The Future of Ecommerce: Utilitarian vs Social

When people think about ecommerce today, they likely think about ecommerce along the lines of C2C (consumer-to-consumer), B2C (business-to-consumer), or B2B (business-to-business) – in other words, classification by type of buyers and sellers.

Or perhaps people think about 1P (1st party) vs 3P (3rd party), depending on whether the ecommerce platform itself engages in the direct buying and selling of goods. Amazon is 1P and 3P while Ebay is purely 3P.

However, both of these classification methods are simply the digitized forms of long-standing offline commerce analogies. They are neither new nor native to the world of digital commerce.

Ecommerce appears to be evolving and giving rise to more native forms of commerce, which I think can be loosely classified as utilitarian vs social. 

The Current Ways of Doing Things

Although ecommerce has been around for over 20 years now, it still bears a striking resemblance to offline commerce.

Consider the way ecommerce businesses/platforms are classified today. C2C, B2C, B2B and 1P vs 3P. Both of these classification systems are applicable to both offline commerce and ecommerce.

Online C2C would be Ebay, where users are largely trying to sell used items to other users. Offline C2C would be school students trying to swap cards or goods or garage sales. The offline world never really formalized C2C because, I suspect, there isn’t much money in this part of the market. The fact that Ebay took off so much faster than Amazon in the early days is simply because the offline competition was non-existent and Ebay filled a vacuum. But in the long run, Amazon was destined to outstrip Ebay because Amazon operated in B2C, a much larger part of the market.

Online B2C would include Amazon and essentially every branded/professional ecommerce business out there where consumers buy from a business. This is also how most offline commerce is conducted – in malls, on the streets, mostly everywhere.

Likewise, online B2B is not too different from offline B2B. For the most part, going from offline to online likely meant swapping phone calls for internet clicks.

In terms of 1P vs 3P, almost all offline businesses are 1P where the buyer interacts directly with a seller that owns and controls the inventory. Online 1P is the same and includes the digital channels of all of the offline 1P businesses. This includes the branded stores for Apple, Nike, Adidas, etc.

Offline 3P would be mall operators. The essence of a 3P business/platform is effectively to be a landlord. Mall operators provide a space for businesses to sell. Online 3P platforms would include Amazon, Ebay, Alibaba, and JD, all of whom are digital landlords. 3P is clearly a more commonly viable business model online because digital real estate is theoretically infinite. There can be an infinite number of online 3P platforms. And who doesn’t want to be a landlord collecting rents without having to do the branding and selling work?

So at the end of the day, ecommerce today isn’t all that different from offline commerce. They are largely direct analogies other than swapping out of physical storefronts for digital storefronts.

The New Ways of Doing Things?

What’s interesting is that ecommerce is starting to evolve in ways that offline commerce cannot follow. And this is enabled by social media, supercharged by the fact that we always have an internet-connected device with us at all times. This new way of doing things is social ecommerce, and eventually the old way of doing things will likely be viewed as utilitarian e/commerce. 

Social ecommerce is just starting to take off in the West, but has been a game-changer in Asia, particularly China.

Here are some examples.

Social ecommerce includes live streaming on Taobao (Alibaba platform). This is effectively QVC for the digital age. But on steroids because you not only watch/hear from sellers, you also see comments from other potential buyers.

Taobao Livestreaming

Source: TechinAsia

Social ecommerce includes WeChat (Tencent messaging platform) stores with integrated messaging. Buyers can message and interact directly with potential buyers in the WeChat messaging app – keeping them updated on new products, offer coupons, and deepen the brand story.

WeChat Ministore.jpg

Source: WeChat Agency

Social ecommerce includes PinDuoDuo encouraging you to round up friends to help you bargain for discounts.

Pinduoduo Bargain.jpg

Source: WalktheChat

What social ecommerce accomplishes is that it makes buying fun, all the time. Buying has always had an element of fun in the offline world, but it required coordination. For example, people (friends and/or families) go to the mall together so that you can get advice and encouragement (or tasteful critique). But that takes coordination. Ecommerce made it very easy for us to shop, but it has not made it easy for us to coordinate to recreate that level of fun. That’s what social ecommerce promises to accomplish.

