technology

Tech's Biggest Fear: Lack Of Growth Opportunities (Part 2)

This is the second article in a 2-post series — the first one covering Facebook can be found here.

When I was originally planning this series, I wanted to cover — and contrast — two companies that had recently started to experience peculiarly similar issues, but in my mind were nonetheless facing completely different challenges and outcomes going forward, despite some obvious similarities in their current states, thus creating an interesting case for comparison. Those companies were Facebook and Apple.

I’ already wrote a lengthy post about Facebook a few weeks back, and given how some of the recent developments made parts of my Apple write-up unnecessary (as the things I intended to cover have already played out), so I decided to make this post a bit less focused on the stock valuation aspects, and instead to spend more time brainstorming on the challenges and opportunities I believe Apple is going to face going forward.

Apple: a trillion dollar company of a single product

Today, Apple’s story is almost legendary — the company almost went bankrupt in 1997, and was worth less than $5 billion in 2000, but then went on to rise to the valuation of $150 billion by 2007, and then again to the top spot of the most valuable publicly traded company in the world in 2012, finally becoming the first publicly traded company to surpass the coveted $1 trillion number.

While one might argue that Apple started on the path of becoming the company it is today with the launch of iMac in 1998, it seems a bit more fair to say that it was actually the iPod, announced in 2001, that clearly signaled the beginning of the new era for Apple, followed by iTunes Store (called “iTunes Music Store” back then) that launched in 2003, and finally, the original iPhone, introduced in 2007. From there, Apple has gone to become the most valuable company in the world and has built what it is perhaps the largest (and for sure the most profitable) consumer tech business of all times, culminating with its market capitalization surpassing $1.1 trillion by the end of September 2018.

And yet, after the announcement of Q3 results (well, Q4 in Apple’s case, because of how its financial year aligns to the calendar one) on November 1, its share price fell more than 7%, constituting the worst decline since 2014, amidst a widespread investor backlash around Apple’s decision to stop reporting the number of devices sold starting next quarter.

So far, the stock price hasn’t demonstrated any signs of recovery; instead, the ensuing news about weaker than anticipated demand for new iPhones dragged the stock price even lower, and as of the close yesterday (December 17), Apple's stock was worth less than $164, down almost 30% from its 52-week high of $233.47 (to be fair, part of the decline could be attributed to the horrible performance of the broader markets in the last few months, but still, Apple’s stock performance was much worse compared to the overall market in that time frame). This decline led Apple to lose the top spot as the most valuable company, passing this title, as luck would have it, to Microsoft, which weathered the volatility of the last few months somewhat better than other big tech companies.

It’s not particularly hard to figure out the nature of the issue Apple’s facing — in fact, it can be summarized in a single chart:

Source:   Statista.com

Source: Statista.com

As you can see here, it’s been now 4 years since the number of iPhones sold has delivered any growth, which, coupled with the fact that iPhone sales account for about 60% of Apple’s overall revenue, poses an obvious problem for the company.

Over the last year or so, the introduction of iPhone X, and then of iPhones XS and XS Max, has helped the company to temporarily address those concerns by substantially increasing the average selling price of an iPhone ($793 in Q4 2018, vs. only $618 a year ago). Still, the broader issue remains largely unsolved — with iPhone sales stagnant, and iPhone accounting for such a large percentage of the overall revenue, it’s hard to see how Apple could continue to deliver substantial revenue growth in the years to come. The revenue growth driven by the increase in the average device price came in handy (and helped Apple’s stock price to continue rising for these last few years), but there had to be a natural limit to how much Apple could possibly increase the prices before hitting the ceiling, and now, with nearly $800 in average selling price, it seems the ceiling might finally be close — the most recent news about less than stellar sales of the new, more expensive than ever, iPhones have further confirmed this hypothesis, and led to the extremely sharp decline of the stock price we’ve witnessed over the last few months.

To that point, this is why Apple’s decision to stop reporting the number of devices sold is viewed as troubling by the investors. Even taking Apple’s argument that the number of devices no longer provides a good estimate of the company’s performance at its face value, there would be no reason for it to get rid of this metric now, unless the company doesn’t expect any further substantial and sustained increases in either the number of devices sold, or the average selling price (and thus would then prefer to altogether stop reporting numbers that are set to lack growth)

Finding new growth points

In many ways, the problems Facebook and Apple are currently experiencing are of the same nature. Both companies have sustained impressive growth rates for years, but now, nearing the saturation point, are facing limits to this growth. Both have done a great job monetizing their existing user base, but have no obvious way to continue growing these revenues indefinitely (the situation is a bit more nuanced for Facebook, where this argument mostly applies to its user base in the incumbent markets; more on that later). Finally, both are heavily dependent on a single product generating the majority of their revenues and profits.

And yet, despite all those similarities, what I personally find interesting here is that the future opportunities that Facebook and Apple are facing are actually vastly different. This is also the reason why I’ve previously mentioned that I wanted to compare and contrast these companies — in my opinion, the markets were right to significantly discount Apple’s stock over the last few months (moreover, the previous expansion of P/E multiple in the last few years had been largely unwarranted); on the contrary, Facebook, in my mind, remains to be one of the most undervalued big tech companies right now.

Let’s dig a bit more into that, starting with Facebook. The company effectively holds a monopoly in the social media space: it owns two of the most popular social networks and the most popular global messenger app. While it might be facing limited growth opportunities in North America, it continues to grow its user base in other markets — one might argue that currently, Facebook isn’t doing a great job monetizing its user base outside of North America and Europe, but that could also be viewed as an opportunity, given that Facebook isn’t facing competitive pressure and isn’t losing its users because of its monopoly position in most markets — despite all the recent outrage against Facebook, most users simply have nowhere to go.

