it through lobbying, financing elections, staffing government, funding research, or establishing systemic importance that they can leverage. They use these strategies to win favorable policies, further entrenching their dominance. Brandeis also believed that the structure of our markets and of our economy can determine how much real liberty individuals experiences in their daily lives. Most people’s day-to-day experience of power comes not from interacting with public officials, but through relationships in their economic lives — negotiating pay with an employer, for example, or wrangling the terms of business with a trading partner. Brandeis feared that autocratic structures in the commercial sphere — such as when one or a few private corporations call all the shots — can preclude the experience of liberty, threatening democracy in our civic sphere.Chairman David Cicilline, in the conclusion to his opening statement, made a clear gesture to the New Brandeis Movement:1Because concentrated economic power also leads to concentrated political power, this investigation also goes to the heart of whether we as a people govern ourselves, or whether we let ourselves be governed by private monopolies. American democracy has always been at war against monopoly power. Throughout our history, we’ve recognized that concentrated markets and concentrated political control are incompatible with democratic ideals. When the American people confronted monopolies in the past, be it the railroads or the oil tycoons or AT T and Microsoft, we took action to ensure no private corporation controls our economy or our democracy.What was notable to me is that in the hearing Cicilline and the other Democrats never really focused on this point; the rest of Cicilline s opening statement, and much of the Democratic questioning, focused on what they perceived as illegal activities that caused economic harm, without necessarily tying that to political harm. Again, that s not to say they were ignoring the linkage, but it wasn t a priority.What made this stand out was that Republicans were focused almost entirely on the politics of monopoly, specifically their contention that large platforms, particularly Google and Facebook (and Twitter), were censoring conservative viewpoints and working to elect Democratic candidates to office, particularly the presidency, and that this was a problem because of their dominance. Leave aside, if you can, your opinion about the veracity of these complaints (and remember my note at the beginning about focusing on analysis): while the Republicans were certainly not endorsing the New Brandeis School — Ranking Member James Sensenbrenner in particular took care to highlight support for the consumer welfare standard, also known as the Chicago School — their concern with the size of tech companies had nothing to do with economic effects and everything to do with political effects. It was a striking contrast.Begging the QuestionOne of the more humorous lines of questioning, at least for language nerds, came courtesy of Republican Representative Matt Gaetz:I want to talk about Search because that’s an area where I know Google has real market dominance. On December 11th, you testified to the Judiciary Committee, and in response to a question from my colleague Zoe Lofgren about Search, you said, “We don’t manually intervene on any particular search result.” But leaked memos obtained by The Daily Caller show that that isn’t true. In fact, those memos were altered December 3rd, just a week before your testimony. And they describe a deceptive news blacklist and a process for developing that blacklist approved by Ben Gomes, who leads Search with your company. And also something called a fringe ranking, which seems to beg the question, who gets to decide what’s fringe?And in your answer, you said to Ms. Lofgren that there is no manual intervention of search. That was your testimony, but … And now I’m going to cite specifically from this memo from The Daily Caller. It says that the … I’m sorry, that The Daily Caller obtained from your company. It says, “The beginning of the workflow starts when a website is placed on a watch list.” It continues, “This watch list is maintained and stored by Ares with access restricted to policy and enforcement specialists.” Sort of does beg the question who these enforcement specialists are?First off, note that this is an example of Republicans linking dominance to concerns about censorship. The point about language, though, is that Gaetz is using the phrase begs the question incorrectly; I know this, because I used to make the same mistake, until a reader graciously corrected me a couple of years ago. What Gaetz meant to say was raises the question begs the question , on the other hand, to use Wikipedia s definition, is: An informal fallacy that occurs when an argument s premises assume the truth of the conclusion, instead of supporting it. It is a type of circular reasoning: an argument that requires that the desired conclusion be true. This often occurs in an indirect way such that the fallacy s presence is hidden, or at least not easily apparent.For an example of this logical fallacy at work, look no further than this antitrust hearing, and Cicilline s concluding statement:Today, we had the opportunity to hear from the decision makers at four of the most powerful companies in the world. This hearing has made one fact clear to me. These companies, as exist today, have monopoly power. Some need to be broken up, all need to be properly regulated and held accountable.If I may nitpick, this is obviously not true — Cicilline had decided well before this hearing that these companies have monopoly power. The problem is that a huge number of questions in the hearing took it as a given that these companies were monopolies, and proceeded to find rather common business practices as being major crimes. In other words, they begged the question.One of the most striking examples of this fallacy — where it is assumed that a company is a monopoly, and therefore its actions are illegal, and because its actions are illegal it is a monopoly — was this exchange between Representative Jamie Raskin and Bezos:Start with the HBO Max-on-Fire TV question. One of the first things you learn about conducting effective negotiations is that you want to negotiate about more things, not fewer. The reasoning is straightforward: if you are only negotiating about a single variable — in this example, Raskin believes that Amazon and HBO should only negotiate on price — the outcome is zero sum: every cent that Amazon wins is a cent that HBO loses. However, if you are able to introduce more variables, then you might find out that one company cares a lot about price, while the other company cares a lot about promotion (just to make up an example); in that case one company can get a better price and give up a lot of promotional opportunities, while the other can get a worse price and gain a lot of promotional opportunities, and thanks to their differing priorities, both feel like winners. That s good negotiating!It also appears to be, at least according to Raskin, illegal, because Amazon is us[ing its] gatekeeper status role in the streaming device market to promote [its] position as a competitor in the video streaming market with respect to content. That s the problem though: there was zero evidence provided that Amazon has a monopolistic position in either streaming devices or video streaming; it was simply taken as fact, which made basic negotiating practices suspect, and evidence that Amazon was a monopoly. Begging the question.Raskin s question about Amazon s acquisition of Ring was an even better example of the fallacy at work; while I don t really understand why multivariate negotiations would be illegal even if you are a monopoly, there are clear antitrust issues raised by a monopolist acquiring a company for market share. Crucially, though, acquiring a company for market share if you are not a monopolist is not a crime.It follows, then, that if Amazon had a monopoly in the home automation market, and acquired Ring for market share reasons, that could very well be an antitrust violation, but if they weren t a monopoly, it would not be. What is critical to note is that you have to establish