We have written regularly about the threat government regulation could have on the information technology companies you own. The headlines recently have demonstrated that our concerns were well founded. Concerns about the power that Amazon, Facebook, Google, and to a lesser extent Apple (we will call them GAAF for short) exert over the world with regards to privacy and monopolistic powers have now also spread to concerns about their ability to be used as tools to influence government. This has led to discussions about freedom of speech (in countries that allow freedom of speech) and under what terms of service these companies should operate, or whether or not they should be allowed to operate at all. Expect the headlines to get worse but also expect the solutions to take many years to evolve. The issues are complex. The companies and interested parties have varying interests—sometimes aligned and at other times conflicting. These companies are all multinational as are their governmental counterparties, making forecasts about regulatory outcomes unpredictable. No one knows the true path of outcomes for the next five years. However, we will briefly try to explain the key issues we believe are facing these companies and the complexity of understanding the likely outcome.
GAAF stocks enjoy their success because of what are called “network effects”. Network effects simply are powers built up as more people use the service and more data is collected, allowing for greater benefits of scale. Google, for example, learns more about your interests as you search, and ranks informational answers based upon your previous interests. This allows the service to quickly and accurately find answers to your individual queries. This encourages more usage, leading to greater accuracy, and the virtuous cycle continues. Google effectively learns more about you the more you use it and as a result, you like the service because it’s fast, free and accurate. They take this knowledge (power) and ‘monetize’ (exploit) it by allowing advertisers to place ads on Google’s services. Google’s knowledge of you allows advertisers to better target and tailor their product, thinking it may be of interest to you, specifically based off your searches. This is valuable information that advertisers pay Google to provide. Google has continuously innovated and in 20 years, has become the dominant advertising business in the world.
Privacy: Privacy has been the biggest investor concern lately and it has been well documented in the press. We expect the GAAFs will continue to ramp up investment in privacy controls due to both self-interest and changes in regulatory requirements. The costs of this will continue to rise and will likely impact profitability. Facebook recently confirmed this much to investor dismay. Declines in profitability are an investor’s greatest fear. Given their skilled application of technology, combined with innovation in new markets (like healthcare), and highly motivated management teams, we expect GAAFs to continue being among the most profitable businesses in the world. Ultimately, we believe the GAAFs will outgrow the cost of privacy controls.
Competition and Innovation: Because network effects are so powerful, companies exploiting these powers quickly come to dominate their industry. A “winner takes all” outcome mixed with business aggression and innovation raise questions of fairness, price, and consumer and competitive protection. Competition law varies greatly by region. In America, the law concerns itself mostly with price. This raises the bar for regulators in their pursuit of action because the GAAFs offer compelling (and often free) services that deliver low prices for consumers, or exceptional products. In Europe, the law worries about the diversity of supply (competition), not price. Does Google, for example, restrict the ability for new, innovative companies to form and compete, and thus do harm? While it is true that the GAAFs often purchase small, innovative, and important companies to bolster their existing business or research efforts, one cannot say that these companies do not also benefit from being part of a larger enterprise with scale. Innovation has never been faster paced nor have more people had access to the technological wonders we see today—often for free.
The facts are indisputable. No four companies spend more on research and have delivered more to the world as a result, in terms of choice and benefit. An excellent precursor to investor returns are high returns on investment in research and development, and the GAAFs continue to plow their huge profits into research and innovation. We expect the GAAFs to continue to lead the world.
Free Speech and Politics: Network effects have made the dissemination of opinion to be free, immediate, widespread, hateful, untrue, true or misconstrued. Politicians globally have used these network effects for their benefit and the outcomes have not been universally liked. This truth (or disagreement about truth), is in our view, the most serious issue. If lawmakers decide that these network effects cannot be controlled for their benefit alone, they will write laws that may be harmful to the businesses you own. The dilemma for politicians is will their voters (or subjects) accept the restriction of their right or will to speak? Our best guess is that most of the free world will err on the unhappy outcome of allowing private companies to regulate themselves out of self-interest versus increasing government control.
In the end, we believe that the GAAFs will continue to evolve into new businesses and continue to grow their profits. The road forward will have bumps and twists ahead. Rarely do companies maintain monopolistic or oligopolistic positions for long, BUT they seldom suffer quick declines after the positions have been eroded through regulation. The large telephone companies of the past were eventually broken up, but they remained highly profitable, and soon began to combine anew as the realities of the world evolved. While the costs to accommodate regulation and government will rise for these companies, their profits will also continue to rise and thus continue to deliver exceptional investor returns.
Uncommon Sense 