(10) Term
In previous installments of this series, inefficiencies were discussed in regard to definitions and comparisons, when a transition is underway in virtually all known categories.
An illustration of the challenge is a recent market clustering of so-called FANG stocks — Facebook, Amazon, Netflix and Google — which at least temporarily seemed to act as points of reference for each other. Differences in business model aside, which are numerous, there is another (related) difference, having to do with life expectancy.
In the current installment we consider this idea through the lens of network character and its optionality (as introduced in last week’s episode) with a special look at two FANGs.
Facebook and the asset’s future
The case used to be straight-forward. At one polar end there is the technology, which requires continuous defense, reinvention and upgrade in order to survive. Technology companies depend on innovation. At the other extreme there is the network, which is robust because it has effect and there are switching costs for its users, who preserve the value of its base with their interconnected presence. At one end there is high volatility (and enhanced option value), at the other there are elements of stability and leverage.
The argument is no longer so concise. When the world’s largest social network makes it a point to acquire several up-comers, at increasing prices, at first for a mere 1% of its market capitalization but later for 10% — in the examples of Instagram and WhatsApp respectively — this is a signal from inside that the network cannot be taken for granted. Maybe it means that the effect is not what it once was, or that the network needs to be expanded and multiplied in order to last. Perhaps, as well, it may have been suggested that software networks are subservient to hardware, so that home-screen real estate on the controlling devices is valuable property to purchase.
Regardless of the rationale, (it might be any and all of the above, or others), when the dominant social network buys a small one, the transaction is a symbol. When the price is high, the message is not subtle. When the payment is in stock, there is a statement in that as well, because a buyer with multiple and ample resources will use the least expensive to transact, (echoing the economic notion that cash is particularly dear during commoditized deflationary phases). And when the successful up-comer quickly sells to the deeper pocket with the greater resources, there is in that as well a sort of message, possibly about necessity.
While the idea of category convergences has been a recurring theme in this series of essays, the reference was usually to industry segments. In the present scenario, however, another convergence is showcased: the thematic blend of network and technology, whereby the former assumes the volatile insecurities of the latter. The notion is introduced that networks in the digital age may have a life expectancy of diminishing duration.
Facebook’s subsequent acquisition of Oculus and its bet on virtual reality as a next social networking phase is consistent with the thesis… at least in a survey size of one. In fairness, however, this one has proven itself to know digital networks better than most, for now.
Netflix and the nature of the base
Is it an entertainment production company? A premium cable service? A distribution outlet? A hub? An over-the-top video product? A retailer? Is it largely or a little bit of all these things? Maybe, but not to the same extent, and narrowly each one comes with its special risks, competitors, and value drivers; all of which are currently in flux. If only Netflix were a network, it could be grounded thus and safer in its “moat,” fending off competitors most effectively. Some think that Netflix is just that.
At one time it was commonplace to refer to the video content distributor as a network. In the sense of unified outlets and brand presence this may have been correct. But in the modern-day connotation of network graphs and directional clusters, the terminology is less straight-forward. It is not merely a question of semantics, but one of economic preservation and defensibility. Nor is it a binary yes or no question, but one of nuance and qualitative details that determine the value of this base — its asset and the options that emerge from it. What kind of network is Netflix?
If it is indeed a network, it is predominantly unidirectional, like a broadcaster, which is less sticky than the bidirectional variety because the worth of the asset is not increased by interaction. And the switching costs for a subscriber are less constraining. In an environment of freely flowing digital bits, distribution mechanisms are not especially defensible when a better or more popular alternative surfaces.
In this line of scrutiny, Netflix is not alone, in fact it is almost marginal in the greater context. Apple, Amazon, Microsoft, IBM, even Twitter, which calls itself a social network, are at similar defining junctures. So also the banking and finance sector, healthcare, education, manufacturing, transportation. All of these segments that are transitioning to software business models, if not already there, will very likely be faced with the same necessary assessment: Is it a network, if so, what kind and what would its economic substance be? And if not, how likely is it to continue in its present form within the commoditization that is spreading all around it?
A question of survival
The introductory passage of this article made reference to imperfect comparisons between certain businesses. What followed were two case specific illustrations (that may seem disjointed), profiling two companies that for some appear to belong to the same digital media category. The point of it was not as much to underscore differences in business model and strategy, as important to comparison as such things are, but to bring to the forefront an aspect that underlies the valuation of any growing enterprise: the implied notion of perpetuity.
It is a large word, so large that it often goes unnoticed, even as the present value of a business asset is dominated by its expected economic productivity forever. Perpetuity is always assumed, for in the other alternative the asset would be depleting by nature, or in some other way expected to cease. This is almost never predicted, even though history is replete with enterprises that have ended. Or, if they still exist, they do so in a wholly different form from what had been their origin.
In a digital economy, the risk (although not new) is much more real than ever, because the pace of change has quickened and the term to a finality (whether as an end or as a transformation) has been abbreviated. Notions about networks and technology, assets and optionality, reinvention and survival, are now as immediate to the valuation exercise as cash flows and the near-term forecast model itself.
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In the coming installment, such and similar ideas as thus far covered in the series with respect to individual business forms, will be expanded out into the economic aggregate, reflecting on general consequences in the macro atmosphere.
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