that Amazon has a monopoly first; only then can you decide if the acquisition was anticompetitive. Raskin, though, begs the question: the fact that Amazon acquired Ring for market share reasons is taken as evidence that Amazon has a monopoly, which then makes the acquisition illegal.The same problem applied to Raskin s final two complaints: Alexa defaulting to Amazon Prime Music, and recommending Amazon Basics. Those may be a problem if you first establish that Amazon has a monopoly in the relevant product areas, but it is not itself evidence that Amazon is a monopoly.I m focusing on this specific exchange, but the truth is that a combination of vilifying common business practices and begging the question was a consistent theme. Things like market research or copying competitor features or improving products were held up as obvious crimes and evidence of monopoly, when they were often not crimes at all, or only crimes if a monopoly in the relevant market had first been established. That is not to say that the committee s investigation didn t produce evidence of illegal anticompetitive actions, but rather that said evidence, such that there was, too often begged the question.The GOP BargainThe combination of the Republicans focus on the political aspects of antitrust and the tendency of the Democrats to see antitrust crimes even in normal business proceedings produced what was, I think, the most obvious political takeaway for tech companies: the Democrats have made up their minds (that tech is guilty), while the Republicans are willing to cut a deal.The outline of that deal could not have been more obvious: Republicans are fine with the consumer welfare standard (which, as I noted back in 2016, inherently favors Aggregators) and tech s business practices, as long as tech companies don t censor the alternating format of Congressional hearings placed these demands in direct contrast to Democratic assumptions of guilt. To put it in explicit terms: We, Republicans, are your friends in Washington, but if you want us to defend you from the Democrats, you need to stop censoring conservatives. Again, it doesn t matter that conservative websites tend to do particularly well on social media, or that the destruction of the media business model helped lay the groundwork for President Trump s rise; Republicans expect that tech companies — by which they mostly mean Google and Facebook (and Twitter) — err on the side of not censoring or checking conservative content if they want help in Washington, because that help is not coming from the Democrats.Tech s United FrontSomething that stood out from the four CEOs opening statements, and the general tenor of their defenses, was their insistence that they supported small-and-medium sized businesses.Bezos:20 years ago, we made the decision to invite other sellers to sell in our store, to share the same valuable real estate we’ve spent billions to build, market, and maintain. We believe that combining the strengths of Amazon Store with the vast selection of products offered by third parties would be a better experience for customers, and that the growing pie of revenue and profits would be big enough for all. We were betting that it was not a zero sum game. Fortunately, we were right. There are now, 1.7 million small-and-medium-sized businesses selling on Amazon.Pichai:One way we contribute is by building helpful products. Research found that free services like search, Gmail, maps, and photos provide thousands of dollars a year in value to the average American. And many are small businesses using our digital tools to grow. Stone Dimensions, a family owned stone company in Pewaukee, Wisconsin uses Google My Business to draw more customers. Gil’s appliances, a family owned appliance store in Bristol, Rhode Island credits Google analytics with helping them reach customers online during the pandemic. Nearly one third of small business owners say that without digital tools, they would have had to close all or part of their business during COVID.Cook:What does motivate us is that timeless drive to build new things that we’re proud to show our users. We focus relentlessly on those innovations, on deepening core principles like privacy and security and on creating new features. In 2008, we introduced a new feature of the iPhone called the App Store launched with 500 apps, which seemed like a lot at the time, the App Store provided a safe and trusted way for users to get more out of their phone. We knew the distribution options for software developers at the time didn’t work well, brick-and-mortar stores charged high fees and have limited reach, physical media like CDs had to be shipped and were hard to update. From the beginning, the App Store was a revolutionary alternative. App Store developers set prices for their apps and never pay for shelf space.2Zuckerberg:We’ve built services that billions of people find useful. I’m proud that we’ve given people who’ve never had a voice before the opportunity to be heard, and given small businesses access to tools that only the largest players used to have.This shared focus was notable for two reasons, one specific to these hearings, and one that tells a broader story about how the Internet is changing the world.First off, probably the most obvious connective thread in the hearing was concern about these companies creating platforms and then favoring themselves unfairly. Amazon, for example, is accused of using data about third party sellers to inform its private-label goods strategy (and data from AWS); Google is accused of using data about search to keep users on its pages; Apple is accused of using its control of the App Store to favor its own apps; and Facebook is accused of using data about app usage to drive its acquisition strategy. What each of these companies is arguing is that focusing on a couple of disgruntled companies is to miss the larger picture, wherein these companies created those opportunities in the first place, and for exponentially more companies than those the Committee may have heard from.What is particularly interesting, though, is that to the extent these companies are right it foretells both a new kind of economy and a new kind of political alignment. Zuckerberg s summary was the shortest yet most explicit, perhaps because Facebook is the best example of this phenomenon; I wrote in Apple and Facebook: This explains why the news about large CPG companies boycotting Facebook is, from a financial perspective, simply not a big deal. Unilever’s $11.8 million in U.S. ad spend, to take one example, is replaced with the same automated efficiency that Facebook’s timeline ensures you never run out of content. Moreover, while Facebook loses some top-line revenue — in an auction-based system, less demand corresponds to lower prices — the companies that are the most likely to take advantage of those lower prices are those that would not exist without Facebook, like the direct-to-consumer companies trying to steal customers from massive conglomerates like Unilever.The Internet is best illustrated by the smiling curve, in which value flows to large Aggregators and Platforms on one side, and small businesses built with Internet assumptions about addressable markets (and Internet cost structures) on the other side, while the folks in the middle that built their businesses on owning distribution in a world of scarcity are increasingly obsolete.That is why you regularly see strange political bedfellows, like Uber and drivers and riders versus taxi companies and politicians, or Airbnb and hosts versus hotels and, well, politicians, or these companies and their small business bases against newspapers, retailers, cross-platform software businesses, vertical aggregators and yes, politicians. Zuckerberg made this point on behalf of the tech industry as a whole:We’re here to talk about online platforms, but I think the true nature of competition is much broader. When Google bought YouTube, they could compete against the dominant player in video, which was the cable industry. When Amazon bought Whole Foods, they could compete against Kroger’s and Walmart. When Facebook bought WhatsApp, we could compete against telcos who used to charge 10 cents a text message, but not anymore. Now people can watch