SITALWeek #347
Welcome to Stuff I Thought About Last Week, a personal collection of topics on tech, innovation, science, the digital economic transition, the finance industry, and whatever else made me think last week.
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In today’s post: why do big tech platforms think we want to strap a giant phone to our faces?; apps can drive market consolidations, but there are few good examples; the mess of online ad privacy meets the folly of regulation; passive ESG investing and gaming scores are hampering real progress; the slow path back in the private investing market; and, much more below...
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Stuff about Innovation and Technology
Serving Up Digital
I generally prefer a good mobile website over an app. Maybe it's the Gen X in me, but I’d like to return to a world where most everything is browser based – with the exception of the few apps that require legitimate, native access to phone chips and sensors. I tend to install apps on my phone only for as long as I need them. The United Airlines app, for example, requires 176Mb of memory, control of my flashlight, and access to my unique device ID and audio recording (see also next paragraph on privacy). Despite wary consumers like me, the fast food industry has found that smartphone apps are proving to be a strong sales driver, especially when combined with loyalty programs and gamification elements. Unlike the United Airlines app, the Starbucks and Chipotle apps have earned (at least for now) a permanent spot on my phone. The US chain Noodles & Co. recently noted a ninefold increase in click-through rates and $71 in incremental orders for every 100 emails sent to app users. Success was strongest when connected to an omnichannel advertising approach that included social media and streamed video ads. The apps also help restaurants collect first-party data on customers, making them less reliant on the increasingly shady third-party ad networks and data brokers. Another chain leveraging technology to improve the customer experience is McDonalds in the UK, which will go to 100% digital ordering via app or kiosk, entirely removing the traditional ordering counter manned by people for 800 locations. We will continue to see such examples of automation solving for stagnating population growth and creating alternative jobs with better pay and working conditions. McDonalds is also signing more delivery partners in the UK. These innovations have been coming to US fast food joints as well. If the eight-year-old version of me were transported to a modern fast food joint today – with robots making fries, machine vision monitoring supply levels, and touch screens – it would feel like the future I imagined, at least until I realized the food hadn’t made any progress in the last four decades. The success of technology in driving restaurant sales may make it far more difficult for independent restaurants to hold their share against the leading digital chains. There are many apps aimed at Mom-and-Pop restaurants, but, as I wrote about last week, they tend to be net negatives. If other retail and service sectors can find a way to make apps more useful, that too might consolidate market share amongst larger companies with bigger budgets for technology. But, beyond the Amazon app, I am not sure there are many good examples. If digital drives power-law market share, then the antidote to keeping smaller businesses alive would be a great horizontal platform that takes a very small toll, but those too are hard to come by.
Privacy Not Included
The Irish Council for Civil Liberties (ICCL), which is currently involved in litigation against the digital advertising industry broadly, reported that European users’ personal and location data are tracked 376 times a day, while US users see data shared 747 times a day. The Mozilla foundation’s “Privacy Not Included” site offers a search engine for popular apps with reviews of privacy protections. In the mental health app category, for instance, there are many problematic examples of data collection and information sharing. Largely, data are used to target ads (significantly subsidizing consumer app costs), but it isn't necessarily clear to users just how much information might be shared and what ultimately can be done with their data. Here’s one scenario Mozilla highlights from the popular Calm meditation app: “[Calm could] get to know all about your meditation practices, your mood, your gender, your location, and more. Then use or share that information to target you with ads about things, like a wine company thinking you're ripe for targeting with wine ads when you're using the app a lot because that might mean you're stressed out. But you're a recovering alcoholic and the wine ads add to your stress.” If you listen to podcasts, you’ll recognize the company Better Help from their frequent ads. The app-based mental health counseling service also fails the privacy test for Mozilla. Consumers have had a Faustian bargain with advertisers for decades (centuries?) that predates the Internet. We get stuff cheaper, or for free, in return for ads. But, as tracker sophistication and the number of interactions has grown, the situation has become untenable. Thousands of data brokers, all tracking people hundreds of times a day, is offensive and potentially dangerous. Given the explosion of companies involved in the real-time ad bidding industry, the complexity of the connections, and the difficulty in getting proper user consent/permissions, I think it’s clear that third-party ad brokers and real-time bidding industries for online ads should be largely shuttered or neutered with regulation. As Apple and Google continue to limit the amount of user information that is shared, a small number of tracking sources should be made available – with transparency and user consent – to small publishers and ad networks in order to compete with the large first-party data owners. Legislation with bipartisan support called “The Competition and Transparency in Digital Advertising Act” may stir the debate on ads and tracking. The bill is targeted at breaking up ad giants with over $20B in revenues so that they can’t reach across more than one part of the ad chain. It would, for example, allow Google to sell ads but not tools to serve ads across other sites and apps. However, the heart of the issue isn’t size or reach, it’s permissions, transparency, and the real cost of ads that consumers are bearing. By forcing Google to exit its marketplace ad business (originally from the DoubleClick acquisition), it could create an even bigger third-party mess of privacy issues. The outline of the bill doesn’t mention privacy once. As I noted in How I Learned to Stop Worrying and Love the Monopoly, power laws are ok for digital platforms as long as there is transparency and proper regulation. For now, regulatory focus continues to be well off the mark.