Social ecommerce also connects us with opinions that we may not otherwise have in our offline lives. Perhaps you don’t have people in your life that would have the best opinion/advice, social ecommerce broadens your scope. That is something that offline commerce can never accomplish or compete with.

The benefits do not solely accrue to consumers. In fact, the benefits are probably even greater for sellers that adapt. Take Taobao live streaming for example. There are many sellers now that will livestream directly from factories to gauge what buyers are most interested in. The buyer will then purchase inventory based on the feedback with minimal inventory risk. This is a phenomenal benefit as it reduces the working capital necessary to run the business. As I’ve discussed in my previous post, the platform/player that has the greatest influence over retailer working capital will likely dominate for a very long time.

Ecommerce’s Shifting Landscape

Social ecommerce has already arrived in Asia, and it is starting to appear in the West.

For example, Apple is rolling out Business Chat, which promises to allow users to directly message businesses creating a whole new way of marketing and selling.

Apple Business Chat.png

Source: Apple

And the gorilla (in the West) is Instagram, which recently rolled out a “Shop Now” button. This is potentially transformative because Instagram is already a very important platform for branding and advertising. Users already follow brands/influencers with an affinity for the products and designs posted. The “Shop Now” button would close the commerce loop.

WSJ Instagram Shop Now

Source: Wall Street Journal 

Of course, every ecommerce post is obliged to comment on Amazon, the de-facto king of ecommerce in the West at the moment. With the emergence of social ecommerce, Amazon’s market positioning appears to be weakening and is ever more dependent on its utility aspects. Amazon still dominates if you already know what you want but want it fast and at a reasonable price.

However, Amazon is not a particularly strong platform for discovery other than for a very narrow range of “similar items” recommendations. People love Amazon because it useful, not because it is fun. Unless Amazon adapts quickly, Amazon risks being eclipsed by social ecommerce players that are superior in discovery if the logistics gap should ever close. 

More on this in a later post. Stay tuned.

 

What Apple, Google, and Facebook’s Business Models Tell Us About Their Ability to Adapt to the Coming AI-Future

 

Judging from market multiples, it’s clear the market is skeptical of Apple’s ability to continue to succeed and has been for many years (currently, 1-yr forward P/E of ~15x despite recent re-rating), while holding limited concern for Google and Facebook (both 1-yr forward at ~26x).

This concern is understandable given the ever-changing tech environment and the long list of tech companies that have been buried over time (e.g. Nokia, Blackberry, Motorola). Even industry stalwarts of the bygone PC-era such as HP, Dell, and even Intel/Microsoft now stand on far weaker ground. And this concern for Apple is not new as Horace Dediu points out at Asymco

However, I contend that Apple’s business model is far more robust than Google’s in the coming artificial intelligence (AI)-revolution. 

Leaving aside potential differences in technical competency, AI is likely more complementary to Apple’s business model, but potentially highly disruptive to Google’s.

And to understand why, it requires understanding the job-to-be-done for search users and how Google’s ad-centric business model fits in.

The Assumptions Behind Search

Let’s start with the user – why do Google users search? What is the job-to-be-done?Seemingly simple question with a straight-forward answer: We are curious about many things and don’t have perfect knowledge. Google can help us answer what we don’t know. For most of Google Search’s existence, the service has approached this job-to-be-done by returning a curated list of search results that are most likely to match what the user is looking for. These are organic results that are designed to improve over time as the algorithm takes into account the answers/results users found most useful in the aggregate. Fairly simple and straight-forward.

So now turning to the business model – Google Search makes money on the ads that appear alongside search results. Every click on an ad (as opposed to an organic result) generates a small bit of revenue for Google.

Under what circumstances would a user prefer an ad over an organic result? 

Philosophically, Ben Evans (A16Z partner and almost always more than a few steps ahead of the curve) hits the nail on the spot:

In essence, the existence of ads on Google Search is the most egregious effigy to the failure of the underlying search algorithm. Every time a user clicks on an ad, it is an implicit acknowledgement that Google Search did not accomplish its job-to-be-done, that the desired answer would not have been provided had the advertiser not paid for that placement.

Given a long enough time horizon, if Google Search is truly improving, barreling towards a future where Google can answer any question without doubt and with perfect context, Google’s business model would have to evolve because ads do not have an obvious place in that future. 

And that future is coming closer with the advancements in AI. 

