Toothless American Internet Giants?
In the past decade, America’s internet giants have grown to an enormous size. But the next few years are likely to be much less friendly to them.
April 12, 2018
For several years, the stocks of America’s Internet giants — Facebook, Apple, Amazon, Google — have been the way to make money. And yet, for all their past prowess, these four companies all have major weaknesses in their business models that are becoming increasingly apparent.
They could thus be destined for a replay of the 1999 dot-coms, the 1972 Nifty Fifty, the 1929 Investment Trusts or the 1720 South Sea Company.
To begin with Facebook, we learned that Facebook intends to set up its own “Supreme Court” to police “hate speech” on its service. This may suit Mark Zuckerberg’s dreams of world domination, but it in no way represents what a private corporation ought to be doing.
At the core of the problem is Facebook’s ability to scoop up private information on people and sell it to third parties, or indeed use it itself in pursuit of some nefarious non-economic goal.
When Facebook started, it appeared to be largely a means for teenagers to communicate, which could be monetized through advertising, but as it has grown its sinister potential has more clearly appeared.
There simply is no solution to Facebook’s censorship problem. In a traditional media environment, a wide variety of media outlets use the skilled judgement of journalists with decades of experience to decide what to print. If they got it wrong, their publication lost subscribers and money.
Not so with Facebook. It is effectively a monopoly. There is no way it can censor the news without becoming Pravda. Unfortunately, for all of Zuckerberg’s soothsaying, under his leadership, becoming Pravda appears to be Facebook’s ambition rather than its fear.
The only solution would be to break up Facebook into half a dozen competing outlets, each with a different political outlook, thereby reproducing a healthy newspaper environment, like in the UK several decades ago.
Alternatively, de-globalization may result in entities like the EU imposing revenue-based taxes on Facebook. Over time, this could lead to “clean/er” national equivalents and a dissipation of Facebook’s power by this means.
Either way, Facebook’s monopoly power will not last, and its revenue generating capacity will be correspondingly diminished. Its business model is broken.
Amazon
Amazon is really two businesses. One of them, Amazon Web Services, is the leader in providing cloud services to businesses and consumers. It is a sensible business and has a good market position.
However, in 2017 it had only $17.5 billion in revenues and an operating profit of $4.3 billion. That’s a nice business, worth about $150 billion if you give it a generous multiple of 35 times earnings, appropriate given its growth.
The problem is the rest of Amazon’s business. In 2017, after 23 years in business, it still made an operating loss of about $1.3 billion, even though it had revenues of around $160 billion.
Even though Amazon has in the past benefited from huge subsidies in not charging state and local taxes (and still has a huge cash flow benefit from paying its state taxes later and not charging local taxes), a most astonishing fact remains: Its entire retailing operation, is still not profitable.
Yet, given that the web services business is worth around $150 billion, one has to wonder why its retail business is valued at $500 billion. For what? It’s no good saying it is valued for its growth potential. Retailing is a notoriously low-margin business. Moreover, Amazon already represents over 40% of on-line sales. In other words, there is not much for it to expand.
With President Trump threatening the company’s sweetheart crony deal with the Post Office, which gives it postal rate some 40% below market, according to a Citigroup report and comes to an end in October, the company’s margins are unlikely to grow, even if gets another point or two of market share in the retail market.
Given that hard reality, its share price is hopelessly over-inflated. In addition, the pains of its deflation may make it difficult for Amazon to sustain its expansion program and its heavy long-term debt. Amazon’s business plan was initially brilliant, but it has failed to mature into a profitable, sustainable economic entity.
Apple
Apple is the oldest of the giants. In its early years, it had an excellent business with Steve Jobs for design and Steve Wozniak pushing the technological envelope, first developing one of the first usable personal computers, then adapting Xerox PARC technology to produce a PC, the Macintosh, that was far easier for non-technical types to master.
Then, after a lost decade, in which products like the Newton hand-held device failed because of poor design, Jobs returned to Apple and proceeded to produce a series of superbly designed products that in some cases, notably the smartphone, were truly paradigm-altering.
Sadly, Steve Jobs died in 2011. After his death, Apple has shown itself incapable of more than incremental product improvement. At the same time, his successor as CEO, Tim Cook, has concentrated on “non-entrepreneurial” maneuvers, such as tax-optimizing Apple’s operations, growing its political influence and maintaining or increasing margins on each new “generation” of Apple products.
Apple’s politicization has already run into trouble; Apple was one of the chief targets of Trump’s tax reform, intended to prevent companies piling up hundreds of billions of dollars in offshore tax havens.
With product innovation slowed (partly by technological factors such as the senescence of Moore’s Law) and Cook’s creative use of tax havens and intellectual property increasingly under attack, Apple’s rating is far below that of the other giants. Its future must be in serious question, although with all that cash its survival is assured at least for the medium term.
Finally, Google, which is now controlled by a holding company, Alphabet Inc. Google shares Facebook’s strategic problems.
First, it is heavily dependent on the digital advertising business, in which Facebook and it hold a duopoly with around a 60% market share. The advertising business is highly cyclical, and it’s unlikely that digital’s share of the total business will grow significantly further.
Second, like Facebook, Google relies for much of its profits on scooping up endless information on its consumers, which comprise more or less the entire population, and using that information for legitimate or nefarious purposes.
As consumers become more aware of the uses to which their personal information is being put, they will erect more sophisticated defenses against its improper use, devastating Google’s profit potential. Like the other three giants, Google has a fundamentally flawed business model.
In the past decade, because of artificial ultra-low interest rates worldwide, the Schumpeteran process of creative destruction has not operated properly. This has allowed the giants to grow to an enormous size, without correcting the flaws in their respective business models and practices. The next few years are likely to be very much less friendly to them.
Disclosure: The author owns a modest put option positions in Amazon and Alphabet/Google.
Editor’s Note: This article was originally published in the author’s “True Blue Will Never Stain” blog.
Takeaways
In the past decade, America’s internet giants have grown to an enormous size. But the next few years are likely to be much less friendly to them.
When Facebook started, it appeared to be largely a means for teenagers to communicate. But as it has grown its sinister potential has more clearly appeared.
Amazon’s business plan was initially brilliant, but it has failed to mature into a profitable, sustainable economic entity.
Apple’s future must be in serious question, although with all that cash its survival is assured at least for the medium term.
Google relies for much of its profits on scooping up endless information on its consumers -- which comprise more or less the entire population