Now compare this to Apple. The company is heavily dependent on the sales of a single hardware product (iPhone) that is facing both the ever-increasing competition from Android phones, and also the longer upgrade cycles, simply because the smartphone category is now mature, and the users don’t feel any significant pressure to upgrade frequently. The lock-in effect of Apple ecosystem that helped the company to cross-sell its products is mostly gone — today, nobody has to use iTunes to update iOS devices or to download content on the devices (which arguably acted as a central hub, effectively locking you in the iOS ecosystem, not to mention helping to boost the sales of laptops and desktops running MacOS, considering how terrible iTunes experience on Windows was at one point); besides that, most applications are now cross-platform and sync to the cloud, making switching devices, even the ones running different operating systems, much easier.

True, iPhone as a product still has an army of loyal followers (with me being one of them, actually) and remains one of the best smartphones available in the market. It also continues to benefit from a substantial lock-in effect created by the easy migration to the newest device, and the app ecosystem (on the surface, this statement might seem contradictory to what I wrote in the previous paragraph, but it’s not: what’s gone — and what I was talking about in the previous paragraph — is the opportunity to sell more iPads or MacBooks to people who use iPhones simply because of this fact). So I personally wouldn’t expect iPhone sales to decline going forward, but there is also no substantial opportunity to sell more of them, and, judging by the events of this fall, the opportunity to continue to grow the average price is most likely gone too.

This leaves Apple in a precarious state, as it really needs to find new growth opportunities. Let’s now take a quick look into what those might be.

Services. The revenue from Services in Q4 FY18 reached $10 billion, or 16% of total revenues, — this includes revenue from App Store, AppleCare, Apple Pay, and Apple Music. Apple is forecasting that the revenue drawn from the Services would increase to $14 billion per quarter by FY20, and Morgan Stanley predicts that the revenue growth for the Services would constitute more than 50% of the total revenue growth for Apple going forward, with the idea that the potential for Apple to improve monetization of their existing users, as well as to add additional revenue streams, is very significant.

To be honest, I find this outlook to be all too rosy. It’s true that Apple has already built a truly humongous business in Services (especially with App Store and iTunes/Apple Music), and has the potential to grow it further over time. However, there are several factors that could make scaling Services business at a fast pace challenging, to say the least.

First of all, the idea that Apple’s currently under-monetizing its user base is, in my mind, a fallacy. Unlike Facebook, that doesn’t sell anything to its users, but rather essentially sells their eyeballs to the advertisers (and thus can indeed improve revenue per user, as long as there is sufficient demand from the advertisers, and the space on their website/mobile app to add additional advertisements without ruining user experience), for Apple to improve its user monetization, it needs to sell additional services directly to its users. The problem is, in most cases Apple users aren’t restricted to purchasing their content from Apple, and chances are, if they are interested in certain services, they are already spending their money elsewhere — which means that in order for Apple to grow its Services revenue (esp. without the corresponding increase in hardware sales, and thus the overall user base), it has to convince those users to abandon whatever service providers they are currently using (such as Spotify/Netflix/Amazon), and switch to Apple offerings instead. To an extent, this is a zero-sum game, and it’s not easy to win it, as was demonstrated, for example, by the fact that Spotify user base continues to be substantially larger than Apple’s, despite a huge number of iOS devices that come with pre-installed Apple Music, and years of efforts spent to promote Apple Music on Apple’s part.

The second issue is that Apple simply wasn’t built with the idea of selling Services in mind. Its highly secretive, centralized and hierarchical environment is very well-suited for the purpose of building the best hardware devices, where Apple controls all the aspects of user experience, both on the hardware and software side. However, building a successful Services business is a different story altogether. So far, Apple has proved that it can do a good job curating a catalog of content (meaning App Store and iTunes), and collecting a percentage of revenues from any sales, but, for example, creating a video streaming service would mean competing against extremely data-driven and highly flexible competitors like Netflix and Amazon, which might prove to be very challenging for Apple, not to mention that Apple’s desire to decide what types of content are allowed to be present on its platforms can prove to be really harmful here, as its competitors aren’t held by any such considerations, and there is no evidence that users would appreciate those.

Finally, while the marketplace model of App Store and iTunes remains highly profitable for Apple, that wouldn’t necessarily be the case for the new businesses such as streaming services — Spotify and Netflix can be viewed as two representative examples, with the first company yet to break-even, and the second turning in minuscule profits, while also being saddled with significant debt ($8 billion+ as of September, and counting). What’s even more important, some of the key players in the market (see Amazon) don’t actually need to make their streaming services profitable, — instead, they might offer such services to improve customer retention, and deepen their relationship with the users. The same strategy, in principle, could work for Apple as well, as long as the sales of hardware continued to rise, but it becomes a problem if Services business is now regarded as a growth opportunity for a company whose investors are accustomed to high margins.

iPad. In itself, iPad sales (or the overall tablet market) are unlikely to grow much — while iPad’s initial success had gotten a lot of people to expect tablets to eventually overshadow the traditional PC industry in a similar fashion to what happened with the smartphones, that never came to pass, and over the last few years tablet sales have been largely stagnant or even declining. Part of this is simply the result of the lifecycle of tablets turned out to be much longer than previously thought. Another reason is that the truly valuable use cases for tablets have simply never materialized — the basic entertainment functionality doesn’t require purchasing the newest and most powerful hardware (not to mention that the never-ending increases in smartphone screen sizes turned the category into a formidable competitor to tablets), and the limitations of mobile operating systems restricted the opportunities to abandon laptops in favor of tablets (the fact that the two-in-one devices from Microsoft and its partners offering a combination of full-scale desktop OS experience and tablet inputs continued to get better didn’t help either).