Search and AI

What could search look like in an AI-driven world?

It might not look all that different – perhaps Google’s I’m Feeling Lucky option or the knowledge graph cards.

But, it could also be radically different such as the search results provided by assistants such as Apple’s Siri or Amazon’s Alexa.

Regardless of the ultimate direction, it’s clear that ads have a far less obvious place in this future. If AI can be used to surface the right answer the user needs, the user would have less of a need to click on an ad.

I think we’ve seen the first instance of this issue with Google’s recent Beauty and the Beast ad on Google Home. The Google Home assistant (like Alexa) does not offer a natural channel for ads, and as a result, Google will have to find increasingly creative ways to adapt their business model for the changing environment. But history is filled with examples of failed business model surgeries.

It also makes Google’s persistent pursuit of a hardware/software business model a la Apple much more understandable. Perhaps selling hardware isn’t just about protecting access to market (after all, it’s unlikely that Android will be unseated now that it is so entrenched, so why continue with the direct hardware efforts?), it could be a deliberate attempt to evolve their business model to ensure financial relevancy in the AI-driven future.

Why Investors Seem Complacent

I contend that investors (or analysts) are confusing two separate concepts to be the same thing – the universal desire to know (hence search) and the need for ads to provide that information.

There is no doubt that search queries will only grow. It’s not farfetched to imagine a future where there are 7 billion search users instead of the less than 2 billion today. But that’s a far different conclusion from assuming Google’s financial future and business model are robust as long as search queries grow.

Search is robust, but are ads robust relative to our AI-future?

Apple’s Business Model is Far More Complementary to AI

Apple’s business model, on the other hand, is much more aligned. Sell the best products available for customers’ job-to-be-done.

AI is not orthogonal to this pursuit and business model. The only question is whether Apple has the technological capabilities to do so. However, even under the assumption that Apple is not the leader in AI-technology, it is not clear that it matters. After all, Apple was not the original leader in GUIs (Xerox PARC was). Apple was not the original leader in phones (Microsoft, Palm, Blackberry, Nokia, etc. were). Despite not being the original leader, Apple had the business model and insight to ensure that they could ride the underlying technological trend, and if I were to take a bet today, I believe Apple’s business model makes them more prepared to usher in an AI-world than Google is. AI is a feature to Apple. AI is a potential danger to Google’s business model.

From a business model standpoint, Apple is far more robust in an AI-world.

What About Facebook?

Facebook’s an ad-driven business model. What about them? Surely, Facebook is potentially in danger as well.

Facebook’s situation is less clear cut because the job-to-be-done for users is different vs search. Search has a “right” set of answers. Facebook’s feeds do not. Users are not necessarily searching for anything specific but rather using the services as an outlet for time. The “wrong” answer in a search query is far more obvious than a “wrong” answer in a Facebook feed.

And if AI can be used effectively to ensure that organic content on News Feed, Instagram, etc. are more relevant and engaging, then perhaps that can even offset any deterioration in experience from an increase in ad load. AI can never make Google’s organic results more engaging to the point where a user will tolerate a less user-friendly ad environment.

Facebook’s job-to-be-done is to, cynically, offer a time sink. Google’s job-to-be-done is to get you your answer as fast as possible. One of these is more complementary for an ad-driven business model. 

Concluding Thought

Is Google as robust as investors think? Borrowing from Peter Thiel – is this something that could be true that no one believes? Is Apple in as much danger as the average person believes?

Disclosure: I have no direct beneficial interest in AAPL, GOOGL, or FB as of publishing date and have no intent to initiate a position within the next 48 hours. 

The Importance of Focusing on Business Models

“Investment is most intelligent when it is most businesslike.” – Benjamin Graham

“I am a better investor because I am a businessman and a better businessman because I am an investor.” – Warren Buffett

Most investors define themselves along a couple of axes: Technical vs fundamental, value vs growth, long vs (and/or) short, contrarian vs momentum, large cap vs small cap, etc. These labels are well understood and established conventions.

However, these labels distract from what is most important when it comes to investing – an understanding of the underlying business.

Whether you are a fundamental investor, a value investor, a growth investor, a contrarian investor, all of these labels serve only to illustrate the “how” and not the “what” or “why”. It seems remarkably odd that few investors refer to themselves as a Business Model Investor, which I believe is a much truer expression of the essence of investing.

