Talks of breaking up big tech have been heating up for years and seem to be reaching a boiling point. This isn't a political show, but the upcoming election has serious potential to shake up some of the biggest companies, so it's time to, as unpolitically as we can, dig into what's being said, why, and what it could mean for investors.
In this week's episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool analyst Evan Niu look at some of the antitrust arguments politicians are putting forth, why the Standard Oil case doesn't give us much of a precedent for these big tech monopolies, why Apple (NASDAQ:AAPL) is under scrutiny along with Facebook (NASDAQ:FB), Alphabet's (NASDAQ:GOOGL) (NASDAQ:GOOG) Google, and Amazon.com (NASDAQ:AMZN), what breaking up could mean for these companies, what kinds of regulations might be put into effect to address these antitrust concerns, and more.
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This video was recorded on Oct. 11, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, Oct. 11, and we're checking in on big tech. I'm your host, Dylan Lewis, and I've got fool.com's Evan Niu with me on Skype. Evan, what's going on, man?
Evan Niu: It's very cold. It was the first snow of the season here in Denver yesterday. It's like 20 degrees, so I have to dress up accordingly.
Lewis: I've actually been watching the forecast for Denver because I'm heading out to our Colorado office next week to meet with some of the folks from our Ascent vertical, the personal finance and credit card vertical that we're standing up. I was looking at that snow forecast. I was like, "This is a little earlier than I thought it might hit."
Niu: Yeah. It wasn't too much, but the temperature's definitely come down quite a bit.
Lewis: Yeah, it's a sign of where we're heading. I'm going to enjoy fall over here on the East Coast for a little bit longer. Evan, today we are talking about big tech. We are specifically talking about big tech being in the crosshairs of some regulators and some people that may ultimately be in power come 2020.
Niu: Right. This has become a pretty popular topic on the campaign trail as we ramp up for the 2020 presidential elections.
Lewis: Yeah. We're going to specifically look at some things Sen. Elizabeth Warren has brought up related to big tech. That conversation has gone on for a while in 2019. Recently picked up a little bit more enthusiasm. Then we're also going to be talking about some things specific to Apple.
But starting with Senator Warren, one of the major campaign pillars for her right now is a vow to break up some of the big tech companies out there. Specifically, we're looking at Amazon, Google, and Facebook here. There are thoughts that maybe Apple is included in that conversation. You go back to a statement on her opinion, and it makes it pretty clear how she feels. "As these companies have grown larger and more powerful, they have used their resources and control over the way we use internet to squash small businesses and innovation and substitute their own financial interests for the broader interests of the American people. To restore balance of power in our democracy, to promote competition, and to ensure the next generation of technology innovation is as vibrant as the last, it's time to break up some of our biggest tech companies."
Now, Evan, we are not a political show in any way. That is not what we're trying to do here. But we are talking about this because it is just another instance of the mounting criticism against some of these companies. The reality is, if it's a major talking point for one campaign, it's probably going to enter the national conversation in a much more profound way in the coming months and years.
Niu: Right. Plus, this whole idea of breaking up these companies has clearly humongous implications for the companies and investors. I do think it is certainly relevant from an investing standpoint. On top of that -- there are some politics involved in this conversation, of course. But underlying that politics is a common perception among average people that agree with her that these companies are becoming too powerful. That also has implications on their business. If consumers don't trust these companies, they're less likely to give them business. There's all sorts of ways that I think it is still very important for investors to really understand what's happening here.
Lewis: If you go back to March of 2019, there was a Medium post from Warren's team. It lays out some of the logic and how a lot of this stuff might happen. A big part of the argument here is that the government stepping in is exactly what has gotten all of us to some of the best parts of the internet as we know it. Part of her philosophy and outlook is that so much of what we experience now would not have been made possible had antitrust stuff not come against Microsoft in the '90s.
Niu: Right, which was, of course, a monumental case, since Microsoft was so powerful at the time because they had essentially a monopoly on PC operating systems. They used that power to bundle in their internet browser. That was certainly a very important time in history in terms of tech.
Lewis: Yeah. The reality is, these businesses -- Apple, Facebook -- a lot of them are trying to do stuff that is fairly similar to what Microsoft was doing back then. They have this one great access point for users, and they are slowly building out the ecosystem to encapsulate as much user activity as they can, because they have all these different ways to monetize that activity.