Spatial Computing Stagnation
I’m baffled by the big tech platforms’ continued fumbling of spatial computing (augmented reality, mixed reality, etc. – see Meta-mess). The Information reported on Apple’s slow progress despite six years of effort. Facebook recently released a pixelated demo of a game that is far more basic than what Magic Leap commercialized four years ago. Indeed, no one is showing off better hardware or apps and games than what Magic Leap produced and released for the ML1 in 2018. I would generously describe Facebook’s demo as an embarrassing ripoff of a much better Magic Leap app that has been around for years. Microsoft’s HoloLens has been a commercial flop. As for Apple and Facebook’s early products, which are both video see-through (VST), I don’t understand the concept of strapping a giant smartphone half an inch from my face given that transparent AR displays (optical see-through or OST) offer a far superior way to experience the technology. Recreating the world with cameras that are not in the same location as our eyes – and using a weighty device that prevents the normal head movements critical to creating a 3D image of our world – seems like a clear dead end for VST-based AR. Google has come up with some interesting use cases, like real-time translation, but they haven’t demonstrated any compelling or unique advances in AR hardware. It’s possible we are just still waiting for the applications to drive the hardware rather than the other way around. Or, perhaps our brain isn’t capable of successfully blending today’s offerings of real and artificial elements, making the entire effort a failed science project until we invent much more advanced technology. (I don’t think this is the case, but at some point we need to admit it’s a possibility). I love the promise of augmented and mixed reality, but I am thoroughly disappointed with big tech's desire for us to strap disorienting phones to our faces, an "innovation" which can only ever be a parody of itself.
Miscellaneous Stuff
COVID Brain Damage
Severe COVID-19 infections appear to cause a material cognitive decline, according to researchers at the University of Cambridge and Imperial College London. The study showed that the effect was equivalent to losing around 10 points of IQ – or aging twenty years from 50 to 70. The FT detailed the research, noting that there is a future risk of increased cases of dementia stemming from the pandemic.
Stuff about Geopolitics, Economics, and the Finance Industry
ESG's Circular Reference: Passive Investing and Ratings Agencies
Citywire proposes that 2022 is the year of anti-ESG, given the growing backlash after the trendy investment style garnered assets and drove relative performance over the last couple of years. An example of this swing in perception was the reaction to the S&P’s removal of Tesla from their ESG index for having a disqualifying DJI ESG score (Tesla’s score stayed relatively flat, but other companies’ scores rose in comparison as they improved – or, in many cases, perhaps gamed – their scores to track better versus the monitored metrics). One thing we know for sure is that when you put a score on something, humans will start managing to that score. Sometimes this behavioral shift is compatible with the goals of the scoring system; but, more often, it creates a game where scores improve but no actual underlying progress is made. There are a lot of important reasons to be focused on many of the fundamental changes called for by ESG investing. However, we think taking a more holistic approach – that goes way beyond scores and grades – is merited. For the past decade, we have instead focused on the relative magnitude of non-zero-sum outcomes, or win-win, created by a company. First noted in Complexity Investing, we further outlined this NZS approach to creating value in more detail in this whitepaper in 2019. Given that no company is likely to be perfect, the most important thing is to analyze the net impact of their products and services on customers, employees, the planet, and society. It may be acceptable to have some weak areas (as long as they are improving) if the overall impact is a positive one. With respect to Tesla, while we would like to see some areas of improvement, we believe that the non-zero-sumness of the company merits a net positive assessment in a complete ESG framework. Taking a longer term perspective is also crucial. Shunning certain types of business today that are critical to achieving decades-out goals, such as energy independence, is likely to lead to an inflationary environment, or, worse, a lack of investment and innovation. While I wouldn’t go so far as to say that ESG has been “weaponized”, as Elon Musk indicated, I would certainly caution investors against blindly following scores/ratings and instead critically assess the net value added by a company against the goals you believe are most important to societal progress. While I suspect many active managers have thoughtful approaches to ESG, the reality is that passive ESG strategies are taking the majority of flows (62% in Q4 