The bizarro world of technology investment

Rob Clark

I recently read an excellent blog post by Elmo Keep discussing the problems that have arisen as technology has stripped the profit and value out of content creation.

The article points the finger at services like Spotify and at us as consumers for making this devaluation happen. However, I believe you can't really fault consumers for behaving like rational beings and chasing the lowest price. It's how the system is meant to work. The problem has been introduced because of the bizarro world that exists in tech, where billions of dollars are showered on companies with only the vaguest hint of how that money will ever be made back. Where CEOs proudly state they have no desire, or intention, to turn a profit any time soon, or, indeed, really ever. Just like in the GFC, pouring billions of dollars into many investments that are not likely to make a decent return is probably going to end up in tears for all.
 

Post-Crisis Bizarro



Broken down to its simplest, for-profit companies are not complicated beasts. Share capital is put up in order to create a business, the business is created and profit is made, which is then returned to the shareholder or investor by means of dividends. Of course, money can also be made by capital gain on the shareholding which is realised by private market sales, at an IPO, or on the market sales once listed. But, in the long term, the model is only sustainable if the company is going to turn a profit, and turn the kind of profit which bears some resemblance to the amount of money invested in the first place. It's no use making a profit of $1 a year if it cost you $10 billion to build the business to make it happen.

This reasoning does not appear to apply in many tech companies.

Take Facebook. Facebook has turned a profit you say! Yes. However, the profit is a very small fraction of the billions poured into the company through its IPO, such that it will take a very, very long time, and a lot more profit, for Facebook's valuation to look at all sensible. Furthermore, Facebook was only able to get to this stage because of the billions that were poured into it by investors before it went public. Those investors made money, yes, but only because the value of their shareholding went up hugely. That increase in valuation, however, must still be predicated on the fact that the business will eventually make enough money to return that value. The jury is still very much out on whether Facebook can pull it off.

Ditto with companies like Twitter, Spotify and Amazon. These tech companies have a spigot of money attached to them, with far fewer strings on that money than most companies could ever dream of and, like almost all free money, this leads to perverse outcomes.

Content is one casualty of the free money. If a tech company has no real need to make money in order to justify its existence, and if investors keep writing cheques, the company can happily strip value out of whatever is the meat in its grist.

For example, Spotify charges no money, or a very small amount of money, to access almost all the music you could ever want to listen to. There is literally no reason to ever buy music again. It then takes some of the pathetic sum generated from advertising revenue and subscriptions and hands it on to the content creators, without whom it would not exist. It keeps some for itself, but of course not nearly enough to make its services profitable, but then this does not matter because its investors apparently don't care about the company ever turning a profit. Were Spotify actually profitable, and properly profitable, content creators could demand a bigger share of the pie and there would actually be a pie worth fighting over. Instead, being a pauper, Spotify simply does not have much to give. Its investors don't seem to care, but content creators do – they are left to fight over a small Lean Cuisine pie, which doesn't taste particularly good anyway.

This forces the value of the content down to near zero. Why don't content creators simply refuse to deal with Spotify? I'm sure they wish they didn't have to, but of course they have to try and get some money for their wares, because on the other side of Spotify is actual zero.

Isn't Spotify better than nothing then? Well no, because at least people know that the 'free' side is wrong. That may not stop all, but it will stop many. But now Spotify gives the stamp of legitimacy for paying almost nothing for content, and, as Elmo says in her article, conditions that to be the price of content. While iTunes stripped a lot of value out of content, $1 per song is still better than percentages of a cent per song.

A similar thing occurs with Amazon, as Matthew Yglesias of Slate points out. Amazon can afford to offer lower prices than everyone else because its investors apparently don't care that it makes virtually no profit. Amazon's share price continues to hold up despite CEO Jeff Bezos having shown no great desire to actually make any money for them. While this is very generous of Amazon's investors, to essentially pay the margin for goods that would otherwise be borne by the consumer, the end result of all this is that all the rest of the companies that don't have rich parents shovelling them free money are forced to also make virtually no profit and to squeeze their suppliers dry.

Something has got to give.

In the case of Amazon, maybe that's the plan: to drive everyone else out of business and then turn into a rent-seeking monopolist. But it’s a pretty ballsy plan, and one that relies on investors not to lose their nerve and withdraw their money early, having thrown in good money after bad and in the meantime putting almost everyone else out of business.

In short, despite the mystique, most tech companies leverage content created by others - whether it is Facebook and Twitter with content created by us, Spotify with content created by artists or Amazon with content created by almost every conceivable business in the world (you can buy light bulbs on there for goodness sake!). While some content is easily created for free (especially in the case of social media) other content unavoidably costs money to make. Unless or until the investors in tech companies start being more rational in their investments and in their demands of their companies (or alternatively stop looking to make billions on the flip), they could well allow their companies to kill the content on which they rely.

Business is business, and profit is the oil that makes all business run - tech is not special in that regard. When that requirement is removed in one link of the chain, it can cause havoc when all the other links in the chain are behaving in a self interested fashion. We consumers are like kids in a candy store, we're going to gorge on candy, even if we know its not good for us in the long run. So for goodness sake stop giving us cheap candy!

Image by ElDave, made available by Creative Commons licence via Flickr.