SITLWeek #194 5-26-19

SITALWeek #194

Stuff I thought about last week 5-26-19

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Greetings – welcome to all the new readers this week and a big thank you to Adam for the kind SITALWeek shout out on Twitter! What happens to open source software and hardware in a trade war? My cautionary view on the barrage of new ESG (socially responsible) passive ETFs and indices; esports hype and identifying who owns the network effect in video games; a farewell and thank you to complex systems pioneer Murray Gell-Mann; and much always reply back with thoughts or grab me on Twitter.

[Please read important disclaimers at the bottom of this email]

Stuff about Innovation and Technology

“I know this steak doesn't exist. I know that when I put it in my mouth, the Matrix is telling my brain that it is juicy and delicious. After nine years, you know what I realize? Ignorance is bliss.” It’s hard to believe it’s been 20 years since The Matrix was released! Slate reports on how VR can trick the brain into what type of food it’s eating. And, while we wait to dine with Cypher in the Matrix, the FT covers “dark kitchens” – centralized, on-demand food preparation – catering to food delivery providers such as Uber Eats. Bundling subscriptions for “food as a service” with “transportation as a service” still strikes me as a potential killer app for consumers. Related: DoorDash’s valuation soars to over $12B as investors go bonkers over food delivery even though no contender has yet to establish durable network effects, not to mention profits, in the industry.

Crowdsourced health insurance continues to take off in China:  Alibaba’s Ant Financial insurance product Xiang Hu Bao, translated as “mutual protection,” has 65 million customers in its first seven months of operations supported by only 50 employees. The service is completely app based and uses AI to analyze claims and records. Tencent is also backing Waterdrop in the “Insuretech” space with 70 million users; each member pays no more than one penny toward another member’s claim.

What's the cost of privacy? At Amazon Body Labs it's a $25 Amazon gift certificate to scan your body in detail. Any takers?

Comcast wants to help you if you’ve fallen and can’t get up with a new in-home health initiative. It’s probably appropriate to roll your eyes at this effort, as it seems akin to UPS wanting to get into the in-home vaccination market earlier this year. However, this effort highlights the importance of platforms and network effects in the Information Age: the winner in at-home health monitoring is likely to be the same winner in home assistants and wearables that follow us outside the house. The data collection network effects to superpower the AI that will detect whether you are making too many nighttime trips to the bathroom likely won’t come from the limited purview of your cable company.

3D printing will make better implants by creating special surfaces to fuse with bones.

Longtime readers know I am a big fan of the ongoing shift to aluminum packaging, and Forbes ran a great article this week on aluminum can king Ball Corp and its CEO John Hayes. We like to look for non-zero-sum (NZS) or win-win outcomes in companies, and Ball is a great example. The shift away from plastic back to aluminum containers is good for customers, good for consumers, good for the environment, and good for Ball employees and investors – everybody wins. Ball has done a particularly good job over the years with capital allocation – it’s unusual to come across a company that is so disciplined about making difficult decisions to exit businesses and reinvest in others.

“In my 20 years at our company, I’ve never seen growth rates like this,” says Hayes, 53. Ball has tried 46 different business lines in its 139 years, and has entered and exited the plastics business three times. Hayes is confident aluminum will stick.

(I wrote a little more about Ball and the big shift to aluminum a few weeks back.)

Open-source technology and trade wars: following up on last week’s comments about the role of technology in the US trade war with China, some interesting questions arose with respect to software. After it was reported that numerous semiconductor companies would cut off supply to Huawei, there was news that Google would no longer provide Android or Play Store support to Huawei. This action prohibits new Huawei phones outside of China from using apps like Gmail or YouTube. However, since Android itself is Linux based and open source, Huawei has access to software builds that it can continue to modify in China. This raises a broader question of open source domicile. Perhaps Microsoft won’t be able to sell Windows or Office 365 to Huawei as a result of the trade war, but what about Microsoft’s GitHub subsidiary, home to tens of millions of software repositories, many of which are open source? Machine learning languages such as Tensorflow and PyTorch have been heavily supported by Huawei, and it would be difficult to determine how one might control access to these important AI technologies. Additionally, we are beginning to see a rise in open-source semiconductor design with new architectures like RISC-V challenging the stronghold of ARM. ARM is the UK company (now owned by Softbank) that powers the processor in the iPhone, Huawei phones, and almost every other portable device in the world, along with many networking devices in data centers. It’s pretty easy to stop soybeans at the border, but how do you stop open-source software or open-architecture semiconductors? Taking a broader view of the tech cold war, there are several key technologies, such as chip-design software (Cadence and Synopsys) or chip-manufacturing equipment (Lam Research and ASM Lithography), that have kept the balance of power in the West. As I’ve pointed out in the past, this puts Taiwan, where 70% of global chip supply is made or packaged, in a geo-political hot seat. And, China has plenty of cards to play as well with their control of 70% of the world’s rare earth elements that are necessary for manufacturing of all electronics. So, as I said at the end of last week’s note, we simply need to conclude the cost of doing business in and with China is structurally higher as East and West race to dominate AI. However, don’t lose sight of the forest for the trees: we are at the very beginning of an explosion of demand for connected devices as we move from markets with billions of units to trillions of units over the next two decades. Optimism should trump fear for investors willing to look long term. The cynic will always sound smart, but the optimist will always be right in the long arc of human progress.