video, get groceries delivered, and send private messages for free. That’s competition. New companies are created all the time, all over the world. And history shows that if we don’t keep innovating, someone will replace every company here today.Companies that used to be big, at least before the big tech companies came along, have the most to lose from tech, but just because they are ill-equipped to compete does not mean they are representative of all businesses, particularly companies that only exist because these platforms and Aggregators exist.3Tech s Differing ProspectsThat noted, just because there were similarities in their messaging does not mean that each tech company has similar prospects as far as potential regulation is concerned. From the companies that should be the least concerned to the most:Apple: It was obvious that the committee only invited Apple because they wanted to say that they invited all of the large consumer tech CEOs. The questions for Cook were hilariously uninformed about the App Store, making it easy for Apple s CEO to run out the clock (often without any interruption). This was certainly disappointing given that many of Apple s policies are clearly anticompetitive (which, as I noted above, is different than being illegal), but for now the takeaway is that Congress doesn t know and doesn t care.Facebook: Facebook was probably the biggest beneficiary of Democrats not focusing on political harm relative to economic harm; as I noted last year in Tech and Antitrust, there really isn t much about the company s business practices (post acquisitions) that are anticompetitive. There was an interesting back-and-forth about Facebook s discriminatory willingness to deal as far as access to their friend graph is concerned, but for that to be illegal you have to first establish that Facebook is a monopoly.On this point I thought the Committee s questioning was frequently unfair: the fact that social networks that existed when Facebook was founded no longer do (MySpace, Friendster, etc.) was taken as evidence that Facebook is a monopoly, with zero acknowledgment of the rise of Snapchat, TikTok, iMessage, etc. Similarly, Facebook s acquisition of Instagram was discussed as if it happened today, when Instagram has over a billion users, as opposed to 2012, when it had 30 million. To be sure, some saw the anticompetitive angle of that purchase at the time, but many more mocked the price; at a minimum we can all agree that judging decisions made in 2012 according to the facts of 2020 isn t necessarily just.Amazon: Amazon seemed to attract the most in-depth scrutiny from the committee (perhaps because of Kahn), and while the biggest focus was on the 3rd-party marketplace and Amazon s private-label strategy, there was a clear attempt across multiple questioners to make the case that Amazon creates innovation kill zones , as Representative Joe Neguse put it, across all of its product lines. There was clearly a target on Bezos.At the same time, as Bezos regularly noted, it is not clear in what markets Amazon has a monopoly, and if it is not a monopoly, a lot of the behavior lawmakers were objecting to is not illegal (and, as I noted above, may not be illegal regardless). Bezos also made the point that only the military has a higher approval rating than Amazon, and when it comes to politics, that still matters.Google: I think that Google is in trouble. The company received the second greatest amount of specificity in its questions as far as competition topics go — Representative Pramila Jayapal s questions about ad exchanges was particularly well-done, especially given the constraints of the format — but more importantly, at least far as the politics of this hearing is concerned, was revealed to have no friends.Specifically, the price of the company pulling out of Project Maven and the Pentagon s JEDI project because of concerns about collaborating with the U.S. military4 is that the GOP deal I detailed above is not on the table: Republicans pushed Pichai on not just censorship and election interference but also its refusal to support the military repeatedly, and it seems clear than if and when an antitrust case is brought against the company, it will have few defenders. That is a particularly big problem for Google because the antitrust case against the company is by far the most straightforward.As I wrote last week before the hearing, I am glad that it occurred. Figuring out how to regulate tech companies — particularly Aggregators, that base their power on consumer welfare — will require new approaches, and probably new laws. Moreover, any such regulations will necessitate difficult trade-offs between competition, privacy, national security, etc. (I was grateful that Representative Kelly Armstrong highlighted how GDPR made big tech companies stronger), which again means that Congress is best situated to decide what tradeoffs we should make.To that end, I think the hearing was more successful than the format made it seem: there is more clarity about both Democratic and Republican priorities, as well as potential new divisions driven by technology generally, and a finer-grained understanding of how individual companies raise different concerns specifically. No, this wasn t Mr. Smith Goes to Washington , but then again that movie was made by a studio about to be convicted of acting anti-competitively.I wrote a follow-up to this article in this Daily Update.That is Khan sitting behind Cicilline [ ]Yes, Cook is pretending like the Internet never existed as a distribution channel [ ]Again, this is not to say that regulation isn t necessary — see A Framework for Regulating Competition on the Internet [ ]Incidentally, I think the real reason that Google pulled out of the JEDI project is that Google Cloud was not competitive with Azure and AWS; citing ethical concerns was a misguided attempt to claim a strategy credit that is coming back to bite the company in a major way [ ] Posted onTuesday, July 21, 2020Wednesday, July 22, 2020 Author by Ben Thompson Manage your Stratechery subscription.One of the more pernicious mistruths surrounding the debate about TikTok is that this will potentially lead to the splintering of the Internet; this completely erases the history of China s Great Firewall, started 23 years ago, which effectively cut China off from most Western services. That the U.S. may finally respond in kind is a reflection of reality, not the creation of a new one.What is new is the increased splintering in the non-China Internet: the U.S. model is still the default for most of the world, but the European Union and India are increasingly pursuing their own paths.The U.S. ModelThe U.S. Internet model is a laissez-faire one, and it is hard to argue against its effectiveness. Not only is the technology sector the biggest driver of U.S. economic growth for many years now, but U.S. Internet companies have come to dominate most of the world, conveying U.S. soft power like McDonald s and Hollywood on steroids. There are obvious downsides to this approach: the Internet s lack of friction both leads to Aggregators dominating markets and creates communities both good and bad.This article, though, is primarily focused on economics and politics, and in that regard the winners and losers of the U.S. s approach are as follows:Winners:Large U.S. tech companies operate freely in the U.S., giving them a large and profitable user base to fund expansion abroad.New U.S. tech companies face relatively few barriers to entry, particularly in terms of regulation of content or data collection.The U.S. government collects the vast majority of taxes from these U.S. companies, including from revenue generated abroad, and also sees the overall U.S. view of the world exported via U.S. tech companies, while also having access to the data of non-U.S. citizens.U.S. citizens operate with a high degree of freedom online, although there are minimal restrictions on the collection of the data generated from doing so by private companies.Non-U.S. citizens operate with a high degree of freedom online, although there are minimal restrictions on the collection of the data generated from doing so by private companies or the U.S. government.Non-U.S. companies are free to operate in the United States without