The Benefits of Focusing on Business Models

Though I bear the risk of promoting myself to Captain Obvious, I think it’s important to call out what’s important – investing is most likely to succeed when we think of ourselves as buying businesses, and buying businesses entail understanding the business model and how it works.

I believe this is distinctly different from just understanding a company’s products, describing Porter’s 5 Forces, and assessing strategic vision / management.

Understanding business models can help us uncover great companies with sustainable businesses that otherwise may not be apparent. 

The Scourge of Retail

Today, most investors understand Amazon’s outsized impact on traditional brick & mortar retailers including the venerable Walmart. But it was not that long ago that many assumed brick & mortar would be able to leverage their larger scale (at the time) to ward off Amazon and other threats. Surely, Walmart with all its might and low prices can take the fight to Amazon if it wanted to. And of course, brick & mortar had the benefit of strong earnings / cash flows, whereas Amazon had none of the 1st and few of the 2nd (still has essentially no earnings today but cash flows are a massively different story). These were prevailing views just 3-4 years ago.

I think this is a perfect example where business model investing has been far more fruitful. All of the traditional retailers did have a scale advantage (not anymore), but scale is not a business model. Scale is merely a competitive advantage, and a disrupt-able one against a well-funded competitor.

Amazon has the benefit of a better business model. It’s a retailer that did not have to carry the significant costs associated with physical stores or sales staff. From a  business model investing perspective, it takes just a few words to understand Amazon’s advantage. These advantages are not as easily understood from just looking at historical financial statements (of which earnings look terrible and earnings-based ROIC looks laughably poor). Understanding these advantages require thinking of the business model holistically.

Finding the “Most Valuable Company in the World” in No Man’s Land

Apple, the most valuable company in the world, is a curious case. It continues to thrive in the metaphorical graveyard of tech. Few companies have survived (and thrived) for long in tech hardware because the fundamental forces at work are overwhelming – commoditized products, persistently declining prices (not least driven by Moore’s Law), fragmented landscape with too many competitors to count…Generally a terrible industry. And all of these elements are likely to remain true for the foreseeable future, leading many investors to make the case that sooner (and perhaps rather than later) Apple will succumb to the same forces that has brought down Nokia, Motorola, HP, etc.

But that view ignores Apple’s different (and unique) business model within the tech hardware industry.

From a consumer perspective, Apple’s business model is simple – sell highly-designed, premium products where every element / component is customized for use.

But from a strategy standpoint, Apple’s business model is secrecy. Whereas Apple’s peers like to run their companies like scientific experiments in broad daylight, Apple’s business model is to play the cards close to their vest. Is it any mystery then why Apple has been and will continue to be a disruptor of the industry? Nearly everything that can potentially disrupt Apple is brandished in broad daylight years before the hero’s blade is finished forging. Apple knows what’s coming from nearly everyone else, but does the rest of the industry know what’s coming from Apple?

And how does this business model address the overwhelming forces of the tech hardware industry? It allows Apple to differentiate their products with non-commoditized hardware, which can be monopolized for a (short, e.g. 1 year) period of time. Apple has to keep fighting these forces, but it’s a perpetual 1 year advantage until ideas run out (and the human race has demonstrated for 10,000 years that there are many more ideas than we can pursue).

Apple’s vertically-integrated product model also has the advantage of getting innovations to customers far faster than peers. Google is a very able peer in the smartphone OS space, but their innovations are taking on average about 3 years to get into customer hands. The majority of their customers are still using an OS that shipped in 2014 or earlier.

One should rightfully assume that tech hardware is a tough space, but from a business model perspective, it’s easier to see that Apple plays a different game and should have been apparent long, long before Apple became a household name or the world’s most valuable company.

Business Model Differentiation Worth More than “Competitive Advantages”?

One idea that I’ve been turning over in my mind is the importance of having a differentiated business model rather than just pure “competitive advantage”. After all, BHP and Rio Tinto have the unbreakable competitive advantage of immense scale in an industry where large mines cannot be willed from thin air through cash alone. But I do not think it is a stretch to say that BHP and Rio Tinto do not have differentiated business models and are bystanders to the same industry forces that buffet their peers.

Are differentiated business models the most important thing?