Niu: Right. I think it's also worth noting that, part of Elizabeth Warren's argument historically is off-base. For example, she argues that the government coming after Microsoft for antitrust helped Google and Facebook come about, which isn't exactly true. Microsoft didn't even get into search until 2009 with Bing. Prior to that, their search products used licensed search results from other companies, and this is all well after that antitrust case that she's referring to, and over 10 years after Google was founded, which was back in 1998. So there's a little bit of a disconnect there. Plus, I don't see how it ties into Facebook, because Facebook came a little bit later. Also, it's not as if Microsoft was super powerful in social networking. Social networking wasn't even really a thing back then. So I think some of it's a little off.
That being said, I do think she does have some other arguments that are valid and worth exploring.
Lewis: Yeah, I think we can quibble with the letter of some of this stuff, but the essence of it definitely rings true, at least for me. Some of the stuff that she is specifically focusing on here is the way that big tech has used mergers to limit competition, and used proprietary marketplaces to limit competition. Really, both of these get at the flywheel effect of being a big platform company, and then rolling other functionality into that platform in a way that prevents upstarts from also jumping into the space.
Niu: Right. There's been massive consolidation, particularly in social media as it relates to Facebook. Facebook has become so powerful in the social networking market. No one comes even close to them. They either destroy any potential competitor or they buy them. At least in the U.S., at this point, no one is even close to their level of power.
Lewis: Yeah. I think it's worth backtracking and thinking about an alternate universe -- I know it exists out there, if you're a multiple-universe person -- where Facebook does not buy Instagram for a billion dollars so many years ago, and the reality that Instagram would be the leading competitor against Facebook now, with activity on the rise, usage on the rise, while this older-guard internet company was starting to wane, particularly in the United States, where the ad market is so important.
Niu: Right, exactly. Plus, you have WhatsApp. They have all of the biggest social platforms on the planet. In the case of Instagram, I will give them credit in the sense that Instagram was so tiny when they bought them, and they really built it up to what it is today. I do think they deserve a lot of credit for what they built. It's not like they bought them when they were humongous. They bought them when they were tiny. But still, the underlying theme here is, it does undermine competition. If you look at all the most popular apps out there for social networking, Facebook owns and operates like seven out of 10 of them.
Lewis: Perhaps the better example of exactly what some of these anti-competitive things look like in practice is the huge drop-off in user growth that Snap experienced once Instagram started rolling in Stories functionality -- which, of course, was something that Snap developed and brought to the consumer marketplace.
Niu: Right, exactly.
Lewis: The other thing that I want to drill into here because it's a little bit more something that needs to be worked through is that proprietary marketplaces to limit competition. The idea here is that you have so many big tech companies that own a platform or own a marketplace where buyers and sellers are coming together, and then they are also a participant in that marketplace. With that dynamic, there are some anti-competitive and seemingly unfair elements to it. You can think about Amazon very specifically here as the example.
Niu: Right. And they've gotten a lot of scrutiny because of the way that they compete with their third-party sellers. Jeff Bezos recently tried to tout how much of a presence third-party sellers are overall. But that kind of ignores the actual criticism that's underlying all of this, which is that they do compete very aggressively with these companies that they also enable and facilitate. There is a pretty obvious conflict of interest. On one hand, you're helping these other companies sell; on the other hand, you're getting in there and competing with them on the platform that you operate.
Lewis: The two main remedies that Senator Warren is proposing for these issues is pushing legislation that requires very big platforms to be designated as "platform utilities," which would prevent them from also being a participant on the platform that they are making available. That helps avoid that seemingly conflict of interest or anti-competitive element to a marketplace.
Niu: Right. If you break them off from the platforms, that allows each entity to be more autonomous and independent. That does reduce the potential for conflicts of interest, I think.
Lewis: And then, the second point is appointing regulators committed to reversing illegal and anti-competitive tech mergers. This specifically gets at all of these acquisitions that we've seen where the App Store is dominated by a very small portion of companies. She specifically called out, back in March of 2019, Amazon, with Whole Foods and Zappos; Facebook, with WhatsApp and Instagram; and Google with Waze, Nest, and DoubleClick. To your point earlier, Evan, some of these acquisitions are quite old. The Instagram acquisition was one that was much more speculative when it happened. We can look at it now and say it was a resounding success and it grew into this monster platform, but it wasn't clear that that was going to happen when Facebook bought it.
Niu: Right. They bought, like, 12 people. [laughs]
Lewis: [laughs] Yeah, it was almost an acqui-hire, in some ways. But the reason that we're talking about this now -- some of this is old news -- is because it recently came back into the news cycle, specifically because there was a Q&A at Facebook that featured Mark Zuckerberg answering some questions from staff, and it gave a good insight into how Facebook management is looking at the looming threat of either a Warren administration or someone else deciding this company needs to be broken up.
