In times of chaos, Capital Flywheels’ preference is almost always to invest in change, not to invest in incumbency. Chaos will eventually be followed by a return to normalcy, but the protagonists almost always change.
This is because the incentives asymmetrically benefit the disruptors. In chaos, incumbents are incentivized to merely survive, while disruptors are incentivized to destroy. Incumbents have much to lose that must be protected, while disruptors have nothing to lose and much to gain.
In good times, incumbents are protected by vast ecosystems. This ecosystem of partners, suppliers, customers, and perhaps even competitors work to reinforce the existing environment because stability is preferred above all else. Stability is predictable, and stability is easy.
But in times of chaos, stability is no longer a choice. Without a choice for stability, businesses will discover that partners, suppliers, customers, and competitors are all open to alternatives that would have never been considered before. Incumbents can suddenly discover hollowness within their ecosystems. And these are openings that disruptors can exploit.
COVID-19 has created such an environment for chaos.
Every company in the last few months has been taking inventory of their situation and ecosystem, and this summer is shaping up to be a summer of change, even for large tech companies that historically have been more disruptor than disrupted.
Not only is change gathering momentum, but there will likely be more in the months to come.
⚔️ Disruption All Around
#1 Challenging The New Big Brother(s)?
The, potentially, most consequential event to discuss is Epic’s (developer behind Fortnite and the Unreal game engine) fight against the Apple App Store and Google Play Store. Epic decided to violate Apple App Store rules that Epic deemed unfair by using its own payment system in order to circumvent Apple’s 30% commission on digital transactions. This led Apple to ban new downloads of Fortnite on iOS devices. Google quickly followed suit with an equivalent ban on the Play Store.
In hindsight, it’s becoming clear that this was a planned attack on incumbent app store business models since Epic had a sharp marketing campaign lined up including this video that recasts Apple as IBM in Apple’s iconic 1984 ad:
Source: Epic
The media currently appears sympathetic to Epic’s side of the argument as this appears to be a story of David vs Goliath. Of course, complaints against Apple’s App Store policies have been going on for years, but in good times, it takes tremendous courage to push against a company as large and powerful as Apple. There’s nothing like a good crisis to give smaller companies the courage they need to pursue the change they want.
It comes at an especially sensitive time for Apple given that the company is already under investigation by both the US and European regulators over potentially anti-competitive practices related to the App Store. Despite the interests of both sides to paint the argument as black and white, the reality is the underlying issues are complex. There are questions about pricing and questions about power.
On the pricing side, is 30% high? Possibly…but what and how would one determine what “fair” pricing is? 20% would be “fairer” but is it “fair” or “fair enough”? 10% would be “fairer” but is it “fair” or “fair enough”? It is not illegal for companies to make or want to make profits. The law only protects against, predatorily low prices that drive out competition, not high prices. For example, if Apple were to lower App Store fees to 0% to drive out competition, that would be a much more challenging legal position to be in based on precedence.
This is even more complicated when considering that Epic’s interest on the “power” side is to get Apple to loosen App Store rules in order to allow Epic to launch its own competing app store and undercut Apple’s own take rate. Are dominant businesses obligated to help competitors undercut one’s own business?
These are broad questions that effectively underpin all of the antitrust investigations going on at all of the large tech companies. Is Google obligated to help smaller advertising-driven companies compete against its own advertising business? Is Facebook obligated to help smaller social networks compete against its own social network by making its proprietary social graph and data accessible (or portable) for peers? Is Amazon obligated to help formerly dominant retailers compete against its own business by making various parts of its infrastructure accessible at non-market determined rates in order to preserve inefficient competition?
Historically, if prices are predatorily low, the law is relied on to correct it. Historically, if prices are too high, the solution is to incentivize more competition. More competition eventually drives down prices. However, both of these mechanisms are now broken. It is incredibly difficult to incentivize new competition against such dominant network businesses. This means Apple faces limited market pressure to lower prices. And on the other side, many network businesses have near-zero marginal costs…it is very hard to establish illegal predatory pricing when marginal costs are near-zero.
Regardless of what happens, the people are revolting…and incumbents should beware.
Nonetheless, Capital Flywheels still believes the tech titans are largely masters of their own destinies and will be able to survive the outcomes. While they are being challenged in their core businesses, they continue to be the disruptors in new verticals and markets. However, any potential changes that might weaken the grips of the giants on their core business would be favorable for smaller players that operate in those ecosystems. For example, Pinterest benefiting from a weaker Amazon. For example, Match benefiting from low App Store fees (Match is perennially one of the largest earners on the App Store paying enormous fees to Apple). And many more.
#2 The End of the Gig Economy?
A California judge ruled that Uber and Lyft must classify their drivers as employees in a stunning preliminary injunction issued Monday afternoon. The injunction is stayed for 10 days, however, giving Uber and Lyft an opportunity to appeal the decision. Uber said it planned to file an immediate emergency appeal to block the ruling from going into effect.
