Market Views: Equities
The “Big Tech” backlash: How sustainable are Google, Facebook and Amazon?
Market Views: Equities
The “Big Tech” backlash: How sustainable are Google, Facebook and Amazon?
In recent months it has felt like the tide is turning against big tech.
Google has been fined for market abuse in the EU. Silicon Valley heads have been hauled in front of the US Senate and the UK Parliament to answer for the abuse of their platforms by extremists and Russian saboteurs. The repeal of net neutrality1 regulations in the US has swung the balance of power away from internet companies and back towards infrastructure providers. The imminent introduction of GDPR (General Data Protection Regulation) in the EU will increase complexity and risk for companies dealing with consumer data.
Add concerns over elevated valuations and a few sharp drops in the tech-heavy Nasdaq index, and it’s been a nail-biting few months for investors with significant positions in the ‘FAANG’ stocks of Facebook, Amazon, Apple, Netflix and Google. Positioning and survey data suggests this includes most long-only2 managers.
As investors we have spent a lot of time debating the positive and negative effects of these businesses. What is their impact on wider society? Is there a long-term risk from a growing regulatory burden?
The range of issues to consider and weigh up is huge, and the pace of change is rapid. Even so, we believe exploring some of the arguments could help investors assess the true sustainability of growth and returns at these companies.
The network effect
One of the most compelling characteristics of the tech giants’ business models is the so-called “network effect”, whereby the value of their service increases with a higher number of users. Social media platforms are the prime example here. With each new user, the pool of potential connections and scope for content sharing increases. Once critical mass has been achieved, it is hard for rivals to lure users away from the market leaders.
For Google, this effect is visible through its algorithmic improvements: each search conducted on its platforms improves the usability and efficiency of its services. For Amazon, the more merchants and consumers that are on its site, the more valuable it becomes to both buyers and sellers.
By delivering “natural monopolies”, the network effect has created a number of market darlings, but this degree of market control has also made regulators twitchy. Google captures over 85% of desktop search queries, a number that rises to 95% on mobile. At the end of 2017, Facebook had over 2 billion monthly active users. In 2017, Amazon commanded almost half - some 48% - of all US online retail, up five percentage points year-over-year. Even so, through the traditional lens of anti-trust policy - focused on prices and harm to consumers – it is difficult to accuse these businesses of abusing their market power.
For a start, most of the products provided by Google and Facebook are ostensibly free, resulting in huge consumer surplus. One study cited in the Economist estimated that users value “search“ at around $16,600 per year, maps at $2,800 and video at $900. Google also provides its Android operating system free of charge to third party device manufacturers (largely, of course, to secure its dominance in mobile search).
Clearly, we as users are creating value for the firms as they harvest our data, which they can then monetise through sales to advertisers. In surveys, consumers claim that we value our data highly and are not willing to trade it for services, but our behaviour strongly suggests otherwise. We unthinkingly tick consent boxes and allow cookies rather than interrupt our browsing/purchasing experience, and data breaches appear to have little to no impact on our behaviour. A recent study found that students were prepared to offer up their email contact lists for as little as a free pizza.
Forthcoming GDPR regulation will in theory allow consumers in the EU to withhold their data, but it is very hard to see many users not consenting to share their data if the alternative is to be ‘cut off’ from services they use multiple times a day. In any case, the value of any individual’s data on its own is negligible: the reason networks are so valuable is because of the sheer volume of data they collect. If pushed by regulators, one could envisage Google and Facebook introducing a ‘freemium’ model, whereby consumers either pay a premium for privacy or continue to trade data for free services: our bet is most would stick with the status quo.
So is it the advertisers that are being squeezed on price? Here too, the evidence is far from damning. Google’s ad pricing is determined by auction, so they are not price-gouging on this front; Facebook’s is set by the company but their current “cost per thousand impressions” (CPM) is still only around $2, cheaper than almost any other media. Looking at it another way, Facebook currently generates revenue of just $20 a year from each user – almost all from advertising – versus a value of $750 that users derive from the platform according to a recent MIT study. Facebook has been particularly cautious of increasing its ad load, wary that any improvement in near-term monetisation might come at the cost of reduced user engagement. This is exactly the kind of behaviour we hope to see from “sustainable” companies.
