Tech Monopolies both create and stifle innovation, but China helps us understand the opportunity cost
Companies: GOOGL, AMZN, FB, JE/, RMV
Monopoly has become the natural optimal end point for many areas of the economy now that technology and the internet have created such a connected world. This has led to healthy innovation in many respects as high margins are reinvested to create further value for customers. However, the incredible progress in China points to a potential opportunity cost of these new Western Tech Monopolies who can squeeze out competitors, perhaps slowing innovation.
Economic theory can cast monopoly as a negative force with good reason, but there are many types some of which are necessary. Natural monopolies such as water infrastructure and rail networks exist because it makes no sense having multiple sets of rival infrastructure. Some monopolies have been created by one company owning or acquiring the majority supply of the good or service, such as Standard Oil’s domination of 80% of the US oil market a century ago. Other monopolies have been possible due to geographical restrictions.
These monopolies are in a position to raise prices. If your company owns all the rail network in an area, then passengers and freight carriers are forced to pay whatever price you decide. This allows it to elevate the price point of its product, impairing consumer surplus and destroying value. Many, such as utility companies, are therefore heavily regulated to protect the consumer.
Technological progress has created more monopolies
Companies in many sectors are now becoming “tech” companies because of the extent the internet has taken over business and commerce. The natural endpoint for many of these industries is a single “winner takes all” platform. I wrote about this a few weeks ago in my Platforms are taking over the world piece, highlighting examples in the UK such as Rightmove for real estate aggregation and Just Eat for takeaway food delivery.
We live in a world where everyone and everything are increasingly interconnected. As a result, many sectors and industries operate most efficiently with one aggregator platform which can maximise the economies of scale, and provide a single point for the end user.
These new monopolies are characterised by a greater customer experience and rapid expansion to create barriers to entry that are too great for other serious competitors. Amazon is an example of a modern monopoly, where being the overwhelmingly dominant marketplace where buyers and sellers meet, and offering first class service to both, has put Amazon in a position of considerable strength.
Google built its monopoly over search through being unquestionably the best at finding what a user is looking for. It then monetised that ruthlessly through advertising creating a cash generating machine that allows it to stay far ahead of competitors. Google accounts for c.90% of search traffic in the UK.
Facebook and its ecosystem (i.e., Instagram, Facebook, Whatsapp, Messenger) has a monopoly over the online social networks in society in most countries now (excluding China). It also has a giant share of the hours spent each day “browsing stuff” and “killing time”.
Tech Monopolies both create and stifle innovation
Tech monopolies capitalise on economies of scale and negligible marginal costs to build high margin cash generative businesses. These margins can be and have been re-invested to drive further innovation. In this way, they can be strong drivers of innovation. However, these tech monopolies can also stifle innovation by using their cash piles to buy up or crush the competition.
The danger comes from a stifling of new ideas and creative destruction. This can be seen by the amount of capital behemoths like Facebook are willing to spend to nip competition in the bud. Whatsapp was acquired for $18bn to keep users from leaving the Facebook ecosystem. Instagram was bought for $1bn for similar reasons. Snapchat was unsuccessfully targeted, and instead, Facebook has employed blatant plagiarism of SNAP's innovation to arrest, and now reverse, the flow of users from Facebook to Snapchat.
Last week SNAP shares fell 22% after it reported only 5% user growth quarter-on-quarter. It has been struggling ever since Instagram, and Facebook Stories neutralised that edge.
I’m not sure this is the answer, but if we are to ensure continued creative destruction, then established Tech monopolies should perhaps be prevented from buying up the nascent competition. If the likes of SNAP get squeezed out because Facebook beat it in the market then so be it, but using your mountain of cash to swallow up competition reduces the ability for real, competitive-led product innovation.
There is a market where the established global giants were not able to dominate through sheer weight, and competition was allowed to do what it does best, i.e., drive innovation. Perversely, given the level of state control, it is China.
China demonstrates the innovation that can be unleashed in an environment not dominated by the Google-Apple-Facebook-Amazon, or GAFA, ecosystem. Tencent has flourished to the point where its app WeChat has changed the way Chinese live, and the user experience and utility in many ways has leapfrogged that available to Western populations used to our GAFA-dominated world. WeChat is now the gateway, operating system, control point, whatever term you would like to use, but WeChat "controls" the relationship with the customer.
There is a presentation called Tech Trends in China that was delivered recently by Andreessen Horowitz's Connie Chan that will make your jaw drop when you see the rate and extent of progress being made in China. It is a fascinating presentation that will change your perspective of the world and its order.
Of course, Tencent has now evolved into its own position of monopoly. A sizeable majority of interactions, goods and services now runs through this one app. Granted, Facebook is approaching two billion monthly active users across the globe, but WeChat gets c.850 million monthly active users, 90% of which are in China, a market which it dominates.
The main pillars of WeChat are the QR code (which hasn't caught on in the West) and payment processing. Combining these has allowed Tencent to venture into what the Chinese call O-2-O, or online-to-offline, far more than our stable of tech giants.
How can we combat this going forwards?
There will always be innovation and change in markets. The giants of tech are at a significant advantage given the wealth of data at their disposal. They are driving huge change in our lives but what 's hard to appreciate is the opportunity cost of their dominant positions. What innovation are we not embracing because of the entrenched market leaders?
With respect to new markets such as Machine Learning, Artificial Intelligence, Augmented Reality and Virtual Reality, there is vigorous competition from all the main players as they seek to dominate, or at least stay relevant, in the face of a potential massive paradigm shift.
However, in the respective markets of some of the tech giants, there is an argument that we have missed out on innovation, and the rapid progress in China and on WeChat are examples of this.
To read a brief outline of how I think about stocks, and what I aim to achieve in this blog, please check out my first blog where I set out my stall.
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Please Note: To be clear, I do not and will not ever give any advice. I will rarely mention individual stocks but when I do these will not be recommendations, instead just my thoughts at that point in time.