No silver bullet: Revenue and “The Three-Body Problem”

A business model accounts for all of a company’s characteristics

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A couple things struck me in reading your thesis about “the best business model” in tech…

Freemium by another name

First off, what you call “shared-value transactions” are literally “freemium” models by another name:

“To understand shared-value transactions, let’s use free mobile games as an example… Because of in-app purchases. Users can optionally pay inside the game to enhance their gameplay. Less than 2% of free mobile game players end up making in-app purchases. And of these users who pay, the top 10% of them drive an astonishing 50% of all revenue for games. So an entire industry is mostly built off of a tiny fraction of a percent of its users. How? Because their very best users are delivering 1,000 times more value to their business than their average user.”

Yes, in-app purchases like those at the heart of mobile gaming businesses are usually discrete/pay-to-own transactions (like traditional point-of-sale), in contrast to traditional freemium arrangements, which feature recurring/pay-to-lease subscriptions (like traditional ARR/SaaS pricing). Yet, you later use Amazon Prime as an example of a “shared-value transaction”, and Prime is a literally a freemium program!

This echos of Ecclesiastes 1:9…

What has been is what will be,
and what has been done is what will be done,
and there is nothing new under the sun.

The advertising straw man

Next, your widely-held belief, as follows, completely ignores the evolution of advertising over the past 15 years:

“…ads also present a critical limitation to the businesses relying on them to make money: they treat all customers the same, and therefore do not maximize the potential value that your best users could bring you. Whether you’re an avid, passionate user of a service or an infrequent, casual user, the ad neither knows nor does it care. Advertisers are simply looking for a pair of eyes…”

This was the case for traditional mass marketing (although brand advertising was that way for a reason), but digital ads changed that with direct response and targeted advertising, as discussed below.

To be clear, you go on to clarify with whom you’re specifically concerned when you say “the business relying on them to make money” (emphasis mine). To wit, the following suggests that, by “business”, you’re referring to the platform who gets paid to serve the ad as opposed to the advertiser who gets paid via ROI from the ad:

“…it’s been proven that the more ads you see, the less effective they are. Advertisers know this so they restrict how often their ads appear (known as frequency capping). Businesses also know this so they too limit all the ads you see overall (known as ad load) from every advertiser.”

But, while you’re making the seemingly obvious point that increasing ad loads are met with diminishing returns, therein lay a common logical fallacy that goes unmentioned…

In both the analog (e.g. newspapers and print) and the linear (e.g. TV and radio) worlds, media formats had structurally limited ad space. When we shifted to digital (e.g. web and mobile), the surface area for ad inventory became effectively unlimited — given infinite streams, generally boundless digital real estate, and a long runway for user adoption.

The consequence of that positive supply shock was driving digital ad prices down to near-zero. To combat that commoditization, Google and Facebook were able to differentiate their ad offerings from “dumb” contemporaries’ by increasing the “R” in advertisers’ “ROI” via targeting. That allowed them to lift their ad prices up from the zero-bound (and ultimately grow into the all-powerful ad duopoly they are today). As I said in “The Four Winds of Modern Media”:

“Google is everything I ask for, and Facebook is everything that asks for me. What else is there?”

Said another way, Google gives you what you ask for, and Facebook tells you what you want. The pull and the push; yin and yang. And, they’re so good at their kind of native, in-stream advertising — targeting and retargeting — that their monetization strategies are almost entirely ambient to the user experience:

“Google’s original search ads… were literally direct responses that helped users find what they were looking for [which] would enhance the user experience without encumbering it the way subscriptions [or shared-value transactions] do.”

After all, look at all of the ads that appear in a Google Search results stream on mobile. You have to scroll down 5 to 10 results before you reach something organic:

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The death of SEO? Google ads are more prominent than organic search results

…but usage, ad spend, and conversions continue to grow unabated for all the reasons discussed ad nauseum on the interwebs, like the following, from “The Carrot and The Stick”:

“Big Tech’s markets all trend toward monopoly, because they operate multi-sided networks with zero barriers-to-entry. Thus, network liquidity is the basis of competition for many of them: Who has the most buyers and sellers; the most producers and consumers; the most supply and demand; etc. That liquidity sets-off the virtuous cycle of network effects, wherein scale improves user experience improves scale and so on. If you add software’s zero marginal costs to that virtuous cycle, you get Aggregation Theory…”

And this, from “A Crossroads Where Platform Meets Proprietary Ambitions”:

“Google and Facebook already have an insurmountable scale advantage that makes the opportunity costs of any constituent switching to rival platforms too large — whether that be users, websites, or advertisers seeking alternatives. So, even if everyone were to have the same data for targeting — perfect competition on that plane — [the duopoly] would still have more attention.”

So, the “frequency capping” and “ad loads” you reference are almost relics from another age — an era of scarcity rather than abundance. Sure, the terms are still bandied-about by big brands and agencies, but the digital ad duopoly itself speaks in terms of “retargeting” and “backlog”.