Uber and Lyft are under increasing pressure to fundamentally alter their business models in California, the state where both companies were founded and ultimately prospered. At issue is the classification of ride-hailing drivers as independent contractors. Uber and Lyft say drivers prefer the flexibility of working as freelancers, while labor unions and elected officials contend this deprives them of traditional benefits like health insurance and workers’ compensation.
Source: The Verge
If the injunction is not stayed, Uber and Lyft have both indicated they will pull out of California in the near-term. Both companies have indicated that it would require significant business model changes to operate with employees, which is not possible in 10 days (and potentially not possible economically).
Interestingly, the judge’s comment suggest that he ruled this way because COVID-19 has materially reduced Uber and Lyft’s ride-hailing volumes already, which therefore reduces the disruption that would have been required otherwise. Reading between the lines, it sounds like the judge (or any judge or politician for that matter) would have found it infeasible to force this change in good times because of how many consumers come to rely on Uber and Lyft.
Uber is diversified and hence will survive a negative outcome in California. But could it raise the potential for other states to adopt similar rules? Who will be the winners and losers of this outcome? Does it destroy the gig economy, or does it anoint Uber (or one of the other incumbents) as the only gig companies that have the scale to comply?
#3 TikTok and WeChat in the Crosshairs
COVID-19 has not only created potential for disruption domestically but also has created political cover for the US government to further pursue its national security agenda against China.
Donald Trump signed executive orders banning US citizens / entities from transacting with TikTok and WeChat:
By the authority vested in me as President by the Constitution and the laws of the United States of America, including the International Emergency Economic Powers Act (50 U.S.C. 1701 et seq.) (IEEPA), the National Emergencies Act (50 U.S.C. 1601 et seq.), and section 301 of title 3, United States Code,
I, DONALD J. TRUMP, President of the United States of America, find that additional steps must be taken to deal with the national emergency with respect to the information and communications technology and services supply chain declared in Executive Order 13873 of May 15, 2019 (Securing the Information and Communications Technology and Services Supply Chain). Specifically, the spread in the United States of mobile applications developed and owned by companies in the People’s Republic of China (China) continues to threaten the national security, foreign policy, and economy of the United States. At this time, action must be taken to address the threat posed by one mobile application in particular, TikTok.
Source: White House
By the authority vested in me as President by the Constitution and the laws of the United States of America, including the International Emergency Economic Powers Act (50 U.S.C. 1701 et seq.) (IEEPA), the National Emergencies Act (50 U.S.C. 1601 et seq.), and section 301 of title 3, United States Code,
I, DONALD J. TRUMP, President of the United States of America, find that additional steps must be taken to deal with the national emergency with respect to the information and communications technology and services supply chain declared in Executive Order 13873 of May 15, 2019 (Securing the Information and Communications Technology and Services Supply Chain). As I explained in an Executive Order of August 6, 2020 (Addressing the Threat Posed by Tiktok, and Taking Additional Steps to Address the National Emergency With Respect to the Information and Communications Technology and Services Supply Chain), the spread in the United States of mobile applications developed and owned by companies in the People’s Republic of China (China) continues to threaten the national security, foreign policy, and economy of the United States. To protect our Nation, I took action to address the threat posed by one mobile application, TikTok. Further action is needed to address a similar threat posed by another mobile application, WeChat.
Source: White House
The wording of the full order is both simultaneously vague and broad, leaving the potential for wider impact than expected. Regardless of what happens, it has materially changed the internet landscape not only in the US but in the rest of the world ex-China. This has raised the risk for Chinese internet companies outside of China (including smaller players that have had some level of success such as YY / Bigo / Likee). This makes it more likely that Chinese companies will think twice before turning away from domestic Chinese market. This could mean higher domestic China competition. Whereas smaller players in China may have shied away from trying to compete against dominant Tencent and Alibaba and preferring to go after more open emerging markets, maybe there is no foreign market alternative anymore.
And to the extent that we consider the short / live video market, the Chinese players are the incumbents. With TikTok under pressure, Facebook and others potentially get an opening to recapture this market that they foolishly let slip by.
Interestingly, Microsoft is currently the leading suitor for TikTok. As an alternative to a ban, Trump is giving the company until September to sell TikTok to an American company. How the stars and world can change in a short period of time…Microsoft, which largely lost the mobile and social era now has a chance to get back in and in potentially pole position in one fell swoop because of COVID-19 and the chaos it has created.
#4 Uber – Kicking Competitors While They’re Down
Echoing the comments earlier regarding tech companies simultaneously being disrupted in their cores but acting as disruptors in new areas, Uber is going after the business / corporate market that Lyft used to be far ahead in.
