I just arrived from China this morning, where I was attending the 6th World Internet Conference. It is a high profile event, attended by CEOs of all big tech companies in China, as well as in previous years by President Xi Jinping.
The main message from China was clear: The adolescent age of Internet is over. For decades we tolerated many things for the kid to grow up. But now as an adult, Internet has responsibilities.
I believe there will be a significant slowdown in the globalization of technology as we know it, in particular of the Internet businesses, and this will increasingly require venture capital investment to become hyperlocal.
There are three reasons:
- The backlash against the American big tech companies, namely Facebook, Google, Amazon and Apple.
- Rising techno-nationalism, which goes beyond the Trump — Xi Jinping trade wars, and which is likely to result in split of Internet into a few blocs
- Potential end of asset price bubble in technology, probably reinforced by a global recession.
I will discuss all these three reasons and then tell you why investing in 212 (and other funds investing to emerging market founders) is a great idea!
1. Backlash against the American Big Tech
Today world’s largest companies are technology companies. 20 years ago, they were all finance and energy giants.
By then, some of today’s big companies were only startups. Actually Facebook did not exist at all. Amazon and Google were still not making money.
The reason that these companies were able to accumulate so large market power is how artificial intelligence works. In its nature, AI is a centralizing technology, since
- more data means better trained algorithms,
- better trained algorithms mean better business models,
- better business models means more users,
- which in turn means more data
These winner companies were the ones which scaled globally.
Reid Hoffman, founder of Linkedin, in his last book, calls this phenomenon blitzscaling — scaling to many markets around the world to dominate those markets, without necessarily making profits.
The startups that blitzscaled include not only Google, Facebook, and Amazon, but also star companies of the last decade like Uber, Airbnb, and Wework (I will come back to them soon).
None of these companies are profitable, yet they enjoyed extreme valuations. Because venture capitalists have had the following thesis: First you do not make money, blitzscale, gather users, and then you monopolize the market.
While Americans have these companies, Chinese also have equivalents of American bigtech:
- Alibaba — Amazon of China,
- Baidu — Google of China,
- Tencent — Facebook (and more) of China
The monopoly power exerted by these is extremely large!
Just an example: Google and Facebook have a 63 percent total share of the global digital advertisement market.
Any B2C startup has to pay a large portion of VC money it receives to Google and Facebook to be able to get into the market.
This market power got different reactions from different capitals:
Brussels is the most reactive:
Google is the fourth largest source of income for the EU budget, yet the fines are actually too low.
Facebook has a 38 percent profit margin on its EBITDA. Last time, it was fined for 4 percent of its turnover.
Margrethe Vestager is now charged with both the digital and competition portfolio of the EU commission — pointing out that digital became the most important competition policy issue for the EU.
Washington DC is divided, but many democratic presidential candidates, including Elizabeth Warren, announced that they will split up the big tech. In reaction, Mark Zuckerberg said in a confidential company meeting, he will fight with Warren, and in turn withdrew the fact checking from the political ads for the 2020 elections. We all know how Facebook can impact elections given the election of Trump in 2016.
But this fight is likely to continue at both political and judicial grounds.
Beijing has actually created its big tech companies,
- by carefully protecting its internet market from the American big tech,
- and at the same time unleashing innovation with government policies.
For example world’s largest fintech companies are from China due to deregulation in finance.
However, we do not know how other countries will react to Chinese giants when they go global.
Emerging markets lastly give reactionary responses. For instance, India banned Amazon to act both as a merchant and as a marketplace for the same products. Reactions may increase as the emerging markets will learn from each other.
2. Rise of Techno-nationalism
The market power I mentioned also granted the big tech ‘a special status’ vis-a-vis the nation states.
Brad Smith, now president of Microsoft, in a 2017 speech said these companies behave as “Digital Switzerlands.”
Embedded in this claim are two suggestions:
- These companies are on par with, and not subordinates to, countries that want to regulate them; and
- They somehow have a neutral status.
Indeed, these companies mostly regulate relationships with their users themselves, through their terms of service agreements, in many cases governed under the rule of third countries.
Facebook took the Digital Swiss status to one step ahead and declared that it will start a digital currency, Libra, above the national currencies — in legal form a foundation of course established in Switzerland!
Given Facebook has have 2,7 billion users globally, Libra has a potential to suppress the national currencies. This is especially the case for emerging markets with unstable macroeconomic policy experiences.
If we want to understand techno-nationalism, Libra is a case in point.
20 years ago, a few EU countries gave up their currencies and declared Euro as their national legal tender. This gave rise to low borrowing costs in southern European countries, which accumulated large debts, resulting in the Euro crisis of 2009–10. As they were in eurozone, these economies were not able to use monetary policy to adjust their economies, and faced austerity measures.
The outcome has been a growing skepticism against the EU, which is at its highest now since the union has been formed.
Libra is just one example on how the Digital Switzerland status can cost nation states its policy-making capacity.
Nation states do not want to delegate their policy-making capacity to global institutions, be it EU or big tech, which are not democratically accountable to their populations.