restriction, and in other countries that follow the U.S. s approach.Losers:Non-U.S. governments have limited control over U.S. tech companies, limited access to their revenues, and limited control over the spread of information.My biases should be obvious: I definitely believe that the U.S. approach is the best one. Certainly many will quibble with the effect on new companies, given how Aggregators tend to dominate their markets, while others are focused on the collection of data; I am concerned that proposed solutions are worse than the harms, particularly given the consumer benefit of data factories. Still, as I noted yesterday, I believe the European Union Court of Justice makes a compelling case that the ability of the U.S. government to collect data from non-U.S. citizens is a serious privacy issue.Those quibbles, though, serve to highlight a point we can all agree on: non-U.S. governments have a lot of legitimate complaints about the hegemony of U.S. tech companies.The China ModelThe driving impetus of the China model is, first and foremost, control over information. This is evidenced by the fact that not only does China control access to Western services at the network level, but also employs huge numbers of censors for the Internet within China, and expects Chinese Internet companies like Tencent or ByteDance to have thousands of censors of their own.At the same time, the economic benefit of China s approach for China can not be denied. China is the only country to rival the U.S. for the sheer size and breadth of its Internet companies, thanks to the combination of a massive market and the lack of competition. Moreover, this led to all sorts of innovation, as China s leapfrog to mobile avoided the baggage of PC-assumptions that still limits many U.S. companies.That noted, it is fair to wonder just how replicable the China model is. Smaller countries like Iran have instituted similar controls on U.S. tech companies, but without a market like China it is far more difficult to capture the economic upside of the Great Firewall. And, it should be noted, there are a lot of losers with the China model, including Chinese citizens.The European ModelEurope, through regulations like GDPR and the Copyright Directive, along with last week s court decision striking down the Privacy Shield framework negotiated by the European Commission and the U.S. International Trade Administration (and a previous decision striking down the Safe Harbor Privacy Principles framework), is splintering off into an Internet of its own.This Internet, though, feels like the worst of all possible outcomes. On one hand, large U.S. tech companies are winners, at least relative to everyone else: yes, all of the regulatory red tape increases costs (and, for targeted advertising, may reduce revenue), but the impact is far greater on would-be competitors. To put it in allegorical terms, the E.U. is restricting the size of the castle even as it dramatically increases the moat.E.U. citizens, meanwhile, are likely to see their data increasingly protected from the U.S. government, which is a win; other protections, meanwhile, seem unlikely to be particularly effective or outweigh the general annoyance and loss of relevance that comes from endless permission dialogs and non-targeted content. Moreover, per the previous point, the number of alternatives to established incumbents are likely to decrease, particularly relative to the U.S.It also seems unlikely that European competitors will fill in the gap. Any company that wishes to achieve scale needs to do so in its home market first, before going abroad, but it seems far more likely that Europe will make the most sense as a secondary market for companies that have done the messy work of iterating on data and achieving product-market fit in markets that are more open to experimentation and impose less of a regulatory burden. Higher costs mean you need a greater expectation of success, which means a proven model, not a speculative one.Worst of all, at least from the E.U. s perspective, is that this approach doesn t really have any upside for European governments. That s the thing with rule by regulation: without a focus on growth it is harder to create win-win situations.The Indian ModelThe India market has always been a bit unique: while foreign companies have usually been unencumbered when it comes to digital goods, leading to a huge number of users for U.S. companies like Google and Facebook, and Chinese companies like TikTok, India has kept a much tighter leash when it comes to the physical layer of tech. This ranges from strong tariffs on electronics to a ban on foreign direct investment in things like e-commerce. Moreover, India has always been one of the most challenging markets in terms of Internet access and logistics.At the same time, the Indian market is the most enticing in the world for both U.S. and Chinese tech companies, which have largely saturated their home markets. This has led to a regular number of collisions between foreign tech companies and India regulators, whether it be Facebook s attempts to introduce Free Basics or WhatsApp payments, increasing restrictions on Amazon and Flipkart s e-commerce operations, or most recently, the outright banning of TikTok on national security concerns.Over the last few months, though, a way to square this circle has become apparent to U.S. tech companies in particular, and it portends a fourth Internet: invest in Jio Platforms.The Jio BetJio, the dominant telecoms network in India, is one of the all-time greatest examples of the power of building, and the outsized returns that come from betting on technology-enabled disruption. I described the economics of the bet by Mukesh Ambani, India s richest man, in an April Daily Update: The key to understanding Ambani’s bet is that while all of the incumbent mobile operators in India were, like mobile operators around the world, companies built on voice calls that layered on data, Jio was built to be a data network — specifically 4G — from the beginning.4G, unlike 2G and 3G, does not support traditional circuit-switched telephony services; voice calls are instead handled the same as any other data.Because everything is data, 4G networks can be built with commodity hardware in a way that 2G and 3G networks cannot.Because Jio was offering a data network, voice calls, which are relatively low bandwidth, were the cheapest services to offer, and capacity was effectively infinite. To put it another way, Jio was a bet on zero marginal costs — or, at a minimum, drastically lower marginal costs than its competitors. This meant that the optimal strategy was — you know what is coming! — to spend a massive amount of money up front and then seek to serve the greatest number of consumers in order to get maximum leverage on that up-front investment. That is exactly what Jio did: it spent that $32 billion building a network that covered all of India, launched with an offer for three months of free data and free voice, and once that was up, kept the free voice offering permanently while charging only a couple of bucks for data by the gigabyte. It was the classic Silicon Valley bet: spend money up front, then make it up on volume because of a superior cost structure enabled by the zero-marginal nature of technology.What makes this story so compelling is the contrast to Facebook s argument for Free Basics: The end result is what Zuckerberg said must be done: hundreds of millions of Indians, a huge portion of them from the country’s poorest regions, were connected to the Internet. Unlike Free Basics, though, it was all of the Internet. That actually undersells just how much better Jio is for Indians than Free Basics would have ever been: Zuckerberg had no plan for upending India’s old mobile order, where operators focused most of their investment on India’s largest cities and competed for the richest parts of society, charging so much that Andreessen could declare, with a straight face, that to not offer Free Basics was “morally wrong.” In that world, India’s poor may have had access to Facebook, but little more, since there would have been no reason for non-Free Basics companies to invest. Instead they not only have the whole Internet but companies from India to China to the United