While Uber has always had a stronger position with consumers (including consumers that choose their own platforms for business-related rides), Lyft has been earlier and more keen on establishing corporate relationships in order to influence employee choices. With ride-hailing in the gutter, these relationships are currently weak and up for grabs. Uber is moving aggressively into the corporate market by leveraging the food delivery side of the business, which Lyft does not have.
As companies around the world continue to prove how nimble and resilient they can be when faced with unanticipated challenges, the desire to stay connected with employees, customers, and guests is stronger than ever. The question for many during this unprecedented time is how? At Uber for Business, we’ve been impressed with how innovative our customers have been in finding new ways to foster employee engagement and customer loyalty with Coca-Cola, the Golden State Warriors, and Shopify leading the way.
Whether it helps with setting up a virtual lunch and learn, celebrating an employee’s birthday, or rewarding a sales team for a strong quarter, meals ordered on Uber Eats have proven to be a welcome surprise.
Uber for Business helps our customers keep their teams productive and clients engaged with an enterprise platform for managing rides and meal delivery. Here are some of our favorite examples of innovative programs our customers have recently created using Uber for Business’s corporate meal programs, vouchers, and gift cards.
Source: Uber
#5 Reimaging Banks
Square’s Cash App continues to be one of the most impressive stories with potential for immense value creation. While Square has initially gone after under-banked merchants and consumers, the problems Square is solving are fundamental and universal.
Many consumers, regardless of whether they are banked or unbanked, do not think banks are doing a good job. And Square continues to methodically build up capabilities that rival the banks in a much more consumer-friendly package.
The latest step putting them closer to replacing the banks for consumers are initial efforts in lending:
Cash App, the peer-to-peer payments service from Square, is giving select users a way to get short-term loans.
The company said it’s only testing the feature with around 1,000 users for now. But it could become more broadly available — and there are probably plenty of people who could use the money, given the state of the U.S. and global economy, not to mention the current uncertainty about further stimulus plans.
Cash App is starting out by offering loans for any amount between $20 and $200. You’ll be expected to pay the loan back in four weeks, along with a flat fee of 5%. (Multiplied over a year, that turns into a 60% APR — which sounds high, but at least it’s significantly lower than the average payday loan.)
Source: TechCrunch
Today, only the unbanked. But tomorrow…Capital Flywheels is very willing to bet Cash App will go after the banked as well.
Banks today only have two advantages: 1/ Lower cost of funding through deposits, and 2/ Financial data built up over years and years.
New digital wallet models like Cash App are allowing players like Square to gather their own “deposits”. And there remains absolutely no doubt in Capital Flywheels’ mind that players like Square will have datasets that are more useful and more sophisticated than the banks in the long run. This allows digital-first players to price risk more appropriately, allowing them to earn equally attractive returns on capital even while offering lower rates to consumers.
And this is before taking into account Square’s innovative marketing campaigns that likely put the banks to shame not only in terms of reach but also in cost and return on investment. Cash App’s recent marketing campaign tied to the hottest game during COVID-19, Animal Crossing, likely widened the user base dramatically.
Source: Square / Cash App via Twitter and King of the Chill
#6 The Amazon Mall
Barbarians at the gates…now inside the gates. Mall operator, Simon Property Group, is exploring a potential partnership that would see mall anchor spots occupied by Sears and JC Penney converted into Amazon fulfillment centers.
The largest mall owner in the U.S. has been in talks with Amazon.comInc., the company many retailers denounce as the mall industry’s biggest disrupter, to take over space left by ailing department stores.
Simon Property Group Inc. has been exploring with Amazon the possibility of turning some of the property owner’s anchor department stores into Amazon distribution hubs, according to people familiar with the matter. Amazon typically uses these warehouses to store everything from books and sweaters to kitchenware and electronics until delivery to local customers.
Source: WSJ
This reminds me of several investment debates I had back in 2012 / 2013. A number of (value investor) skeptics debated whether Amazon’s asset-heavy model would ever be able to successfully out-compete incumbents given the attractive store footprints players like Macy’s, JC Penney, and others had. Maybe mall traffic would decline, but the stores would be better fulfillment centers than Amazon’s given its proximity to consumers. Of course, this was all quite silly because if it turned out to be true, Amazon could just buy JC Penney or Macy’s solve the problem. There was almost no scenario in which Amazon would not win. The incumbents had neither the capital nor time to survive to see the day in which their assets are worth something.
That seems to be the case. JC Penney has already declared bankruptcy. And most retailers are in similar position today.
And more interestingly, the chaotic environment of COVID-19 is forcing mall property operators to rethink their strategies. An Amazon fulfillment center seems infinitely more attractive right now than a big box retailer that does not have the ability to pay rents at all.
Who are the sitting ducks likely to be impacted next?
🌟 Other Interesting Links
#8 Excellent Infographic from Visual Capitalist on Online Games and Esports
#9 Paypal / Venmo Rolling Out Crypto Trading Potentially Challenging Cash App