In The Tipping Point, Malcolm Gladwell describes three major factors required for any trend to go viral and become an epidemic. First, you need the buy in of a handful of unusually insightful and influential people eager to spread the message. Second, you need to have a message that resonates strongly with others. Third, you need a fertile environment for that message to be received.
After years of directly benefitting from these precise dynamics, big tech now finds itself threatened by them. Viral memes, videos, platforms and products paired with powerful network effects rapidly built companies like Facebook, Alphabet, Netflix, Amazon, Apple into some of the most profitable and powerful institutions on the planet. Now, with the help of several important insiders and thought leaders armed with a powerfully “sticky” message that has found a uniquely fertile environment, the companies find both their profits and their power at risk of a major tipping point.
People like Roger McNamee, Tim Wu, Lina Kahn, Tristan Harris, Jaron Lanier, Shoshana Zuboff, Chris Hughes, Brian Acton and others have all come out to publicly shine a light on the damage big tech has done to competition and innovation, democracy, personal privacy, human health and individual autonomy, and, of course, inequality. Due to their varied spheres of influence their message is now being shared across the worlds of finance, academia, politics and technology.
'Social media’s toxicity is not a bug — it’s a feature. Behavioral scientists involved with today’s platforms helped design user experiences that capitalize on negative reactions because they produce far more engagement than positive reactions.' https://t.co/DtmXUCTu1N
— Jesse Felder (@jessefelder) May 29, 2019
Their message is getting stickier, too. If the loss of personal privacy was not enough to inspire people to care about the rise of big tech, the message that is now gaining traction is the simple fact of their massive size and scale. Just as “big bank” became an epithet several years ago in the wake of the financial crisis, “big tech” is now becoming a term of derision, as well. People hate bullies; they love to root for the underdog. There’s just something about an unlevel playing field that gets people fired up and big tech has unleveled so many playing fields that just drawing attention to this fact is enough to get broader buy in.
All of this comes in an environment that is uniquely receptive to just such a message. Over the past several decades, wealth and power has been concentrated into the hands of the few to a degree rarely, if ever, seen before. This rising inequality around the world is a message that has itself already gone viral in recent years. And who better embodies the concentration of wealth and power than companies like Alphabet, Amazon, Facebook and founders like Jeff Bezos and Mark Zuckerberg?
The combination of these three factors, influential insiders sharing a sticky message in an environment ripe for just such a message, is turning the tide of sentiment against these companies in both the eyes of users and politicians. Investors, on the other hand, seem blind to the risks presented by the spread and adoption of this viral phenomenon.
Specifically, there are three major risks to these companies the spread of this viral message makes more apparent: increased regulation at home and abroad, ordinary cyclical forces and outright fraud. Any one of these has the ability to permanently impair these companies. Together, they represent a very serious threat to their dominance and financial well-being if not their existence.
To begin with, regulatory risks came to the forefront last week with the revelation that both the Trump administration and Democrats in congress are beginning the process of investigating anti-competitive behaviors by these companies. This comes on the heels of parliamentary hearing in Canada regarding Facebook the week before and a series of rulings against the companies over in Europe. It also comes amid a rapid deterioration in public sentiment towards them. Finally it seems the pressure on Washington to address the “curse of bigness” has risen to the point at which they can no longer sit idly by.
The possible remedies being discussed range from the usual fines and censures to raising taxes on certain unique tech business activities to undoing past acquisitions, such as the purchases of Instagram and WhatsApp by Facebook, to even nationalizing certain platforms, such as Google search and Facebook, in the interest of public utility. Trying to handicap these is probably a fool’s errand.
What we do know is that increased regulation is coming both here in the U.S. and abroad. And the history of increased regulatory efforts is not a benevolent one when it comes to Wall Street, as my friend Tom McClellan recently pointed out. The antitrust case against Microsoft was clearly one of many catalysts for the dotcom bust. Because big tech has become such an important component of the overall stock market, we may look back at the bipartisan investigations being announced today as a catalyst for a similar stock market bust.