States competing to serve them.I wrote that Daily Update on the occasion of Facebook investing $5.7 billion for a 10% stake into Jio Platforms; it turned out that was the first of many investments into Jio:In May, Silver Lake Partners invested $790 million for a 1.15% stake, General Atlantic invested $930 million for a 1.34% stake, and KKR invested $1.6 billion for a 2.32% stake.In June, the Mubadala and Adia UAE sovereign funds and Saudi Arabia sovereign fund invested $1.3 billion for a 1.85% stake, $800 million for a 1.16% stake, and $1.6 billion for a 2.32% stake, respectively; Silver Lake Partners invested an additional $640 million to up its stake to 2.08%, TPG invested $640 million for a 0.93% stake, and Catterton invested $270 million for a 0.39% stake. In addition, Intel invested $253 million for a 0.39% stake.In July, Qualcomm invested $97 million for a 0.15% stake, and Google invested $4.7 billion for a 7.7% stake.With that flurry of fundraising Reliance completely paid off the billions of dollars it had borrowed to build out Jio. What is increasingly clear, though, is that the company s ambitions extend far beyond being a mere telecoms provider.Jio s VisionLast Wednesday, after announcing Google s investment in Jio Platforms at Reliance Industries Annual General Meeting, Ambani said: I would like to first share with you the philosophy that animates Jio s current and future initiatives. The digital revolution marks the greatest disruptive transformation in the history of mankind, comparable only to the appearance of human beings with intelligence capability on our planet about 50,000 years ago. It is comparable because man is now beginning to infuse almost limitless intelligence into the world around him. We are today at the initial stages of the evolution of an intelligent planet. Unlike in the past this evolution will proceed with a revolutionary speed. Our world will change more unrecognizably in just eight remaining decades of the 21st century, than today s world has changed from what it was 20 centuries ago. For the first time in history mankind has an opportunity to solve big problems inherited from the past. This will create a world of prosperity, beauty, and happiness for all. India must lead this change to create a better world. For this all our people and all our enterprises have to be enabled and empowered with the necessary technology infrastructure and capabilities. This is Jio s purpose. This is Jio s ambition. Friends, Jio is now the undisputed leader in India with the largest customer base, the largest share of data and voice traffic, and a world-class next-generation broadband network that covers the length and the breadth of our country…Jio s vision stands on two solid pillars. One is digital connectivity and the other is digital platforms.In short, Jio is determined to achieve the dream that has long eluded telecom providers in other countries: moving up the stack from fixed-cost infrastructure to high-margin services. Ambani s vision is comprehensive:What gives Jio a chance are three important differences from telecom efforts in other markets:First, Jio has created a huge portion of its addressable market; whereas a Verizon in the U.S., or a NTT DoCoMo in Japan was seeking to offer services on top of a competitive telecom market, Jio is the only option for a huge number of Indians (and for those that have options, Jio is so much cheaper because of its IP-based network that it can afford the extra costs).Second, instead of seeking to usurp companies like Facebook or Google that already have major marketshare in India, Jio is partnering with them.Third, Jio is positioning itself as an Indian champion, and the lynchpin of the Indian model.Notice how Ambani introduced Jio s 5G plans: Jio s global scale 4G and fiber network is powered by several core software technologies and components that have been developed by the young Jio engineers right here in India. This capability and know-how that Jio has developed positions Jio on the cutting edge of another exciting frontier: 5G. Today friends, I have great pride in announcing that Jio has designed and developed a complete 5G solution from scratch. This will enable us to launch a world-class 5G service in India using 100% homegrown technology and solution. This made in India 5G solution will be ready for trials as soon as 5G spectrum is available, and can be ready for field deployment next year. And because of Jio s converged all-IP network architecture we can easily upgrade our 4G network to 5G. Once Jio s 5G solution is proven at India-scale, Jio platforms would be well-positioned to be an exporter of 5G solutions to other telecom operators globally as a complete managed service. I dedicate Jio s 5G solution to our Prime Minister Shri Narendra Modi s highly motivating vision of Atmanirhbhar Bharat . Friends, Jio Platform is conceived with this vision of developing original captive intellectual property using which we can demonstrate the transformative power of technology across multiple industry ecosystems, first in India, and then confidently offering these Made-in-India solutions to the rest of the world.Make no mistake: Jio s network and its work on 5G, which takes years, was by definition not motivated by a phrase Prime Minister Modi first deployed two months ago. Rather, Ambani s dedication hinted at the role Jio investors like Facebook and Google are anticipating Jio will play:Jio leverages its investment to become the monopoly provider of telecom services in India.Jio is now a single point of leverage for the government to both exert control over the Internet, and to collect its share of revenue.Jio becomes a reliable interface for foreign companies to invest in the Indian market; yes, they will have to share revenue with Jio, but Jio will smooth over the regulatory and infrastructure hurdles that have stymied so manyWhat is fascinating about this approach is that the list of winners and losers gets pretty muddled pretty quickly. On one hand, Jio brought the Internet to hundreds of millions of Indians that would never have had access, and the benefits of that investment are only going to increase as Jio s services and partnerships come on line. On the other hand, locking in a monopolistic player, particularly in the context of a government that has shown a desire for more control over the flow of information is a real downside.The economic outcomes are just as muddled. Monopolies always have deadweight loss; then again, if an efficient market means that all of the profits flow to Silicon Valley, why should India particularly care about efficiency? In a Jio-mediated market it is U.S. tech companies that make less than they would have, and not only does India collect more taxes along the way, Jio s vision of being a national champion abroad could be a huge win for India in the long run.The Indian CounterweightIt is increasingly impossible — or at least irresponsible — to evaluate the tech industry, in particular the largest players, without considering the geopolitical concerns at stake. With that in mind, I welcome Jio s ambition. Not only is it unreasonable and disrespectful for the U.S. to expect India to be some sort of vassal state technologically speaking, it is actually a good thing to not only have a counterweight to China geographically, but also a counterweight amongst developing countries specifically. Jio is considering problem-spaces that U.S. tech companies are all too often ignorant of, which matters not simply for India but also for much of the rest of the world.Still, Facebook, Google, Intel, Qualcomm, et al should proceed with their eyes wide-open: they are very much a means to an end for a company and a country that is on its own path. That is not to say these investments are not a good idea — I think they are — but India s path is perhaps a more populist and nationalistic one than many Americans would prefer. Still, it is less antagonistic to Western liberalism than the Chinese Communist Party, and again, an important counterweight.The only question left, then, is whither Europe, and frankly, the picture is not pretty:What differs Europe s Internet from the U.S., Chinese, or Indian visions is, well, the lack of vision. Doing nothing more than continually saying no leads to a