Niu: Right. He addressed this with employees, this internal meeting that leaked. I was actually surprised he wasn't more upset about it. He basically says, if a candidate like Elizabeth Warren, or any candidates who've proposed similar ideas, if someone like that gets elected president, then you're going to have a big-deal challenge on Facebook's hands. He's pretty confident that they will be able to beat the government in that situation.
Lewis: One of the things that we haven't quite gotten to yet -- we focused a lot on the anti-competitive and monopolistic elements of this. Some of it also has to do with the way that information is passed along. There is this definite campaign quote of, "These types of platforms are controlling information, and that lends to the possibility of some form of election interference," or them being able to swing an election one way or the other. Zuckerberg has an interesting take on that, Evan.
Niu: He's had a couple of defenses against this whole idea of breaking them up. He has argued -- and he has a good point here -- that Facebook's size and scale gives it more resources to combat the problems on its platform. He believes that these companies should be able to fix these problems themselves without the government intervening and getting in there and breaking them up and forcing them to do things that may not be the best way to address these underlying problems. He made a good point during this leaked audio thing where, the amount of money that Facebook is putting into platform security is greater than all of Twitter's revenue. Facebook is gigantic, and they do have far more resources to be able to address these problems. Whereas, if you split these companies up, each company, while there may be more competition, there's not as much financial resources that each company can put into securing their platforms in a way that addresses these criticisms.
Lewis: I guess the counterpoint to that would be, if that was the case, no individual platform would be so capable of swaying things, which is hard to say. Information is going to move pretty quickly one way or the other. I think what makes all of this so hard to take a step back and look at how we generally look at antitrust. The seminal antitrust case that people tend to look at is Standard Oil, right? This is a company that was founded in 1870. In 1911, the Supreme Court ruled that it was an illegal monopoly. You think about that timeline -- over four decades, they were able to grow and then operate. Think about the lifetime of some of these businesses that we're talking about now. Most of them, born either during the internet boom or after the internet boom. They aren't touching 40 years of age, but they move so much faster because they aren't working in physical goods and infrastructure.
Niu: Right. Tech evolves so rapidly. Five years in tech is like decades in any other industry.
Lewis: And you wonder how we got here. Well, if you go back and watch lawmakers interviewing Mark Zuckerberg for his testimony, and some of the questions they were asking, it's clear that policymakers often lag where an industry is going, particularly one that is moving as quickly as tech is.
Niu: Right. I think another topic that relates to this is also accountability. It just comes down to basic accountability at the corporate governance level. These companies don't really have any of that. Most of the companies that we're talking about now, they have these voting structures that give the insiders all this power. And if you didn't have that structure to the point where investors had more say in the governance, and they can bring more accountability to keep these companies in better line with how they operate, making sure that they're not undermining competition.
Lewis: If we're looking at the outlook for these businesses now, Evan, it's impossible to know what is going to be going on in the next couple of years. So much of this is so speculative. But I do think, if you're an Amazon, Alphabet, or Facebook shareholder -- and I am -- you have to be prepared for the fact that, one, business is going to be a lot tougher for these companies. They're going to continue to face a lot of scrutiny because they've enjoyed a pretty free ride for a really long time. Up until about maybe 2016, they were able to do a lot of things without having to worry too much about regulators hopping in. That's going to end. And there is the possibility, for sure, that some of these businesses get broken up. What does that do for the value of those businesses? It totally depends on the complexion of that breakup.
Niu: Right? A lot of times, there's a sum-of-the-parts analysis. Sometimes companies can be, generally speaking, worth more as separate entities than as combined into one. That's an interesting thing to think about. If any of these companies do face something as drastic as getting broken up, what happens to the value?
Lewis: All right, Evan, Apple has not been under quite as much fire as some of the other big tech names. That does not mean that they don't have problems of their own.
Niu: There's been a lot of scrutiny coming from lawmakers and regulators all around the world around Apple. Speaking of Elizabeth Warren, she's also included Apple in these calls to be broken up. She recently said, Apple, you've got to break them apart for their App Store. It's got to be one way or the other. You can either run the platform or you can play in the store. You can't have both. It ties back into what we were talking about before, which is the whole idea of the platform and the marketplace. In this case, it's not about Apple's hardware business. It's really all about the mobile app store. iOS is a very locked down platform. The App Store is the only way you can get apps on your phone, outside of a few niche circumstances.