And as a result, there has been a lot backlash against it, making Mastercard, Visa and Paypal leave the group as a result of letters from U.S. senators. European countries also reacted negatively.
The so-called Digital Switzerland status in itself is attracting much reaction from nation states.
China is the first country to ban Google, Facebook, and Amazon for many years, and developing its own alternative companies. The Chinese big tech, on the other hand, are far from enjoying Digital Swiss status. They are closely associated with the Chinese Communist Party.
On the other hand, EU decided to be the leading rule-setter in the global internet. EU gives priority to the individual rights, and individual ownership of data in a clear move against the business models of the American big tech.
GDPR is the largest reflection of this, but there are many other instances, such as the right to be forgotten, an EU Court of Justice decision that forces Google to remove search results on request of individuals.
Some call the European Internet as “bourgeois” internet.
So we have,
- the “bourgeois” internet, led by Europe,
- the authoritarian internet, led by China
- and the commercial internet led by American companies
Internet was designed as an open structure which led to blitzscaling of big tech companies. No longer.
Now internet is broken into at least three co-existing blocs.
As a result,
- Forced data localization has become a common policy tool used by many countries. Turkey also has this policy for many industries like finance, energy, health and public serviced.
- We see emergence of digital services tax that targets American big tech. The first country to put digital services tax was France at a rate of 3% from the revenues of these companies (not profits). Turkey is likely to follow with 7.5%.
- Next year, the moratorium of the WTO on customs taxes for digital business will end.
Last year’s G20 declaration mentioned interoperability of different frameworks for internet.
The future is not likely to have an open global internet where companies can expand globally in a seemless fashion.
It will be more a splinternet, where different governance regimes co-exist.
3. Potential end of asset price bubble in technology
Now let’s go back again for 10 years to the time of the financial crisis.
Major central banks reacted the 2008 crisis with monetary expansion and asset purchases. This drove the interest rates to record lows and asset prices to record highs. Tech stocks were only one of the assets that had huge gains.
Now many central banks have negative rates, and this is becoming business as usual. If you go to a Swiss bank with more than a hundred thousand US Dollars, you have to pay the bank to keep your deposits.
Bonds are usually purchased for current income, and stocks for future income. Now, bonds serve the future income due to their appreciation as interest rates fall, and stocks for current income as their value and dividends skyrocket as a result of share purchases by big tech companies.
Yet we see signals that this asset bubble in tech might be coming to an end.
Many tech companies in the last 10 years preferred to stay private as there was lot of private venture capital funding available.
Best example is Softbank with its 100B global fund. Softbank actively invested in blitzscaling companies globally.
Scaling globally without necessarily making profits. Gathering users and data. And eventually and hopefully for Softbank backing monopolies and making Facebook-like profits.
Best example is ride-hailing industry.
- Uber, as a Softbank portfolio company, scaled globally — both organically as well as with 3B acquisitions like Careem.
- Uber owns 17 percent of Didi, its equivalent in China,
- Didi owns shares in Ola and Grab, equivalents in India and ASEAN.
- Softbank Vision Fund is the major investor in all these companies.
So Softbank wanted to back a network of global ride-hailing monopolies.
But when Uber went public, arguably the most waited-for tech IPO, it has been a dismal failure. Same for its competitor Lyft.
Yet, the disappointment was not comparable to what happened with Wework, another Softbank portfolio company.
Wework filed for IPO at 47B valuation, only for delaying delaying and finally cancelling the IPO due to investor reaction.
Certain debt were tied to the IPO conditions, and was called back.
As of yesterday, Softbank has to intervene. Having already invested 10 billion into Wework, and now has to invest 5B in equity more to take over the ownership. The valuation, which was around 47B is now 8B. This deal means Wework is effectively bankrupt, and is rescued by its largest shareholder.
Now as there is more of a talk about global recession risk, the tech bubble might have come to an end.
And hard funding environment will make the global blitzscaling story even harder.
Conclusion: Why invest in emerging market founders?
So we mentioned,
- The backlash against big tech
- The rise of techno-nationalism and split of Internet into blocs
- And the end of abundant funding for global scaling
This does not mean disruption is over. Because the global technological underpinnings of disruption, AI, Internet of Things and 5G will still be here.
As a result of the trends I discussed, the disrupted industries will become more regulated even if they were not at the outset.
And all regulation is local.
And local entrepreneurs know the local environment best.
After all, all the trends we discussed point out extreme global uncertainty. Entrepreneurs from emerging markets are so much used to uncertainty. Especially if they are from Turkey.
So as the adolescent internet age is over, in the adult internet age, investing in emerging market founders could be the next big investment thesis.
Dani Rodrik (2018). Straight Talk on Trade: Ideas for a Sane World Economy (on why nation states want policy autonomy vis-a-vis global insitutions or companies)
Scott Galloway (2018). The Four: The Hidden DNA of Amazon, Apple, Facebook, and Google (on the monopolization of American big tech)
Ussal Sahbaz (2019). “Artificial Intelligence and the Risk of New Colonialism” Horizons Summer 2019 Issue: 14