'Wall Street does not like attention from Washington.' https://t.co/eNzgzUVyJ0 by @McClellanOsc pic.twitter.com/nLoZiT0kHt
— Jesse Felder (@jessefelder) June 3, 2019
What we can be more certain of is the fact that technology companies will see their tax rates rise significantly in the coming years. Bloomberg reports:
Companies have long been able to expense their R&D costs upfront, even if the product of that research ends up being a product or patent that could generate revenue for years. Recognizing those costs immediately, rather than spreading them over a number of years, like a company would do if it were to build a new plant, reduces near-time profits and therefore corporate tax bills. Starting in 2022, companies will have to amortize their R&D costs over five years, lowering the immediate expenses they can use to offset profits and therefore raising their tax bill. The following year, companies will also have to start phasing out a part of the tax bill that allows them to temporarily expense more of their capital expenditures upfront as well…. All told, strategists at Morgan Stanley estimate that the provisions, which they call tax cliffs, will cost corporate America as much as $800 billion over a decade, which they say is the equivalent of raising the federal corporate tax rate back up to 28%, or halfway back to what it was before the 2018 tax change. The biggest losers could be the big tech stocks, which spend more than $100 billion a year on R&D.
All else being equal, this will have the effect of lowering profit margins and expanding earnings-based valuation measures. But it’s not just here in the U.S. where big tech companies will see their tax bills go up. Europe is looking to find ways to tax these companies for profits earned in their jurisdictions. The Wall Street Journal reports:
International negotiators say they are making progress on rewriting rules for how countries tax multinational corporations, marching toward consensus on how to respond to increasing digitalization even as trade and climate policy divide developed nations…. Countries are addressing the mismatch between existing corporate income tax rules that assign profits to jurisdictions, based on where value is created, and a digital economy where profits are harder to trace to particular locations. The rise of U.S.-based companies such as Facebook Inc., Apple Inc. and Alphabet Inc. has caused particular angst in Europe.
Europe has been ahead of the game in terms of regulating these companies and now, even while those efforts are ongoing, it is turning its attention to rectifying the glaring mismatch between the amount of profit they extract and the amount of tax they pay in the Eurozone. The viral backlash against big tech only convinces people that, due to the massive size of their cash piles, they can easily afford to bear the burden of just such tax increases.
In all, the regulatory risks facing big tech are only gathering steam. While we can’t know how it will all shake out I think we can be certain that some sort of major change is coming. The groundswell of support in favor of it has already become too strong and thus their days of unfettered growth and profitability are over. Investors counting on just such growth and profitability are in for a rude awakening.
'The rise of corporate market power is receiving increasing attention in research and public discourse—including the current U.S. presidential election debate—with good reason.' https://t.co/x59CJswO4P
— Jesse Felder (@jessefelder) May 28, 2019
Perhaps the greatest misconception about the these companies today, however, is the idea that they are invulnerable to the normal business cycle. Even many of those that still believe in the archaic concept of recession also believe these companies are immune to its effects. They extrapolate the past decade’s growth and profitability indefinitely into the future.
However, Facebook and Alphabet are advertising companies; Amazon is a retailer and Apple is a consumer goods producer. You would be hard pressed to find any tech companies whose major lines of business are more cyclically sensitive than these. And while it may have been true in the past that these companies were able to overcome cyclical weakness by taking market share, the fact that they have entirely saturated their markets by this point means they are now more cyclically sensitive than ever before.
In other words, when the economy finally cycles down from one of the longest expansions in history, advertisers will do what they always do: cut their budgets. Consumers will also do what they always do: cut their spending. As a result, these uber-popular “growth” names will cease to show the sort of the growth they have in the past. What’s more, the veil will be lifted from the eyes of investors as they realize these are now just cyclical stocks like the old advertising agencies, retailers and consumer product manufacturers. The rapidly shifting sentiment towards big tech will only hasten this realization.