However, I believe that the recent developments in the tablet space have created an interesting and unexpected opportunity that, if executed in the right fashion, might open a valuable new market for Apple.

Gaming. The third generation of iPad Pro that was released earlier this year was equipped with A12X chips — a proprietary 64-bit system on a chip developed by Apple and currently used to power both iPhones and iPads. Apple’s CPUs had been getting better and better throughout the last few years, but the truly outstanding performance of the latest chips was nonetheless a surprise — according to some tests, iPad Pro now boasts a performance comparable to that of the latest generation of 13-inch MacBook Pro which is powered by the most recent Intel processors belonging to the Coffee Lake series. In my mind, this achievement could now open a path to some pretty exciting new opportunities for Apple.

The gaming industry in 2017 was approaching $110 billion in annual revenues, with Mobile accounting for $46 billion (tablets brought in a bit less than 25% of that), and consoles representing the second largest segment, estimated at $33.5 billion. Apple already draws very decent revenues from gaming on smartphone and tablets, but the incredible performance of its newest chips, coupled with the success that Nintendo Switch has seen over the last 2 years (it sold 20 million devices in 15 months, which, according to some estimates, is on par or better than the sales numbers for PS4 at the same point of its lifecycle), indicates that there is a very clear demand for a more serious portable gaming devices, and Apple might just have the tech necessary to build such product.

To be fair, I am not saying that this would be easy to do, or that Apple is necessarily the right company to execute on such an opportunity. Building a console business would likely require Apple to learn how to collaborate with the largest game studios much more closely than it currently does, and possibly would also mean that it would need to build its own production and publishing business, similar to what Microsoft currently does with Microsoft Studios; it might also face challenges creating a device that provides gamers with an experience comparable or superior to the one currently offered by the Switch, given Apple’s relative lack of expertise in the field (although it’s worth noting that Apple already made a couple of attempts to expand into the space, so it won’t be completely clueless).

And yet, I would argue that Apple stands a much better chance of expanding its presence in gaming, than it does, say, building a successful streaming service, as its success in gaming would rely on the very same capabilities that made Apple so successful in the first place, namely, manufacturing a hardware product that offers users a superior experience through a tight integration of hardware and software, whereas creating a streaming service (and the same is true for some of the other businesses that can be classified as Services) often requires capabilities that Apple currently doesn’t possess.

The final question here would be, if Apple enters the console gaming space and manages to build a successful presence there, would it help the company to alleviate concerns about future growth? That remains to be seen: first of all, right now Apple hasn’t publicly announced any intention to do so, therefore, everything described above remains speculation on my part. Second, even if it manages to eventually replicate the success of Nintendo Switch, it would still need to build a huge business in the area for it to start making a difference in the broader context of the company’s financial performance.

To put Nintendo Switch numbers into context, 20 million devices sold at $300 retail price means bringing in $6 billion in revenues, which is a great deal of money for Nintendo, but not so much for Apple — therefore, it would likely need to do even better for this opportunity to be really worth it. However, the Gaming market is growing at a healthy pace, and the revenues from devices are not the only possible revenue stream here (production and publishing of gaming is another one; so is streaming), so in the long term, it might indeed turn out to be Apple’s best bet for growth.

MacOS. I believe the chance that macOS would present any substantial growth opportunities for Apple going forward is very low; rather, it’s actually much more probable that the revenue share of the desktops and laptops in the overall mix would continue to decline. The introduction of iMac Pro in 2017 represented an interesting development, but it remains a niche product, with limited appeal to the wider audience, and the rest of the updates over the last few years were thoroughly unexciting. There is a small chance that the rumored upcoming switch to ARM processors would help Apple to create a more differentiated offering in the space, but even then, the chances of a substantial growth coming from this segment remain slim.

Apple Watch and AirPods. Apple Watch is arguably the most successful wearable device today, but at this point, the category is fairly mature, and while in Q4 FY18 Apple reported a 50% growth in revenues for the category year over year, going forward the growth would be slower.

AirPods, however, represent a different case — according to some estimates, Apple will sell 26 to 28 million units in 2018, vs. 14 to 16 million in 2017, which represents a growth rate of 62% to 100%, and could continue to aggressively grow the category, potentially reaching 100 to 110 million units in annual sales by 2021. If that turns out to be the case, Apple could draw an annual revenue of up to $18 billion from this category.

On the surface, that’s a huge number, but in Apple’s case, the same argument I made about Gaming above applies here: even $18 billion in annual revenues would constitute only about 6.5% of Apple’s total revenue for FY 2018, and 6.1% of $294 billion in revenues forecasted by Morgan Stanley for 2021, which means that AirPods, however successful, might not become a category that is large enough to make a real difference going forward. Still, right now, AirPods might actually be Apple’s best bet for short-term growth.

And this brings us to the final conclusion:

Facing the future

In my opinion, it would be a mistake to either underestimate or overestimate the scale and seriousness of the challenges Apple’s facing today. On the one hand, Apple today remains one of the most successful tech companies in the world, and it is highly likely that the business it has built will continue to bring in huge profits for years to come, — to that point, the predictions of Apple’s inevitable demise are very unlikely to materialize. On the other hand, tech companies today are to a very significant extent judged by their ability to continue to grow (indefinitely, if possible), and that’s where Apple is likely to face serious, if not altogether insurmountable, challenges.