Zendesk is a customer service software platform that helps 145,000 companies interact with their customers in a more efficient, modern way through chat, voice, social media etc. Zendesk’s platform is also growing into the sales and IT support channels where traditional players like Salesforce and ServiceNow dominate. At their customer and analyst event this week, COO John Keiser discussed customer expectations in the Information Age and how new businesses are disrupting legacy industries primarily through customer interactions:

“The world in the space that we're in is being disrupted. And it's being disrupted by companies that are looking at and creating better customer experiences for their customers. And we're seeing that disruption in absolutely every industry...The traditional industries of every kind...are in fear of being disrupted. They're watching startups come into their industries and disrupt them. And they're disrupting around customer experience and customer communication and making things easy for their customers.”

Keiser makes an important point: in many cases disruptive companies aren’t necessarily reinventing products, they are simply taking service expectations to a whole new level. Transparency and commitment to customers are critical to win as the economy goes through the current digital disruption of every industry.

Last week I covered the unexpected co-opetition between Sony and Microsoft in the shift to streaming video games as a result of the high cost of cloud computing mega-platforms. A few more details came out this week implying Sony had also considered Amazon and Google. It appears Amazon and Google are seen as significant threats to the traditional console business that Sony and Microsoft dominate today which provokes the question: who owns the network effect of gamers? Is it the publisher who creates the game itself (e.g., Activision Blizzard or Take-Two), the distribution platform (e.g., Tencent in China), the console makers (e.g., Sony and Microsoft), or the new streaming platforms (e.g., the one Google hopes to launch)? It’s hard to argue that the value lies in the console maker going forward; in fact, you could argue there is no long-term value to the console business, which leaves Sony in a vulnerable position beyond their own game studio business. Another network effects opportunity will be the social aspect of gaming, which is now dominated by YouTube and Amazon’s Twitch, dwarfing XBOX Live and Playstation Plus. It appears that Google and Amazon are in the lead to create dominant streaming+social gaming platforms. In light of this analysis, the Sony+Microsoft partnership almost feels like it was a defensive reaction to an existential threat.

Speaking of video games, Kotaku ran a story this week about the hype cycle of esports, with many industry insiders fearing a near-term bubble popping. While everyone believes in the long-term trend here, expectations near-term are likely too high. Again, I would also stress the importance of network effects in determining the winning games for esports – the publishers and platforms that create the most win-win for players, viewers, sponsors, etc. will dominate. What drives the network effects for the NBA, NFL, MLB, NHL, etc.? Is it the leagues, or perhaps the stories and narratives built up around players and rivalries - the core of the sports tribalism? The network effects of traditional sports will translate to esports as well with the twist of digital distribution platforms like Twitch and YouTube thrown into the mix.

As the autonomous vehicle debate around the necessity of LIDAR, or laser-based mapping, continues, Intel suggested that their silicon photonics technology will allow them to do coherent light radar mimicking on a single chip. Meanwhile Aurora, the autonomous startup from ex-Google Waymo execs, has acquired a LIDAR startup, and Wamo itself is looking to sell its LIDAR tech to other autonomous vehicle makers. While Tesla maintains optical imaging will be enough to get to fully autonomous driving, the jury’s still out. Bezos was also reportedly talking up how exciting the auto industry is at an employee all-hands meeting this week.

Speaking of the auto industry, China has accounted for 76% of the growth in the car market over the last two decades and now represents around 34% of the 81M unit annual market. Last year, 5% of those 81M units were electric, but EV is expected to approach 60% over the next 20 years. The auto market is an excellent example of a complex adaptive system where making accurate predictions is very difficult. You could drive a bus through the range of outcomes for the transportation industry over the next decade as we see a shift to transportation and logistics as a service with Lyft, Uber, Waymo, Tesla, etc.  