2021 in the US) for this rapidly growing segment of investing. That skew will likely lead to a vicious spiral of further metrics gaming, which will run counter to accomplishing real ESG goals. In 2022, ESG strategies hauled in $70B in the US alone, up 35% from 2020. We should encourage and reward companies for managing toward real, positive change rather than gaming a scoring system. And, investors seeking passive ESG vehicles may be causing more harm long term than they realize. A recent paper titled “Bet on Innovation, Not ESG Metrics, to Lead the Net Zero Transition”, from a former managing director at Credit Suisse HOLT, echoes a similar sentiment by using systems thinking to approach ESG issues: “The conventional Net Zero perspective with its emphasis on ESG metrics represents linear cause-and-effect thinking. That is, implementation of the metrics will then change company behavior with the eventual effect of a successful Net Zero transition. Different perspectives are presented rooted in systems thinking. Numerous company examples explain why innovation, not ESG metrics, will be the prime mover in achieving Net Zero.”
Realigning Public and Private Valuations
Closing the gap in reality that opened up over the last year between private and public market valuations will likely require a long digestion period as companies and VCs are reluctant to mark assets down. In prior corrections, we have seen a decline in the IPO market as private asset owners were hesitant to face the scrutiny of a public investor assessment of value. Even if public markets were to experience a bounce in valuations, they’d likely still be far below where private valuations sit. The change in sentiment is also likely to cause many of the tourists (such as crossover investors managing public funds reaching into later stage private markets) to exit VC investing. One time, many years ago, we marked down a private investment, and the company called to buy the shares back rather than have that valuation be made public. As hard as it is for VCs to endure markdowns, it can be even more painful for employees to see their options sink underwater. As I wrote in #320 last October:
One of the quirks of venture investing is that a very small number of agents work to set the valuation of a funding round. Given the wide range of outcomes for high-growth, early-stage companies, it’s anybody’s guess, but, generally, more guesses are probably better than fewer. A problem you want to look out for in venture investing in times like this – when there is way too much money chasing way too few opportunities – is funds that make repeat investments, each round at an increasingly higher valuation as they are raising new, bigger funds. This lack of good price discovery can compound when a company goes public, as some of those same private market investors (typically crossover funds, but potentially evolving traditional VCs as well) hold onto, and maybe even buy more of, the floating shares of a company. This limited investor pool creates a value (due to scarcity of shares) that is perhaps not as accurate as you might have with a greater number of participants working to create a consensus value for a company. Companies are also waiting much longer to go public, which allows more time for inflated markups along the way. The real losers in the process are the company and its employees (and, ultimately, the investors who end up taking losses on their inflated investments). Valuing a company far too high vs. its long-term addressable market and raising too much capital create an impossibly high set of expectations for the vast majority of companies. Under mounting performance pressure with disappointment inevitably looming, employees may end up permanently underwater on equity and the company may lose discipline and focus. Because the economy has yet to adjust return expectations to a low- (or even negative-) rate environment, this pseudo Ponzi scheme will continue to offer an artificial source of performance as long as the low-rate music keeps playing.
This past week, we saw evidence the correction in private market valuations is continuing to play out, with companies seeing a 40-60% discount today compared to 2021, as noted in Business Insider. Overall, it’s a healthy correction, and companies with real futures should continue to invest appropriately in opportunities ahead of them – even at the expense of short-term losses – to ensure long-term relevance and profitability. The world is not nearly as bad as investors, both public and private, think it is, and optimism will always win.
✌️-Brad
Disclaimers:
The content of this newsletter is my personal opinion as of the date published and is subject to change without notice and may not reflect the opinion of NZS Capital, LLC. This newsletter is an informal gathering of topics I’ve recently read and thought about. I will sometimes state things in the newsletter that contradict my own views in order to provoke debate. Often I try to make jokes, and they aren’t very funny – sorry.
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