Yes, there are some promising opportunities that the company can execute upon with its existing products and capabilities — Gaming and AirPods being the two that in mind represent the most attractive targets. But even if both of those would pan out, the main issue Apple is facing today stems from its sheer size — it is really hard to find opportunities that are large enough to make a difference for a company with an annual revenue of over $260 billion (with AirPods being a great illustration of the issue - even if the wildest forecasts would prove to be true, it would remain a small percentage of the company’s overall revenue).

What Apple really needs, if it has any hopes of continuing to grow at the pace it has enjoyed over the last 15 years or so, is to find another opportunity of the iPhone-like size that also aligns well with the company’s know-how and the organizational capabilities. The problem is, such opportunities are so extremely rare that there is simply no guarantee that one would emerge over the next decade, not to mention that even if it does, there is a good chance that Apple wouldn’t be the best organization to act upon it. And this is the key thing that distinguishes Apple from Facebook — the latter doesn’t really need to go look for new opportunities (not that they shouldn’t search for those, of course, but there is no immediate pressure to do so), but rather has the luxury to focus on their existing products, while for Apple it is an economic imperative, if the company wants to continue to grow.

Disclosure: This article expresses my own opinions, and my opinions only. I am not receiving any compensation for it. I have no business relationship with either Facebook or Apple. I hold no position in Apple stock, and a long position in Facebook stock, and have no plans to adjust those positions or initiate new ones within the next 72 hours.

Amazon's HQ2: Why Blaming The Company Misses The Point

Not to worry, the second part of my previous post is coming, but today I wanted to focus on a different topic altogether — that is, on Amazon HQ2 announcement.

As I am sure most of you have heard by now, Amazon finally announced the location of its HQ2 yesterday, which, after all, isn’t going to be exactly an HQ2 (surprise!). Instead, the company has decided instead to split the jobs between Crystal City in Northern Virginia and Long Island City in Queens. This news was met, well, unfavorably by most, to say the least.

HQ1, HQ2, HQ[X]?

Perhaps the first thing one would notice is the outrage over the fact that HQ2 ended up being, well, not exactly a full-blown HQ. On the surface, that’s a fair thing to fume about — after all, Amazon has spent over a year promoting their plans to create a huge office that would be comparable to its current base in Seattle both in terms of influence and the number of jobs, and the company has obviously used such framing to try and extract concessions from the cities lining up to compete for the opportunity, which again might justify the outrage over the fact that there would actually be no HQ2, at least not as it has been previously described.

That being said, focusing too much on this would mean missing two important points. First, if we are really talking about the global headquarters here, there is simply no such thing as a second headquarters, no matter the rhetoric. Instead, the global headquarters is by definition a singular phenomenon, and Amazon is by now so deeply rooted in Seattle that no other office would stand a chance to assume a comparable position, no matter how large it would be. And while one might argue that if that’s the case, then it was from the start deceptive of Amazon to describe their plans for a new office in a way they did, this point is so simple that the only people who might have been deceived by Amazon’s marketing spiel, were, well, willing to be deceived in the first place.

With that comes the second point — while there is no such thing as the second HQ, you don’t really need to have the same number of jobs as the original HQ to wield a very significant influence over the company — just take a look at Google Zurich office, for example, which houses only about 2,000 employees, but still managed to gain a wide recognition as a very well-respected engineering & research location, wielding significant influence over the company. And there are many more examples like that.

So, if the influence is what you’re after, how many jobs your local office houses doesn’t really matter that much — rather, what really matters is the kind of those jobs, and whether there is a substantial number of them are in engineering, research, and product, not just sales and marketing — which is not to say that those jobs are in any way less important — but it’s often the engineering jobs (or lack thereof) that define the nature of the office. Quantity should really be at best a second priority here.

In any case, I find the statement that going from the initially promised 50,000 jobs in one city to 25,000 in two of them somehow changes the nature of those offices and turns them into “glorified satellite offices” to be quite ridiculous. To my knowledge, no tech company today has offices even remotely approaching this size — again, just as an example, Google in NYC has recently stated that it plans to grow to (only) 14,000 employees in the 10 years — so there is simply no point of reference to use to judge what those offices might turn into, but, if anything, it seems highly unlikely that an office of 25,000 corporate jobs would ever be reduced to being a mere satellite to the headquarters.

The poisoned apple of tax subsidies

Next, the announcement has surfaced (or, rather, resurfaced) a growing wave of complaints about Amazon securing substantial tax subsidies that it doesn’t really need while putting additional strain on the already overextended infrastructure of NYC and Northern Virginia.

To that point, I am not here to argue that Amazon really needs or deserves to receive those tax subsidies (there is simply no way to objectively judge something like that in any case), or that tax incentives always work out as intended (hint: they don’t). Truth is, tax incentives can in some cases be quite harmful to the local municipalities, creating situations where they have to spread thin the tax dollars they collect from the rest of the taxpayers or even downright depleting cities’/states’ coffers in some cases (see cash grants). To echo the recent article in the Atlantic, one could make a sound argument that at least some of the tax subsidies that are currently being offered by the regional governments to woo corporations to their dominions should be made downright illegal, or at the very least frowned upon (although to be fair, that mostly applies to tax subsidies that are being used to move the existing jobs across the state lines, which is very different from creating new jobs, as is the case with Amazon here).

Still, while it might be fair to pose the question of whether the big tech companies are the best recipients of the significant tax breaks they are often able to extract from the local governments, as long as such subsidies are legal and available, it seems strange to blame Amazon, or any other company, for taking advantage of such opportunities — after all, big tech companies remain commercial entities whose key purpose for existence is to make money for their shareholders, not try and solve the complex social issues of the cities or states they happen to reside in (which, realistically, they are simply unequipped to tackle too, for all their size and power).