The always humble Marc Benioff: “It’s hard, because I’m somebody who can see things that other people can’t see,” he says. “It’s frustrating when I can’t communicate what I’m feeling. This is one of my challenges.” Perhaps the best part of this story is Marc video conferencing in to Cisco board meetings from Hawaii on his elliptical machine. Kidding aside, Marc’s decision to put Bret Taylor in charge of product development and Keith Block in charge of the business, as Marc continues to focus on the future, has been an excellent recipe for the success of Salesforce to date.

For fellow Disney watchers, here is a good story on the new head of ESPN and the stabilization of that profitable division of Disney. Speaking of media, this ESPN story came to me through my friend Jason Hirschhorn who runs content site REDEF – I recommend his newsletter, as well as the podcast he recently did with Peter Kafka, which covers just about every hot topic in the media and streaming video world these days.

Miscellaneous Stuff

Murray Gell-Mann, Nobel prizewinning physicist and co-founder of the Santa Fe Institute (SFI), passed away Friday. SFI, home to the study of Complex Adaptive Systems, has heavily influenced our investment philosophy Complexity Investing. Gell-Mann collaborated late in his career with Ole Peters to overturn fundamental problems with economic theory (we discussed this starting on page 7 under “Flaws in Traditional Economics” in our paper). A heartfelt thank you to Gell-Mann not only for his contributions to physics, but for the flexibility and curiosity throughout his career that greatly influenced our thinking.

Most people who have worked from home know that, for the most part, you can get much more done in a shorter amount of time without the constant barrage of interruptions and often unnecessary meetings in the office. The founder of WordPress, which powers about one third of the Internet’s websites, discusses the reasons why being a distributed officeless company is better in the modern era. The WSJ also covered GitLab, which operates as a distributed company. Obviously, there is something special about software development that lends itself to remote and isolated work. We know from the research of Geoffrey West that there is a tension between bureaucracy and innovation, but an environment with the potential for ad hoc interactions is critical to innovation. I’ve always preferred distributed investment teams because it helps avoid groupthink, which is a big problem for investors. At the same time, it’s hard to know what dots might miss connections as a result of too much isolation – something to keep in mind for balancing centralized and decentralized structure for any given industry.

After 25 years, Picard is coming back!

Stuff about Geopolitics, Economics, and the Finance Industry

Index creators, like MSCI and S&P, are classic examples of companies that create more value for themselves than their customers. These are middleman businesses that extract too high of a tariff for the service they provide. As the shift to passive investing continues, ETF providers are forgoing the high fees demanded by the index makers by using their own custom indices.

In related index news, S&P is launching 22 ESG indices around the world. ESG is an investment world acronym for environmental, social, and governance and is often a catchall for socially responsible companies. I would caution folks against using a quantitative and/or passive approach to ESG investing, which tends to resemble sector allocating (for example, underweighting the oil sector). Instead, I think it’s important to dive deep into each company and investigate how they handle their global responsibilities (we outlined some of the process in our NZS whitepaper). Companies that are improving their focus on the environment, society, and governance might not show up in quantitative screens while these changes are underway. Further, active investors can exert active pressure on companies to influence their policies and drive a greater ESG impact, something passive shareholders have so far largely ignored.

Speaking of ESG – Amazon faced multiple ESG-related votes at its annual meeting this week. While Bezos reportedly refused to take the stage for the debate and question period, and all of the items failed to garner enough votes, it’s worth noting that 90M+ votes (out of around 350M total votes logged) were in favor of many of the proposals addressing environmental issues and the risks of government use of Amazon’s AI technology. I think that’s a pretty strong message from shareholders that Amazon would be mistaken to ignore.


Nothing in this newsletter should be construed as investment advice. Nothing contained in this newsletter is an offer to sell or solicit any investment services or securities. The content of this newsletter is my personal opinion and may not reflect the opinion of NZS Capital, LLC. I may own long or short positions in stocks discussed in this newsletter. This newsletter is simply an informal gathering of topics I’ve recently read and thought about. It generally covers topics related to the digitization of the global economy, technology and innovation, macro and geopolitics, as well as scientific progress, especially in the fields of cosmology and the brain. I will frequently state things in the newsletter that contradict my own views in order to be provocative. I may change my opinions without updating them in the newsletter. Lastly, I often try to make jokes, and they aren’t very funny sorry.