pale imitation of the status quo, where money matters more than innovation.I wrote a follow-up to this article in this Daily Update. Posted onTuesday, July 14, 2020Monday, August 3, 2020 Author by Ben Thompson Manage your Stratechery subscription.Over the last week, as the idea of banning TikTok in the U.S. has shifted from a fringe idea to a seeming inevitability (thanks in no small part to India’s decision to do just that), those opposed to the idea and those in support seem to be talking past each other. The reasons for this disconnect go beyond the usual divisions in tech, culture, and national security: what makes TikTok so unique is that it is the culmination of two trends: one about humans and the Internet, and the other about China and ideology.The Analog WorldIt is always tricky to look at the analog world if you are trying to understand the digital one. When it comes to designing products, a pattern you see repeatedly is copying what came before, poorly, and only later creating something native to the medium.Consider text: given that newspapers monetized by placing advertisements next to news stories, the first websites tried to monetize by — you guessed it — placing advertisements next to news stories. This worked, but not particularly well; publishers talked about print dollars and digital dimes, and later mobile pennies. Sure, the Internet drew attention, but it just didn’t monetize well.What changed was the feed, something uniquely enabled by digital. Whereas a newspaper had to be defined up-front, such that it could be printed and distributed at scale, a feed is tailored to the individual in real-time — and so are the advertisements. Suddenly it was print that was worth pennies, while the Internet generally and mobile especially were worth more than newspapers ever were.At the same time, while mediums change, humans remain the same, and here analog history is helpful; last month I pointed out that while newspaper revenue grew throughout the latter half of the 20th century, circulation actually fell. It’s the same story when it comes to newspapers’ overall share of advertising:Assuming that advertising revenue is a reasonable proxy for attention, it turns out that humans like pictures more than text, and moving pictures most of all; so it has gone on the Internet. Once Facebook introduced the news feed the company quickly figured out that photos drove much more engagement; that meant that Instagram, a fledgling social network made of nothing but photos, was a tremendous threat and, once acquired, a tremendous opportunity.Four years later, it was Instagram that Facebook used to counter Snapchat’s Stories feature, an even more immersive way of interacting with content than the feed. The point was not to win users back from Snapchat, but to prevent Instagram users from even trying Snapchat out; the gambit succeeded beautifully.The Rise of TikTokThe rise of TikTok, though, suggests that Facebook didn’t learn the correct lesson from the Snapchat threat: while part of Snapchat’s allure was the possibility of creating a new network in an app predicated on chat and disappearing media, what made Stories particularly compelling is that the experience was closer to video. That meant there was an opportunity to focus on specifically that.Of course Facebook had spent plenty of time trying to get video to work in its feed; flush with money from its targeted feed-based advertising the company lurched from initiative to initiative predicated on encouraging professional video makers to focus on Facebook instead of YouTube. The error the company made is obvious in retrospect: what has always made Facebook powerful is that its most valuable content is generated by its own users, yet the company was counting on 3rd-parties to make compelling videos.You can understand Facebook’s thinking: while it is easy for users to create text updates, and, with the rise of smartphones, even easier to create pictures, producing video is difficult. Until recently, phone cameras were even worse at video than they were photos, but more importantly, compelling video takes some degree of planning and skill. The chances of your typical Facebook user having a network full of accomplished videographers is slim, and remember, when it comes to showing user-generated content, Facebook is constrained by who your friends are (the company got busted by the FTC for trying to switch posts from private to public).All of this explains what makes TikTok such a breakthrough product. First, humans like video. Second, TikTok’s video creation tools were far more accessible and inspiring for non-professional videographers. The crucial missing piece, though, is that TikTok isn’t really a social network.ByteDance and the AlgorithmThis is where it is important to understand the history of ByteDance, TikTok’s Chinese owner. ByteDance’s breakthrough product was a news app called TouTiao; whereas Facebook evolved from being primarily a social network to an algorithmic feed, TouTiao was about the feed and the algorithm from the beginning. The first time a user opened TouTiao, the news might be rather generic, but every scroll, every linger over a story, every click, was fed into a feedback loop that refined what it was the user saw.Meanwhile all of that data fed back into TouTiao’s larger machine learning processes, which effectively ran billions of A/B tests a day on content of all types, cross-referenced against all of the user data it could collect. Soon the app was indispensable to its users, able to anticipate the news they cared about with nary a friend recommendation in sight. That was definitely more of a feature than a bug in China, where any information service was subject to not just overt government censorship, but also an expectation of self-censorship; all the better to control everything that end users saw, without the messiness of users explicitly recommending content themselves (although that didn t prevent ByteDance CEO Zhang Yiming from having to give a groveling apology for giving users too much low-brow content).ByteDance’s 2016 launch of Douyin — the Chinese version of TikTok — revealed another, even more important benefit to relying purely on the algorithm: by expanding the library of available video from those made by your network to any video made by anyone on the service, Douyin/TikTok leverages the sheer scale of user-generated content to generate far more compelling content than professionals could ever generate, and relies on its algorithms to ensure that users are only seeing the cream of the crop. I noted while explaining what Quibi got wrong: The single most important fact about both movies and television is that they were defined by scarcity: there were only so many movies that would ever be made to fill only so many theater slots, and in the case of TV, there were only 24 hours in a day. That meant that there was significant value in being someone who could figure out what was going to be a hit before it was ever created, and then investing to make it so. That sort of selection and production is what Katzenberg and the rest of Hollywood have been doing for decades, and it’s understandable that Katzenberg thought he could apply the same formula to mobile. Mobile, though, is defined by the Internet, which is to say it is defined by abundance…So it is on TikTok, or any other app with user-generated content. The goal is not to pick out the hits, but rather to attract as much content as possible, and then algorithmically boost whatever turns out to be good…The truth is that Katzenberg got a lot right: YouTube did have a vulnerability in terms of video content on mobile, in part because it was a product built for the desktop; TikTok, like Quibi, is unequivocally a mobile application. Unlike Quibi, though, it is also an entertainment entity predicated on Internet assumptions about abundance, not Hollywood assumptions about scarcity.To summarize:Humans prefer video to photos to textTikTok makes it easy to create videos, ensuring a massive supply of content (even if most of the supply is low quality)TikTok relies on the algorithm to surface compelling content, and is not constrained by your social networkThis both explains why TikTok succeeds, and why it is an app the United States ought to be concerned about.China’s WarIt was just over a year ago, after the U.S. government placed restrictions on selling components to Huawei, that I pushed back on declarations that tech was entering a cold war: This is where I take the biggest issue with labeling this past week’s actions as the start of a tech cold war: China took the first shots, and they took them a long time ago. For over a decade U.S. services companies have been unilaterally shut out of the China market, even as Chinese alternatives had full reign, running on servers built with U.S. components (and likely using U.S. intellectual property). To be sure, China’s motivation was not necessarily protectionism, at least in the economic sense: what mattered most to the country’s ruling Communist Party was control of the flow of information. At the same time, from a narrow economic perspective, the truth is that China has been limiting the economic upside of U.S. companies far longer than the U.S. has tried to limit China’s.I can’t emphasize this point enough: one of the gravest errors made by far too many people in the U.S. is taking an exceptionally self-centered view of U.S.