Finally, there is the risk of outright fraud. Facebook and Alphabet, along with more recently Amazon, have done a fabulous job convincing their clients about the wonders of behavior-based advertising. They have done such a terrific job, in fact, that the Wall Street Journal reports, “A 2009 study by Howard Beales, a professor at George Washington University School of Business and a former director of the Bureau of Consumer Protection at the Federal Trade Commission, found advertisers are willing to pay 2.68 times more for a behaviorally targeted ad than one that wasn’t.”
The “miracle” of big tech is a message that was swallowed hook line and sinker not just by their clients but also by users, politicians and everyone else over the past couple of decades. The truth, however, is that not only does this “miracle” come with some major undesired side effects but it is also nowhere near is miraculous as it was made out to be. As noted in that same WSJ article, “One of the first empirical studies of the impacts of behaviorally targeted advertising on online publishers’ revenue, researchers at the University of Minnesota, University of California, Irvine, and Carnegie Mellon University suggest publishers only get about 4% more revenue for an ad impression that has a cookie enabled than for one that doesn’t.”
So advertisers are paying for digital ads multiples of what they have paid for traditional ones even though they are really no more effective at driving business. The truth of digital advertising is that it is a sham. It has been marketed to marketers as the holy grail when, in truth, it is really just another plain old coffee mug. Now you may see this as fraud or something much more benign – sort of like what most marketing does when it shows you a Big Mac in a television commercial and when you go get the real thing it’s far more mundane than they represented it.
Still, there is an element of true fraud in the digital advertising space that is much harder to quantify. Because these companies are black boxes that disclose only what they choose, we have no idea how big the real problem is. What we do know, however, is that Facebook just told us that it recently removed 3 billion fraudulent accounts. That’s a huge number on its own but its even more huge in the context of Facebook’s 2.4 billion monthly active users. How many times did these 3 billion fake accounts click ads that advertisers were charged for? We may never know.
We do know that one of the cottage industries that has grown up in the era of big tech is the click farm. Thousands upon thousands of workers create fake accounts to generate fake clicks to help make things look more popular and successful than they really are. And really this is the overriding lesson of social media; it’s entire purpose is to make things look better than they really are.
On Facebook and Instagram it’s users living their #bestlife curating an alternate reality that has nothing to do with their real lives at all. It is all fluff with very little or no substance at all. Actually, it’s fluff created to hide or distract from what’s real, from what has substance. For marketers and advertising agencies it is exactly the same. It is an effort to make their clients believe things are far better than they really are, that the “miracle” of digital advertising is real.
'The mythology of tech as the carrier of progress has imploded, just as it did for the robber barons of the late 19th century, ushering in the trust-busting era.' https://t.co/YGc21faZCk
— Jesse Felder (@jessefelder) June 5, 2019
The backlash against big tech threatens to lift the veil, not just from investors’ eyes, but also from advertisers’ eyes. And once they, as a group, come to the conclusion that they should pay no more for a digital ad than for a print or television one then the jig up. The “miracle” of big tech comes to an end just as a salesman of liquid remedies or boy’s band paraphernalia finds he has exhausted the territory.
That is not to say that there is no value to what Alphabet, Facebook or Amazon produce. Of course, there is value. But their extraordinary value in being disruptors evaporates once there is nobody left to disrupt and they become the incumbents. They only deserve to earn extraordinary profits and carry extraordinary valuations so long as their businesses are extraordinary. Becoming ordinary, by displacing the ordinary companies they disrupted, means losing precisely that which made them special.
The growing backlash against big tech threatens to expose the true extent of the problem of “click fraud” but also threatens to expose this other sort of fraud. These companies are not what they have led users, politicians or customers to believe. They are not a force for leveling the playing field of ideas so much as a means of further stratification of wealth and power; they are not recession-proof but highly sensitive to the economic cycle; they are not a miracle cure for marketers so much as a means for them get a taste of their own medicine.
As the scales fall from the eyes of users, politicians, customers and investors and they begin to see these companies for what they are, with the help, of course, of a small group of influencers armed with a sticky message in an environment ripe to receive it, there will be a tipping point for big tech. In fact, it may have already passed. As The Atlantic recetly put it, “The mythology of tech as the carrier of progress has imploded.” The market just hasn’t recognized it yet.