Moreover, tax subsidies are, well, subsidies, meaning that, at least in theory, they shouldn’t really make local budgets poorer, if set up correctly (that’s why I am personally inclined to argue that cash grants shouldn’t be classified as mere subsidies, and probably deserve to be banned altogether). It is still possible, of course, for the subsidies to become so large that the company receiving them would be essentially capitalizing on existing infrastructure and using city/state services without ever (or at least or a long time) paying its fair share for those, — but the point is, it doesn’t have to be that way. Instead, smart tax subsidies could be tied to specific KPIs, be it number of jobs created, the amounts invested in the region, or something else, essentially functioning as profit-sharing agreements between the companies and local authorities, and thus benefiting both, and it’s the job of the governments to ensure that this is indeed the case.

Going back to Amazon HQ2, if we look at the arrangement it negotiated with Long Island City as an example, the company is expected to receive up to $1.2 billion in tax subsidies over 10 years, in exchange for investing $2.5 billion in office space, and then paying up to $10 billion in taxes over the next 20 years, which roughly translates into $48,000 to $61,000 in subsidies for each of the 25,000 jobs it promised to create there, according to TechCrunch calculation. With the cited 31% tax rate for a job paying $150,000, the subsidy would translate into ~1.5 years of foregone tax revenue for the city. Is that a lot? Maybe, but I am inclined to say that that’s not necessarily an outrageous price to pay, especially taking in account all the additional spending that typically follows those high paying tech jobs (again, quoting the same article, Amazon claims that it boosted the local economy by $38 billion from 2010 to 2016).

Now, one might argue that Amazon was likely to pick up NYC for their HQ2 in any case, even if the city had decided not to offer any tax subsidies. That, of course, might be true (after all, NYC was deemed a top contender from the start), but it’s also possible that Amazon would have chosen a different location (e.g. one of those that would have still offered subsidies), and all the upside from capturing those jobs would be lost to NYC. The point is, there is simply no way of knowing this, so it all again comes down to the question of whether tax subsidies are beneficial and should remain lawful, but whatever the answer to that question, it seems reasonable that as long as those continue to exist, the companies will (and should) continue to use them, and the cities or states should continue to offer them whenever they believe it would boost their chances of securing the business — after all, that’s what rational market participants are supposed to do.

Actually, we don’t want those jobs here

Finally, the announcement led to an outcry from some of the people who live in the neighborhoods selected to house the new Amazon offices, as well as the local politicians, already blaming the company for the upcoming increases in the cost of living, and the inevitable displacement of the local communities that would come with it.

While the other two issues discussed above are rather complicated and hard to untangle (and also might justify different opinions), I find this one to be ridiculous in a sense that it completely misplaces the blame, and also risks throwing the baby with the water, metaphorically speaking.

Of course, it’s true that the ever-increasing COL is a huge issue in many places with the strong tech presence, and it’s a tragedy when people in local communities find themselves unable to stay in the neighborhoods they often spent a significant chunk of their lives in, and had no intention of leaving, if not for the rising costs. But it is hard to see how this is the fault of the companies based in those places — if anything, the blame should really lie with the local politicians (and sometimes, in the end, with the people themselves, however unfortunate that might sound), who often help to create the conditions that eventually lead to these problems in the first place.

Therefore, I am willing to argue that focusing on questioning the cities’ or states’ officials’ decisions to grant permissions to build in already congested areas, calling to investigate the reasons for the underinvestments in local infrastructure if that appears to be the case, or gathering political will to repeal regulations that prevent construction of additional housing (which often has a lot to do with the NIMBY attitudes of the locals — take SF, for example, whose ridiculous cost of living to a significant extent is a direct result of the laws passed 30 years ago that put severe restrictions on the amount of housing that could be built in any given year, coupled with the desire of those who already own real estate in the city to preserve their way of life) would do much more good than lashing out on the companies as the ultimate evil instead.

The main point, however, is to remember that in order to pull people out of poverty and help them, one still needs to command the necessary economic resources, which in turn could only come with the jobs, and, at the same time, that it’s not the job (no pun intended) of the private companies to address the broad social issues, but rather it’s the exact reason for existence of the local governments, and one of the means to achieve that is to tax the economic outputs of those companies and then responsibly spend the collected resources. This idea, however simple, seems to be escaping a lot of people lately — I’ve previously written how, for all their benefits, some of the EU members are starting to forget this, and now it increasingly seems that some parts of the U.S. are following suit. This is most unfortunate, if only for the reason that vilifying successful companies doesn’t really help to resolve any issues, and instead diverts the attention away from the real source of the problem, which could eventually deepen the issues even more, and make the processes that lead to them in the first place even more broken.

P.S. I do think that it’s possible that creating multiple relatively large offices in 2-tier tech hubs instead of putting two huge ones in the already saturated markets would have been a better idea, but I also reckon that even if Amazon had decided to do that, those would have still been the cities that are already doing quite well (Denver, Austin, etc.), and not the mid-western cities or deep south cities many hoped Amazon would help to revitalize. That, again, goes to back to a point that it’s not exactly Amazon’s job to rebuild the economies of the struggling regions, and the hard truth is that the company has to go where people who will fill the jobs it creates are or want to be, not where others need them to be.

Tech's Biggest Fear: Lack of Growth Opportunities (Part 1)

It’s been a while since I’ve published anything here — hopefully, it’ll now change. I’m looking forward to get back to writing on a regular basis, aiming for a post per week or so.