-China relations, where everything is about what the U.S. says and does, while China is treated like an NPC. Indeed, it is quite insulting to China, a great nation with a history far longer than that of the United States.To that end, this long history looms large in how China thinks about its relationship to the U.S. specifically, and the West generally. China is driven to reverse its “century of humiliation”, and to retake what it sees as its rightful place as a dominant force in the world. What few in the West seem to realize, though, is that the Chinese Communist Party very much believes that Marxism is the means by which that must be accomplished, and that Western liberal values are actively hostile to that goal. Tanner Greer wrote in Tablet: Xi Jinping endorsed this explanation for the Soviet collapse in a 2013 address to party cadres. “Why did the Soviet Union disintegrate?” he asked his audience. “An important reason is that in the ideological domain, competition is fierce!” The party leadership is determined to avoid the Soviet mistake. A leaked internal party directive from 2013 describes “the very real threat of Western anti-China forces and their attempt at carrying out westernization” within China. The directive describes the party as being in the midst of an “intense, ideological struggle” for survival. According to the directive, the ideas that threaten China with “major disorder” include concepts such as “separation of powers,” “independent judiciaries,” “universal human rights,” “Western freedom,” “civil society,” “economic liberalism,” “total privatization,” “freedom of the press,” and “free flow of information on the internet.” To allow the Chinese people to contemplate these concepts would “dismantle [our] party’s social foundation” and jeopardize the party’s aim to build a modern, socialist future. Westerners asked to think about competition with China — a minority until fairly recently, as many envisioned a China liberalized by economic integration — tend to see it through a geopolitical or military lens. But Chinese communists believe that the greatest threat to the security of their party, the stability of their country, and China’s return to its rightful place at the center of human civilization, is ideological. They are not fond of the military machines United States Pacific Command has arrayed against them, but what spooks them more than American weapons and soldiers are ideas—hostile ideas they believe America has embedded in the discourse and institutions of the existing global order. “International hostile forces [seek to] westernize and divide China” warned former CPC General Secretary Jiang Zemin more than a decade ago, and that means that, as Jiang argued in a second speech, the “old international political and economic order” created by these forces “has to be changed fundamentally” to safeguard China’s rejuvenation. Xi Jinping has endorsed this view, arguing that “since the end of the Cold War countries affected by Western values have been torn apart by war or afflicted with chaos. If we tailor our practices to Western values The consequences will be devastating.”This is why it was not enough for China to have blocked Western social networks like Facebook or Twitter within China, but to also demand that Western entities like the NBA police Twitter content in the United States; I wrote at the time: The problem from a Western perspective is that the links Clinton was so sure would push in only one direction — towards political freedom — turned out to be two-way streets: China is not simply resisting Western ideals of freedom, but seeking to impose their own.This understanding of China’s belief that it is fighting an ideological war explains why the severe curtailing of freedom that happened in Hong Kong this month was inevitable; if the Party’s ideology is ultimately opposed to liberalism anywhere, “one country-two systems” were always empty words in service of China’s rejuvenation, and Marxism’s triumph. To see that reality, though, means taking China seriously, and believing what they say.TikTok and DataIn that light, the latest TikTok news missed the mark, and ultimately, missed the point; from the New York Times: Amazon on Friday asked its employees to delete the Chinese-owned video app TikTok from their cellphones, putting the tech giant at the center of growing suspicion and paranoia about the app. Almost five hours later, Amazon reversed course, saying the email to workers was sent in error. In the initial email, which was obtained by The New York Times, Amazon officials said that because of “security risks,” employees must delete the app from any devices that “access Amazon email.” Employees had to remove the app by Friday to remain able to obtain mobile access to their Amazon email, the note said.While traditional applications on Macs or PCs had full access to your computer — including your email — on modern smartphones apps exist in “sandboxes”, which, as John Gruber and I discussed on Dithering, are much more akin to a vault or a prison; apps can only access their own data, and a limited set of external data to which they are explicitly granted permission. In other words, banning TikTok because it is surreptitiously stealing your email doesn t make technical sense.That is not to say that TikTok is not capturing data: it is vacuuming up as much as it can, from your usage to your IP address to your contacts and location (if you gave the app permission). This, as many TikTok advocates note, is similar to what Facebook does.This, to be clear, is absolutely true. It is also at this point where important differences emerge. First, Facebook is a U.S. company, and while TikTok claims that it is independent from ByteDance and stores data in the U.S. and Singapore, its privacy policy is clear: We may share your information with a parent, subsidiary, or other affiliate of our corporate group.That means that TikTok data absolutely can be sent to China, and, it is important to note, this would be the case even if the privacy policy were not so honest. All Chinese Internet companies are compelled by the country s National Intelligence Law to turn over any and all data that the government demands, and that power is not limited by China s borders. Moreover, this requisition of data is not subject to warrants or courts, as is the case with U.S. government requests for data from Facebook or any other entity; the Chinese government absolutely could be running a learning algorithms in parallel to ByteDance s on all TikTok data.If anything it would be a something of a surprise were it not; an important piece of China s thousands of years of history is the presence of a bureaucracy focused on collecting data on, well, everyone and everything. I see examples of it here in Taiwan, where my household is registered, cameras are everywhere (and routinely accessed), and cellphone data is a pandemic fighting tool, and this is a democratic country based on liberal values. China, which combines this tradition with a totalitarian government, takes data collection to the max. Facial recognition is omnipresent, nearly all transactions, even