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Dear avid readers,

Dan is offline these weeks, attending a crash course in how to be a Dad (his son Albert was born on 2 March).

So issue #9 has been guest-edited by Ben Robinson. Hope you enjoy it!

Capitalism without capital

👓 In 2016, I wrote a paper with David Galbraith
We took aim at the theory, popularized by a Tom Goodwin article, that internet platforms are asset-light. We argued the theory confused a moment in time with a trend since there is a clear tendency for disruptors to grow their asset base and become more vertically integrated over time as they seek to improve customer experience and stay ahead of competitors (Tom Goodwin, incidentally, later acknowledged the same thing). We could, however, have also pointed out that the theory focused too much on tangible assets - while Uber, for example, was not buying cars, it was investing heavily in its app. Internet platforms may be tangible asset-light, but they are not intangible asset-light.

⚖️ In their fascinating new book, Capitalism Without Capital, Jonathan Haskel and Stian Westlake argue that it is this shift in company investment away from tangible to intangible assets that lies at the heart of many of the phenomena we observe today in the digital economy, such as the dominance of internet platforms and growing inequality.

The intangible economy
As firms have sought to capitalize on digitization, so intangible assets have grown much faster than tangible investments, or as Marc Andreesen put it, software is eating the world. This is significant, the authors argue, since intangible assets possess four characteristics that make them fundamentally different from tangible assets, namely:
  • Scalable – intangible assets are inherently easier to scale allowing the most successful companies to leverage investments globally over much higher volumes and so dominate their markets.
  • Sunk – intangible investments are generally very specific to a company and carry little residual value. This makes them harder to finance by traditional bank lending and, as this really interesting academic study shows, explains in part why bank lending to SMEs has fallen in favour of residential property lending.
  • Spillovers – it is much harder for companies to appropriate the value of intangible assets vs tangible assets which is why many people are arguing for better patent protections and a greater role for government in the digital economy (including sharing in the rewards).
  • Synergies – it is easier to combine intangible assets in value-creating ways, which underlines the importance of clusters and explains both the growing relative importance and economic power of cities as well as their desirability as places to live.

Strategy and Business Models in the Entrepreneurial Age

👓 In this intangible economy, traditional sources of competitive advantage are changing and existing business models are under pressure, as evidenced by the shrinking longevity of S&P 500 companies. This demands a new approach to strategy. As John Hagel puts it, this requires a move from building walls to cultivating networks. Essentially, he argues, firms should shift from protecting their position to leveraging their position, turning themselves into a concentration point for information flows that would see them maximize synergies and minimize spillovers. In the B2C world, this explains the success of the platform models like Amazon, Alibaba and Facebook, which have been able to turbocharge economies of scale with network effects to leverage the sunk investments they make and generate outsized returns on capital. It is also why the race is on in the B2B market to create the systems of intelligence that will pull together and draw insight from corporates’ stores of data.

Centralization vs decentralization
🖧 The model that John Hagel describes is one of openness, where the moats have disappeared. But the paradox of network effects is that they lead to increasing returns to scale and ultimately to a winner-takes-all scenario. This makes it difficult for new entrants to challenge incumbents since incumbents have the capital to invest in risky projects, to copy and to buy up the most interesting innovations. And, as with any monopoly situation, it leads to welfare losses where the monopolist extracts value from the ecosystem, by for example competing against former partners.

📉However, there are reasons to believe that the situation may change. Firstly, as John Hagel himself notes, many of the platform models rely on advertising models which put them in conflict with consumers’ best interests and we may start to see a backlash. Secondly, there seems to be growing regulatory reaction to platforms, which might lead to initiatives such as data portability to loosen network effects. And, thirdly, the nature of the internet itself may be changing. As Tim Dixon writes, cryptonetworks may usher in a new decentralized era which would break the GAFA hold. Cryptonetworks replicate data across the network, reducing barriers to entry, and use tokens to incentivize users to act towards a common goal while having the ability to reach consensus in the absence of a centralized body. If they are successful, argues Dixon, they would create a better outcome for developers, entrepreneurs and businesses.