This is the first part of a 2-post series. The second article can be found here.

An IPO priced at $104 billion, followed by the company’s valuation dipping below $50 billion within 3 months, and then recouping all losses in a year, and never stopping ever since, with its valuation peaking at over $600 billion this year. Recognize the company? I bet you do — this is, of course, Facebook.

Where does one go from 2 billion users?

As with any platform relying on the advertising revenue, there are 4 key metrics Facebook’s performance relies upon: number of active users on the platform, time they spend there daily/monthly, advertising space utilization (with 2 aspects associated with it — e.g. whether it’s possible to add more advertising blocks per screen, or sell a higher percentage of the existing ones), and, finally, price per ad. It’s worth noting that the last metric — price per ad — often isn’t really an independent one, in a sense that unless the utilization is at capacity, and is coupled with excess demand, thus creating scarcity for the advertising space, it’s unlikely that price per ad would increase on its own (and even then, the price per ad is still subject to the competition from other platforms).

Source:  Facebook Q3 2018 Earnings Presentation

Source: Facebook Q3 2018 Earnings Presentation

Now, when Facebook went public in May 2012, it had around 900 million monthly active users, and a bit over $1 billion in quarterly revenue. Today, the number of users has increased to 2.27 billion, while the revenue has grown to $13.7 billion. Granted, not all in 2018 not all of Facebook’s revenue is coming from Facebook.com — while the company doesn’t break out Instagram’s revenue, it’s estimated to have reached about $2 billion per quarter this year, and is posed to continue to grow. Still, it’s obvious that since 2012, Facebook has significantly ramped up its efforts to monetize its user base, to a point where it appears that it can no longer increase the number of ads in the News Feed. That, coupled with the slowing user growth (which came almost to a halt in its most lucrative markets — Europe, US & Canada — in the recent quarters), makes it challenging for Facebook to continue growing revenue at the same pace in the future.

Source:  Facebook Q3 2018 Earnings Presentation

Source: Facebook Q3 2018 Earnings Presentation

Concerns over the slowing revenue growth, and revised guidance for the upcoming quarters were the main reason for an extremely sharp decline of 20%+ in Facebook’s stock price in July, after it announced Q2 results. Granted, the Cambridge Analytica scandal and overall concerns over privacy probably didn’t help either; however, it’s worth noting that by the second half of July Facebook was back to trading at an all times high, so it seems unlikely that either Cambridge Analytica incident, or the privacy concerns had much to do with the drop in stock price that followed Q2 earnings announcement.

Reported on October 30, Q3 earnings did little to dissuade investors’ concerns over the company’s ability to continue to grow at a fast pace: while Facebook exceeded the expectations for earnings, it missed forecasts on revenue and DAUs/MAUs, which arguably are more indicative of the growth potential. It’s therefore curious that despite of that, the market didn’t register any further decline in the stock price (although there were a couple of wild swings before the price settled at more or less the same levels as before the earnings’ announcement). That being said, given that the current price of ~$145 per share is 18% lower than the $176 per share after the disastrous announcement of Q2 earnings, and 33% lower than 2018 peak price, one could argue that the not so stellar results of Q3 were simply already baked into the stock’s price.

Now, it’s obvious that Facebook in 2018 is quite different from what the company it was back in 2013, when its stock started its mind-blowing ascent (close to 10 times returns in 5 years, from July 2013 to July 2018). Many of the concerns surrounding Facebook’s potential to continue to grow are justified, and require addressing. And yet, at 22x P/E, Facebook appears to be much cheaper than most of the other big tech companies: for instance, Google is currently traded at 42x P/E, Netflix at 108x, Microsoft at 45x, and Amazon at 96x (to be fair, P/E isn’t always a good benchmark to use to compare valuations, but in this case, the discrepancy between the Facebook’s valuation and that of others is too substantial to be ignored, even if the metric itself is flawed).

Some might notice that one company is conspicuously absent from the list above. That company is, of course, Apple, which represents another potentially interesting case, as it’s currently trading slightly above 17x P/E.

It might indeed be worth spending some time to dig into Apple here. In many ways, the problems Facebook and Apple are currently experiencing are of the same nature. Both companies have sustained impressive growth rates for years, but now, nearing the saturation point, are facing limits to this growth. Both have done a great job monetizing their existing user base, but have no obvious way to continue to grow those revenues indefinitely. Finally, both are heavily dependent on a single product generating the majority of their revenues and profits.

And yet, despite all those similarities, what I personally find particularly interesting here is that the future opportunities that Facebook and Apple are likely to face are actually vastly different.

Side note: Apple was originally supposed to be a part of this article, with me intending to cover both Facebook and Apple in one post. However, since it was getting way too long, I’ve decided to split this article in two, therefore Apple would be covered in the next piece.

Growing beyond original limitations

I think it would be fair to state that Facebook.com is unlikely to grow its MAUs much further, and the opportunities to monetize the geographies where it is still acquiring new users are likely to lag behind those of North America and Europe. The lagging monetization of the new content formats, namely Stories, represents another growing problem for the company.

That being said, however, it seems unwise to underestimate just how well protected Facebook’s market position currently is.

At the time of its public offering in 2012, Facebook’s monopoly on the market wasn’t yet solidified. Since then, however, it managed to acquire and then very successfully scale Instagram, which arguably would have represented its strongest competitor otherwise; it also removed the threat of WhatsApp by acquiring it, and managed to copy and then improve on some of the key features of Snap that are now available both on Facebook and on Instagram, thus crippling its ability to grow or retain its user base. All that, coupled with the decline of some of the stronger regional social networks (e.g. VK.com and Orkut), left users with no alternative but to continue to use Facebook’s properties (which includes Instagram and WhatsApp). You do, of course, still have Twitter and LinkedIn, but the nature of those networks is substantially different from Facebook, to point where it could be fair to argue that the common scenarios all three of those could possibly compete for are exceedingly rare.