Lewis: Yeah. That's both what makes Apple so great if you're an investor, and one of things that makes it so problematic if you're thinking about it from a regulatory perspective. We love the control in the ecosystem they have. That's how they've been able to curate this wonderful experience and how they've been able to create some very high-margin revenue on the services side. But it's also going to draw some attention as well.
Niu: Last month, the House Judiciary Committee, as part of a bipartisan investigation into antitrust, sent Apple a letter requesting information on a bunch of topics that all tie into this antitrust conversation. Again, it all really revolves around the App Store and the policies that Apple has in the App Store, and how it enforces those policies. Just as a couple of examples, Apple doesn't let people change the system-level defaults for a bunch of really important functions, like the web browser, music, maps, email, etc. Some developers can get around this by having their specific apps redirect to specific other apps, but at the system level, at the default, you can't change it. And all apps have to go through the App Store. That means Apple gets to review them. Apple has final say over what gets in and what gets out. And then, on top of that, they get 15% to 30% cut on all digital sales and subscriptions.
Lewis: We've talked in the past about the "Apple tax" and the toll, basically, that they get to collect for making that marketplace available to people. Some big companies, specifically Netflix, have gone out of their way to avoid taking that haircut on everything that they're doing through the App Store.
Niu: Right. Apple was actually sued over the summer by a bunch of developers alleging that it has a monopoly on app distribution in iOS, and basically forces them to pay this tax, and there's no competitive forces, because there's no alternative App Stores, no alternative way to distribute your content, other than Apple. There's no competition bringing that cut down, which you might see if you had other ways to distribute stuff. This doesn't apply to Apple's Mac platform, because on a Mac, you can download things from pretty much anywhere. They have the App Store on the Mac, but the Mac is not nearly as locked down as iOS.
Lewis: I've also seen some headlines recently about the Apple-Spotify dynamic, and how a lot of regulators are now looking specifically to Spotify to provide some information on anti-competitive practices and how that's impacting music streaming as well.
Niu: Right, exactly. Spotify has complained to regulators in Europe, and I think in other markets, too, basically arguing that Apple is anti-competitive because if Spotify wants to sell subscriptions through the App Store, it has to pay this 15% to 30% cut, which undermines Spotify's business, which is already struggling to scale profitably. They have a lot of valid complaints, and Apple is slowly starting to address them, in part because a lot of other developers are echoing the same arguments that Spotify has been making.
Lewis: Yeah, and this is a legitimate issue if you're an Apple shareholder. We know the services segment is such a large part of the thesis. Much like Facebook, Apple has their defense for some of these allegations.
Niu: Apple keeps trying to downplay this, saying, "Oh, there's plenty of competition. There's no big deal." But the issue isn't really exactly whether or not competition exists. It's always been about how Apple competes. In addition to the App Store tax and stuff like that, they have a bunch of little things that they do that tilt the odds even more in their favor. For example, they have a lot of policies in the App Store that apply to third-party developers, and Apple strictly enforces these, but they don't apply them to themselves. Just a couple of small examples -- apps are not allowed to use push notifications for marketing and promotional purposes. Apple regularly uses push notifications to promote its services, to promote engagement, and to sell iPhones. They'll send you a notification -- "Hey, the new iPhone's ready! Go buy one!" [laughs] They also don't follow their own policies around how billing information is supposed to be presented. There's a bunch of these little things, but when you add them all together, it just makes things even harder when Apple already enjoys a bunch of huge advantages. It's their store; they pre-install a bunch of apps on the phone. They also have search algorithms that allegedly favor their own apps. When you throw this in there, it just looks really bad for them.
Lewis: When I look at this whole landscape, whether we're talking about Apple or we're talking about some of the companies that Senator Warren is specifically targeting with some of her proposed policies, I think it's much more a matter of when rather than if we start to see a little bit of a pinch for these big tech companies, and more pressure to be either breaking things up or adopting policies that are a little bit more competition-friendly.
Niu: Right. In the case of Apple, the App Store is a pretty big business, but proportionately, compared to the hardware side, it's not nearly as meaningful. When compared to all these other companies that we've been talking about, like Facebook or Google or Amazon, I think the implications of a breakup are much more significant for them than Apple.
Lewis: Evan, thanks for hopping on today's show! Maybe I'll get a chance to see you when I'm out in Colorado.
Niu: Yeah, let me know. Thanks for having me!
Lewis: All right, listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, shoot us an email over at email@example.com, or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes, or check out videos from the podcast and tons of bonus video content over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass today! Go Nats! For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!