Amazon’s business model is very different, but again we see little evidence here to see that their dominance of ecommerce is resulting in consumer harm. In fact, Amazon’s disruptive impact has resulted in massive deflation across a wide range of products and industries, largely by cutting out the middleman of distribution/retail and improving price transparency. The reality or threat of being “Amazoned” has prompted innovation across the economy.
In the most traditional sense therefore, consumers do not appear to have been harmed by the market dominance of these firms.
Tech giants have also been accused of stifling innovation by gobbling up promising start-ups and monopolising the best talent. Google, in particular, has such a huge balance sheet and such a broad reach – from internet balloons to drones to “smart” contact lenses that measure blood glucose levels – that it could be argued to be “crowding out” potential innovators. Critics point to the precipitous decline in the number of start-ups in recent decades, with most years seeing more companies fail than start.
In our view, Google and Amazon have not only been hugely innovative on their own account but also prompted new and established companies across the economy to raise their game. In the same way that Amazon dragged retail into the 21st century, Google has put the fire under telecoms operators to accelerate their rollout of high-speed broadband and the auto industry to invest in developing self-driving cars.
Start-up activity, growth, and entrepreneurship have ticked up encouragingly since 2014, suggesting the dip was more a function of the economic environment than structural change.
That said, we do agree that in hindsight it was too lax of regulators to allow Facebook to acquire Whatsapp and Instagram, both of which could have gone on to become potential competitors. Disruptive competition cannot emerge if the tech giants are allowed to subsume all possible rivals. We also have more sympathy with the view that flouting of copyright laws by YouTube in particular is damaging to the creative industries.
Soap box or echo chamber?
Things become more difficult to gauge – particularly in reference to social media - when we step away from pure economics.
The unprecedented level of access to data enables subdivision and targeting of audiences on social media far more effectively than ever possible for conventional media. Even in its most benign application, profiling social media users can mean that a tailored content experience only ever echoes existing views, hindering effective and informed debate. The more malign use of this data, of course, could be to more directly manipulate what a user sees.
Social media can, on the other hand, be seen as an important platform for free speech. It can elevate civic engagement: a boon to democracy, especially for marginalised or repressed groups. For example, Facebook played an important role during the 2011 Arab Spring, allowing protestors to disseminate information, organise demonstrations, and raise local and global awareness of events.
This leads us to ask to what degree social media platforms should continue to be treated as just that – platforms – versus publishers, which would entail taking responsibility for content posted on them. If widely mandated, this would be extremely challenging due to the sheer volume of content. The equivalent of 65 years worth of video is uploaded to YouTube every day. Already, Facebook, and to a lesser extent YouTube, are proactively increasing their scrutiny of content, improving their Artificial intelligence and hiring real people to identify and remove false and extremist material. Germany has recently introduced legislation threatening fines of up to €50 million for platforms that fail to adequately police their content, with the result that Facebook now has over one-sixth of its moderators in Germany, compared to just 1.5% of its users. Yet balancing the need to protect users without tipping over into censorship is extremely difficult, risking reputational damage and undermining user engagement.
For the greater good?
Measuring “social value”, and how much of it is created or destroyed by big tech, is far from straightforward. On balance, we are comfortable that – for now at least – these companies are contributing more to society in the form of free products and innovation than they are detracting by monopolising our data and crimping competition. We will, however, continue to monitor developments and remain wary of tail risks that could threaten the long-term durability of their business models. We see the most likely risk as taking the form of regulation on the one hand and/or consumer backlash on the other
The companies mentioned above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
1. Net neutrality is a term to describe the principle that internet service providers should treat all of the data they are providing to customers equally, and not to use their own infrastructure to block out competitors.↩
2. Long-only refers to the traditional investment approach of buying a holding expected to increase in value.↩