Another trend that, while doing Facebook some (limited) harm short-term, might be actually helping to further entrench the company as a market leader is the current push towards privacy. Today, with the developers no longer enjoying the freedom of access to the entire Facebook’s social graph as they did in the earlier years, it becomes even more challenging for any aspiring competitor to scale its services, as it now has to compete against the incumbent whose services are already being used by everyone (and that is thus enjoying tremendous network effects), and at the same time can no longer piggyback on Facebook’s social graph for its benefit.

The same goes for regulations like GDPR — instead of, or rather, in addition to, putting oversight over what tech giants can and cannot do, it also makes it much more challenging for the data to flow freely, which (surprise!) helps incumbents the most, and actively harms smaller startups that are often dependent on 3rd-party user data being shared with them — which is exactly why, as I wrote previously, I believe GDPR stands to do more harm than good, and other countries, including the U.S., would do well to be wary of implementing similar regulatory frameworks (that’s not to say that privacy isn’t important — but it’s crucial to clearly understand the trade-offs you’re making).

In that sense, while Facebook might be currently struggling to monetize some of its geographies and/or content formats, the one thing (and an extremely unusual one for a tech company to have too) it has is time, as it has by now all but eliminated competition, and its network effects are simply too strong for any new players to successfully compete against it. That, of course, doesn’t mean that no company could ever unseat Facebook from its throne as the king of social, but it could be a long time before anyone figures a way to do that, which leaves Facebook an opportunity to continue to extract rents from its user base, while also figuring better ways to do so.

Finally, Ben Thompson made an interesting point in his August post about Facebook: it’s possible that the new content formats, and Stories in particular, might eventually allow Facebook to finally tap into the brand advertising market, unlocking a huge market that the company hasn’t been able to substantially penetrate yet. If that turns out the case, a short-term hit associated with the limited opportunities to monetize Stories Facebook has to take now would be more than worth it in the longer term — and indeed, intentionally pushing the customers towards Stories, even it means sacrificing some of the revenue from the News Feed, might prove to be exactly the right strategy.

Still a great opportunity

Source:   Macrotrends.net

To that end, I believe that Facebook today is considerably undervalued, compared to its big tech peers. While the company has a number of issues to work through, some of which weren’t apparent earlier (which might justify some of the correction in stock price we’ve witnessed), none of the fundamentals have really changed in 2018, which makes the extremely aggressive decline in P/E ratio this year (or even more generally, over the last 3 years) hard to justify.

After all, Facebook remains the largest social platform on the planet, and, in many cases, the only viable option, with plenty of opportunities for growth, and, more importantly, the luxury of having the time to figure out how to execute on those (again, the time here is simply a function of the lack of alternatives to Facebook/Instagram from the users’ perspective), which is really a rare thing in the tech space.

Disclosure: This article expresses my own opinions, and my opinions only. I am not receiving any compensation for it. I have no business relationship with either Facebook, or Apple. I hold no position in Apple stock, and a small position in Facebook stock, and have no plans to adjust my position(-s) or initiate new ones within the next 72 hours.

Cambridge Analytica Crisis: Why Vilifying Facebook Can Do More Harm Than Good

Throughout the week, I've been following Facebook and Cambridge Analytica scandal as it's been raging on, growing more and more incredulous. Yes, this is a pretty bad crisis for Facebook (which they inadvertently made even worse by their clumsy actions last week). But it still felt to me that the public outrage was overblown and to a significant degree misdirected. Here are the key things that contributed to those feelings:

1. Don't lose sight of the actual villains. Aleksandr Kogan and Cambridge Analytica are the ones truly responsible for this, not Facebook. Facebook practices for managing users' data might have been inadequate, but it was Kogan who passed the data to Cambridge Analytica in violation of Facebook policies, and then Cambridge Analytica who chose to keep the data instead of deleting it to comply with Facebook requests.

2. Nobody has a time machine. It might seem almost obvious that Facebook should have reacted differently when it learned that Kogan passed the data to Cambridge Analytica in 2015 — e.g. extensive data audit of Cambridge Analytica machines would have certainly helped. The problem is, it's always easy to make such statements now, yet nobody has a time machine to go back and adjust her actions. Was Facebook sloppy and careless when it decided to trust the word of the company that already got caught breaking the rules? Sure. Should it be punished for that? Perhaps, but rather than using the benefit of hindsight to argue that it should have acted differently in this particular case, it seems more worthwhile to focus on how most companies dealing with users' data approach those "breach of trust" situations in general.

3. Singling out Facebook doesn't make sense. To the previous point, Facebook isn't the only company operating in such a fashion. If one wants to put this crisis to good use, it makes more sense to demand for more transparency and better regulatory frameworks for managing users' data, rather than single out Facebook, and argue that it needs to be regulated and/or punished.

4. Don't lose sight of the forest for the trees. It's also important to remember that the data privacy regulation is a two-way road, and by making the regulations tighter, we might actually make Facebooks of the world better, not worse, harming the emerging startups instead. This is a topic for another post, but in short, strict data regulation usually aids the incumbents while harming the startups that find it more difficult to comply with all the requirements.