Tech, Policies and Misdemeanours

👷  There has been much discussion about whether internet platforms are bad for employment. One criticism is that they have produced a world of more unstable incomes and more inhuman work. It is certainly the case that platforms have engaged in egregious practices, tricking workers into longer hours and using technology to micromanage them. But, as Tim O’Reilly points out, internet platforms did not necessarily introduce these practices nor are they necessarily the worst offenders - this exposé of the retail sector, for example, shows how monitoring and smart scheduling software have been in widespread use for a long time. And, argues O’Reilly, internet platforms are better at matching supply and demand as well as giving workers more agency over when they work. The issue is how to balance people’s desire for independence with the precariousness of digital age work. Encouragingly, there are many examples of how technology and practices are emerging to limit the excesses of the digital age, like teaching entrepreneurs about ethics, creating new kinds of support networks and the advent of human-centred, rather than task-centred, platforms that give consumers more choice and allow workers to charge more.

👐 Another criticism is that internet platforms are destroying jobs faster than they create them while generating lower-paid work. This interesting study from the Progressive Policy Institute suggests that, in aggregate, internet platforms pay better than other firms and are adding jobs faster than destroying them. In fact, their findings echo what other studies (including Haskel and Westlake) have shown: that growing income inequality is more of a function of company performance inequality, since the most successful firms can afford to pay better. The report also highlights that internet platforms have much higher productivity, which should translate into higher living standards once their share of overall employment rises materially. But this seems to get to the crux of the issue, which is that productivity improvements haven’t yet been translating into higher wages. Evidence would suggest that the benefits of productivity gains have been accruing to shareholders and in particular to consumers, who have benefitted through lower prices and higher consumer surplus. One possibility put forward by Ryan Avent is that, in the absence of a strong safety net, workers displaced by automation seek out continually less well-remunerated work, pushing down productivity and wage growth. This is why many proponents argue for a basic income, so that people are not forced into taking badly paid work– or can start a business they love – if their jobs are automated away. But, this excellent critique suggests the basic income idea is superficial, difficult to implement and full of unpalatable trade-offs. A better solution would seem to be the Swedish model of unions, extensive government retraining and a strong employer/employee contract, which has seen higher productivity translate into higher wages.

Our Skynet moment
🤖 A closing thought for this section. In his excellent book WTF, Tim O’Reilly argues that the biggest problem with the digital age is not the companies nor the technology, but the shareholder maximization doctrine under which it operates. He says, “The design of the system determines the outcomes. The robots did not force a human-hostile future on us, we chose it for ourselves.” If this is the case, then companies staying private for longer (in part a consequence of spillover and sunken attributes of intangible investments) and the emergence of public market alternatives may bode well.

FinTech snippets

🏦 There was much excitement last week about the news that Amazon is apparently considering a deeper foray into banking, discussing with JP Morgan launching a checking account to its customers. Many pointed out that this would massively shake up the competitive landscape in banking, which  is indeed the case, but it has been widely anticipated. Internet and mobile technologies make it possible for the internet platforms to distribute any kind of digital products, including banking, and open banking regulations are making this easier still, since they obligate banks to share customer data. What makes Amazon different from some of the other platforms is that they don’t rely on advertising revenues, which in part explains why they are much more trusted. This makes Amazon the biggest threat of the GAFA companies. A more interesting question is how banks will respond. While mentions of “digitization” and “automation” pervade banks’ year end results statements, there is little concrete detail on banks’ digital investments and strategies. As Amazon and WeChat, which now has 1bn users, make bigger bets on banking, it is imperative that banks move to the ecosystem model that McKinsey believes will restore profitability to pre-crisis levels and that we believe can see banks offer a superior proposition to the internet platforms.

💱In the world of crypto, the Swiss regulator FINMA issued some simple and practical guidelines about how different kinds of ICO would be regulated as it attempts to cement Switzerland’s position as a international crypto hub. Meanwhile, in the US, Wyoming passed a set of bills as it attempts to become the US hub for crypto assets.


👀 Would love to hear your thoughts on Twitter, @RobinsonBenP

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     My name is Dan Colceriu and I hope this reading was rewarding. Any opinions expressed here do not represent financial or investment advice. Also, they represent my personal view, and not my employer's, which is in no way associated with this email. 
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