If you are investing in tech companies you should read “The Platform Delusion”. You might disagree with some of the arguments made in the book but you will also find that the core proposition of the book – that the competitive position of the FAANG stocks (and companies similar to them elsewhere in the world) is far weaker than people understand them to be – is convincingly argued with detailed research. In specific, here are our key takeaways from this thought-provoking book:
- Barring Facebook, the FAANGS and other so called “platforms” like Uber and AirBnB don’t seem to benefit significantly from network effects. In fact, many of these businesses don’t even have network effects in the first place.
- Many of these businesses actually have low barriers to entry and make little or no money specifically because entry barriers are low. Eg. The world over several independent retailers specialising in a vertical have been able to do to Amazon what Nykaa has done in India. In so doing they have taken away from Amazon some of the most profitable parts of the online retailing and delivered much higher profit margins than Amazon. In fact, outside America it is unlikely that Amazon will ever make money from retailing. Another example of a low barriers to entry business is Netflix – read this article to understand how fragile Netflix’s market share leadership is: https://jscottmo.medium.com/book-review-the-platform-delusion-4769ae8ed440
- These businesses have made sub-optimal capital allocation decisions which has hurt their free cash flows further eg. Netflix is making content and the book argues convincingly that Netflix has no competitive advantage in making content (neither does it have network effects).
- These firms do NOT operate in winner takes all market. Neither do they operate in markets where digital has an inherent competitive advantage over analogue. (Eg. as the NYT article explains, a conventional local shopping or a local cinema has a far stronger local competitive position than either Amazon or Netflix). In fact, these firms operate in highly competitive markets with low or no margins eg. for obvious reasons, taxi operators make little or no money whether they are analogue or digital and whatever little money they make is on account regulators creating barriers to entry.
- Because these firms do NOT have natural competitive advantages, they constantly spend capital acquiring other businesses. This pushes their free cash flow further into the red.
- “Platform” companies in general – have charismatic leaders who have run these firms for very long time periods with long term horizons, great execution and the ability to game regulation. It is not obvious how sustainable these competitive advantages are. For example, can these companies game regulation in India like they have done in America? If they can’t, can they succeed in large markets like India? And by the same token, can the Indian “platform” companies which are attracting private and public market capital game regulation on a sustainable basis given that these companies seldom have deep competitive advantages (and therefore have low or no cash flows)?
- It is possible to create highly profitable digital businesses but the methods to do so are NO DIFFERENT from what you use to make highly profitable analogue businesses.
Dr Knee’s book is filled with detailed case studies which those who want to avoid losing a boatload of money on delusional investments would do well to read. As the NYT reviewer puts it: “…the delusion Knee has identified…the two primary misjudgments that cause it. The first is a belief that platforms emerged with the dawn of the internet. In fact, they’ve been around for decades. Shopping malls are platforms. Movie theaters are platforms. Credit cards are platforms. (Not to blow your mind, but money itself might be the original platform.) Moreover, Knee argues that these analog businesses were often better than the digital ones that replaced them. A suburban shopping mall operator will never achieve global scale, but the business comes with built-in competitive advantages: Stores are locked into long-term leases, and shoppers traditionally have no choice unless they drive many miles away. In e-commerce, where it is said that 90 percent of businesses fail in their first four months, these barriers don’t exist. My dog’s preferred food is available for the same price on Amazon or Chewy or many other sites I can reach with a few keystrokes. While much has been made of the mall’s decline, Knee writes that the most successful of them still have operating margins of 70 percent. Amazon manages only about 7 percent.”
Sequoia partner Michael Moritiz’s review of the book in the FT is less flattering but ironically the review itself – by referencing another very interesting book – “An Ugly Truth: Inside Facebook’s Battle for Domination” by Sheera Frenkel and Cecilia Kang – underscores why the FAANG stocks’ competitive moats are not in the domain of conventional business: “An Ugly Truth, by journalists Sheera Frenkel and Cecilia Kang, is at pains to unearth original — frequently fascinating — material that I suspect the PR departments of Facebook and Amazon would have preferred to remain hidden. As such it complements Brad Stone’s Amazon Unbound, published earlier this year, in illustrating how the law and, in some cases, popularly accepted economic doctrine has failed to keep pace with the tech companies. No wonder that chief executives are often forced into the uncomfortable position of being judge, jury and censor.
Yet the overmighty subjects have advantages that no elected leader possesses. Their companies operate with far greater speed and agility than any legislative body. They also have a secret weapon — longevity. They can plan and operate for the long-term and often ride out unfavourable political winds. Since Jeff Bezos formed Amazon in 1994, there have been five US presidents, 18 permanent or acting attorneys-general, 11 chairs of the Federal Trade Commission and 10 Treasury secretaries. If a company had that sort of leadership turnover, it would never accomplish anything.”
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