5. Data privacy is a right — since when? Finally, while the concept of data privacy as a right certainly seems attractive, it's not as obvious as it might seem. Moreover, it raises an important question — when exactly did the data privacy become a right? This isn't a rhetorical question either. It certainly wasn't so in the past: many of the current incumbents have enjoyed (or even continue to enjoy) periods of loose data regulation in the past (e.g. like Facebook in 2011-2015, or so). So if we pronounce the data privacy to be the right today, we are essentially stifling the competition going forward by denying the startups of today similar opportunities. Does this sound nice? Of course not, but that's the reality of the market, and we have to own it before making any rash decisions, even if some things seem long overdue.

Overall, this crisis is indicative of multiple issues around data management, and can serve to launch a productive discussion on how we might address the data privacy concerns going on. At the same time, it doesn't do anyone any good to vilify Facebook beyond necessary (and some of the reporting these days was utterly disgusting and irresponsible), the #deletefacebook campaign doesn't really seem to be justified (again, why not get rid of the vast majority of the apps then, given that Facebook isn't that different from the rest) and any further discussion about data privacy should be carefully managed to avoid potentially harmful consequences - most of us have no desire to find themselves in the world where we have perfect data privacy, and no competition.

Assessing The "Worthiness" Of Companies' Missions

Recently, I've stumbled upon a discussion somewhere (I believe it was on Quora) about whether people who state that they'd only work for companies with whose missions they can strong empathize are mostly being hypocritical. The author of this argument used Uber as an example, stating that it seemed highly unlikely that so many people had suddenly found themselves so interested to work for a company that at its core remained a taxi hailing business.

While I believe that Uber and its competitors are so much more than just taxi hailing services, I found the question itself rather intriguing. How much does the company's mission actually matter to most of us? Should it even matter? And how might we approach assessing this mission in the first place?

Those are, of course, deeply philosophical questions, and I don't entertain any illusions regarding my abilities to provide the answers that would be universally applicable to everyone. I also don't have any desire to argue whether people have to care about the mission of the companies they work for. Rather, I wanted to share my take on the second half of this question - how we might approach thinking about the companies' missions and values - in the context of the tech industry today.

First, it's useful to consider how the nature of the tech products we use has evolved over the last 10-15 years. In the past, we often evaluated the products and services we used based on the new features or functionality they offered us. Today, however, that's not the case anymore: we would often be hard pressed to name even a few new features the new generations of the apps and services we use bring us, and not because we don't care for that additional functionality, but rather because what we really value today above everything else is convenience.

The New York Times has just published an essay called "The Tyranny of Convenience" on exactly this topic, which I found rather entertaining. Still, the reason I believe the change in our priorities matters in the context of this post is that it actually makes so much more difficult to answer the questions asked in the second paragraph in any reasonable fashion.

In the world that valued features, assessing the importance of the work done by many tech companies was relatively easy: the users typically had a certain type of problem, or pain point, they required solving, which in turn created an opportunity for the companies to come with a software product, a hardware device, or some combination of both, that would allow to solve that issue. Of course, it was still entirely possible that the users didn't realize that they actually had a problem, but most of the time, at least some indicators were there: the office workers of the early 1980s probably didn't know that they desperately needed spreadsheets, but someone who decided to pay close attention to the work they were doing for a reasonable amount of time, might have noticed that there was a huge potential to digitize their activities, in one way or the other.

In the world of convenience, however, the situation seems remarkably different. First of all, the users often might not even realize that they have a problem to begin with. Did most of us know that we actually need that 2-hour guaranteed delivery? What about those sophisticated algorithms that allow us to create discover new compositions based on what we listened to in the past? Or the opportunity to upload the photos to the cloud on the PC, and immediately access them from our phones? There are a thousand things we can't imagine our lives without that we would have a really hard time even dreaming of 10 or 15 years ago.

Next, in this strange new world, there is no way to solve the problem once and for all, as there is often no limit to how much something can be improved upon. Getting a guaranteed 1-day delivery from Amazon is nice, but why not focus on 2-hour delivery next? Uber and Lyft might be so much more convenient that the traditional taxi services, but the cars could still arrive even faster, and, by the way, wouldn't it be nice if it cost less? And while Amazon Echo is helping us to make some of our routines so much more efficient, it can definitely be further improved by integrating with additional services, and employing more sophisticated machine learning capabilities.

All of that implies that there is no task or problem that isn't worth solving, as long as it improves the experience for the end users (not to mention that the large advances can sometimes start as minor efforts to solve a particular issue). By extension, this also means that the true complexity of the systems aiming to provide the users with a more convenient way of doing something is often hidden from the eyes of those users. Most of us have no idea of the amount of efforts behind Spotify recommendation engine we take for granted nowadays, or the cloud infrastructure that the majority of the services we interact with today are built upon, or Amazon 1-day guaranteed delivery. Moreover, we don't care: the entire point of convenience is that the users don't need to concern themselves with all of that to benefit from those services.

Now, going back to the initial argument, if we look at the Uber from the perspective of feature-driven world, it undoubtedly is just another taxi hailing service, albeit a much more convenient one compared to the traditional taxi services, where you had to call a local company on the phone. However, in the world of convenience, Uber and the likes of it are so much more than that: they help us save time and money, while also feeling more secure and experiencing a nicer way to travel. Moreover, they hold promise of bringing us an entirely new level of convenience in the years to come, once the self-driving cars hit the roads. And when you frame the problems Uber is trying to solve like that, it seems unsurprising that they might want to recruit some of the best engineers or businesspeople, or that those people would be genuinely interested to come work for Uber and its peers.

That, obviously, doesn't mean that everyone out there does (or even should) care for the mission of the companies they work for. Rather, I'd like to argue that the question itself is somewhat flawed, at least in relation to the tech companies, given the realities of the world today.