in the real world, are digital, and social networks like WeChat are completely open to censors, both from Tencent and the government; the government even hacks your computers as a matter of policy. Given this reality it is completely reasonable to be concerned about TikTok data!That, though, is not the primary risk: what should truly concern Americans is the algorithm.TikTok s AlgorithmLast month, after President Trump held a rally in Tulsa with a far-smaller crowd than he anticipated, the New York Times suggested that TikTok might be responsible: President Trump’s campaign promised huge crowds at his rally in Tulsa, Okla., on Saturday, but it failed to deliver. Hundreds of teenage TikTok users and K-pop fans say they’re at least partially responsible… TikTok users and fans of Korean pop music groups claimed to have registered potentially hundreds of thousands of tickets for Mr. Trump’s campaign rally as a prank. After the Trump campaign’s official account @TeamTrump posted a tweet asking supporters to register for free tickets using their phones on June 11, K-pop fan accounts began sharing the information with followers, encouraging them to register for the rally — and then not show.Leaving aside whether or not the TikTok campaign or coronavirus concerns were responsible for the low turnout, I actually am inclined to believe that this movement on the video service was genuine. It is important to note, though, that there is no way we can know for sure, and, to the extent that TikTok actually did have an impact on the rally, that should frighten people of all political persuasions.After all, this certainly wasn t the first time that TikTok has seemed to act politically: the service censored #BlackLivesMatter and #GeorgeFloyd, blocked a teenager discussing China s genocide in Xinjiang, and blocked a video of Tank Man. The Guardian published TikTok guidelines that censored Tiananmen Square, Tibetan independence, and the Falun Gong, and I myself demonstrated that TikTok appeared to be censoring the Hong Kong protests and Houston Rockets basketball team.The point, though, is not just censorship, but its inverse: propaganda. TikTok s algorithm, unmoored from the constraints of your social network or professional content creators, is free to promote whatever videos it likes, without anyone knowing the difference. TikTok could promote a particular candidate or a particular issue in a particular geography, without anyone — except perhaps the candidate, now indebted to a Chinese company — knowing. You may be skeptical this might happen, but again, China has already demonstrated a willingness to censor speech on a platform banned in China; how much of a leap is it to think that a Party committed to ideological dominance will forever leave a route directly into the hearts and minds of millions of Americans untouched?Again, this is where it is worth taking China seriously: the Party has shown through its actions, particularly building and maintaining the Great Firewall at tremendous expense, that it believes in the power of information and ideas. Countless speeches, from Chairman Xi and others, have stated that the Party believes it is in an ideological war with liberalism generally and the U.S. specifically. If we are to give China s leaders the respect of believing what they say, instead of projecting our own beliefs for no reason other than our own solipsism, how can we take that chance?A Reluctant PrescriptionI am not a China absolutist; to give one timely example, while I mourn the end of a free and vibrant Hong Kong that I have had the pleasure of visiting on multiple occasions, I am unmoved by complaints about China s promised adherence to the Basic Law; it has become clear that was a means to the end of reclaiming Hong Kong from a colonial power,1 and Hong Kong is unquestionably a Chinese city, ultimately subject to Chinese law. Similarly, I abhor and condemn and encourage all to speak out about what is happening to Uighur s in Xinjiang, but I am not counseling U.S. intervention.What is increasingly clear, though, is that China s insistence that the West ignore the country s internal affairs is a sentiment that is not reciprocated; the list of Western companies bullied by China for Western content is long and growing, the country is flooding Twitter and Facebook with coronavirus propaganda, and is leveraging WeChat to spread misinformation and to surveil the Chinese diaspora.In short, I believe it is time to take China seriously and literally: the Communist Party is not only ideologically opposed to liberalism, it believes that only one of liberalism or Marxism can prevail. To that end it has been taking action for over 20 years to control information within its borders and, over the last several years, to control information outside of its borders. It is time for the U.S. to respond, both on the government level and corporate level, and it should do so in a multi-faceted fashion.First, data security is absolutely a concern. To that end all companies that deal with valuable intellectual property or national security-related information should ban the use of WeChat by any of their employees, as should the government; it is simply too easy to pass information, even by accident. In addition, that same group of companies and governments should not use Zoom until the (American) company has shifted the bulk of its engineering out of China and demonstrated vastly improved corporate controls.What matters more in an ideological war, though, is influence, and that is why I do believe that ByteDance s continued ownership of TikTok is unacceptable. My strong preference would be for ByteDance to sell TikTok to non-Chinese investors or a non-Chinese company, by which I mean not-Facebook. TikTok is not only a brilliant app that figured out video on mobile, it is also shaping up to be a major challenge to Facebook s hold on attention and thus, in the long run, advertising. This would be a very good thing, and I fear that simply banning TikTok will simply leave the market to Instagram Reels, Facebook s TikTok clone.However, if ByteDance is unwilling to sell, then the U.S. government should be willing to act. One possible route is a review of ByteDance s acquisition of Musical.ly by the Committee on Foreign Investment in the United States (CFIUS), or invoking the International Emergency Economic Powers Act (IEEPA), which would require declaring a national emergency; I would prefer that Congress take the lead. What is notable is that because of the dominance of the iOS App Store and Google Play Store there is no need for an ISP-level firewall; Apple and Google can not only remove TikTok from the App Store, they could, if ordered, make already-installed apps unusable.This is, without question, a prescription I don t come to lightly. Perhaps the most powerful argument against taking any sort of action is that we aren t China, and isn t blocking TikTok something that China would do? Well yes, we know that is what they would do, because the Chinese government has blocked U.S. social networks for years. Wars, though, are fought not because we lust for battle, but because we pray for peace. If China is on the offensive against liberalism not only within its borders but within ours, it is in liberalism s interest to cut off a vector that has taken root precisely because it is so brilliantly engineered to give humans exactly what they want.I wrote a follow-up to this article in this Daily Update.This originally said, “that was an agreement imposed on China by a colonial power” which is not technically correct; the point I was trying to make is that China promulgated the Basic Law as a response to British rule, not because it believed in it [ ] On Exponent, the weekly podcast I host with James Allworth, we discuss the Indian internet, TikTok, and whether or not the U.S. should ban it.Listen to it here. Posted onTuesday, July 7, 2020Thursday, July 9, 2020 Author by Ben Thompson Manage your Stratechery subscription.On November 2, 2016, Microsoft announced Teams at a special event in New York City. Slack decided to mark the occasion:That feeling when you think we should buy a full page in the Times and publish an open letter, and then you do.

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