As discussed above, your business model advice is directed toward these businesses — the platforms themselves — as opposed to other counterparties across the supply chain. But there have been appreciable net benefits for these other consituents too. Trading traditional concepts of strong-form “frequency capping” and “ad loads” for more modern strategies like “retargeting” and “backlog”, direct-to-consumer brands have readily adopted this new lexicon, which has been a driving force behind the rise of niche upstarts — at the expense of traditional behemoths in CPG and beyond.

Furthermore, the resulting consumer surplus from these dynamics has been magnanimous, which is why I’m befuddled by your assertion that eroding that consumer-benefit is somehow in the consumer’s interest. You assert:

“I’m not trying to suggest that advertising is a bad business… But advertising has its own ‘bad economics’ that can be exploited. What if instead you had a business model that could maximize revenue from your best customers, and then share that value across all your customers, while not annoying users in the process? […] I’ll call this strategy shared-value transactions.”

Every possible business model has its pluses and minuses — incentives and misincentives that can be exploited. That goes for shared-value transactions just as much as advertising. The median consumer doesn’t like ads any more or less than he/she likes paying cash out-of-pocket — not to mention the opportunity costs forgone by adding friction to information access. I discussed this in “The Market Inefficiency Sustaining Big Tech” and “Attention Merchants”.

Now, this is all good-and-fine, and I suspect you’d agree with much of it. But the following straw men are the lynchpins to your populist repudiation of advertising:

  1. “[Ads] treat all customers the same, and therefore do not maximize the potential value that your best users could bring you... Advertisers are simply looking for a pair of eyes…”
  2. “it’s been proven that the more ads you see, the less effective they are.”
  3. “advertising has its own ‘bad economics’ that can be exploited.”

As discussed above, #1 is not true; #2 has been marginalized by targeted digital advertising (and retargeting); and #3 is merely a truism that applies to any economic arrangement.

A square is a rectangle but a rectangle isn’t a square

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In sum, as my title asserts, there is no panacea. There are categorically bad business models, but there is not a ubiquitously good one. That right there is “The Three-Body Problem”: A business model must juggle the needs of the business itself, its end-user demand, and its suppliers; but it’s fundamentally impossible for all three to coalesce in a copacetic utopia. (Some refer to this triumvirate as “product/market/business fit”.) In a world of finite resources, one party’s price is another party’s cost; incentives and misincentives; short term and long term consequences. These tradeoffs are inextricable.

Accordingly, advertising is not a bad business model — it’s just bad product/market fit for some businesses and good for others. No doubt, digital ads have their problems, for which there are also common sense solutions, but that doesn’t make them bad if you’re a supermassive aggregator like Google or Facebook.

And, despite your explanation of advertising’s “bad economics” (i.e. misincentives), as discussed above, you don’t say that it’s a bad business model — in fact, I commend you for saying that it’s not inherently bad. But, you do say that shared-value transactions are better, and you try to fit that square-peg-into-a-round-hole with your implementation proposals for Google and Facebook. I call that an awkward fit not just because shared-value transactions are orthogonal to these businesses' strategic moats as aggregators, but also because your proposals don’t fit your own definition of the approach:

“What if instead you had a business model that could maximize revenue from your best customers, and then share that value across all your customers, while not annoying users in the process? […] I’ll call this strategy shared-value transactions… it combines principles of direct sales and indirect advertising, tied together through commerce.”

Now, compare that framework to your specific proposals:

  1. How does Facebook inserting itself as another intermediary between buyers and sellers on Marketplace add value to any part of the user experience — as required of a shared-value transaction? That would be the opposite of disintermediation; ortogonal to Facebook’s raison d’être as an aggregator; and repeating the mistakes of the past in which Facebook’s tried crossing-over to become something it’s not — a platform for 3rd parties instead of an aggregator of user-generated comms.
  2. How is a fully-integrated Google Shopping offering an example of “shared-value transactions”? What you describe is no more than a me-too Amazon clone, without its Prime subscriptions, and without the scale. Sure, Google has some value propositions were it to go that route, but Google Shopping is the way it is for a reason. First, there are antitrust concerns about Google using Shopping as a fulcrum, in the way you suggest, for vertical foreclosure. Second, knowing full-well the openings within the competitive landscape, Google has been making smart strategic choices in developing an ecommerce service that’s both complementary to Amazon’s offerings and supplementary to Google’s own competitive advantages.
  3. A Shopify acquisition presents all the same problems as your Google Shopping recommendation, as mentioned in #2.
  4. How do buy buttons on YouTube and Instagram qualify as shared-value transactions?

I think you need to be a bit more surgical about this whole hypothesis: If you still stand-behind your specific proposals, what exactly is a shared-value transaction? Unless you think it’s a panacea, for what businesses is it strategically sound to implement (and what not)? Who are good examples/candidates (and who aren’t)?

While there’s no such thing as a panacea, there’s such a thing as a better way…

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