the force awakens

Yep, it’s an end-of-the-year technology prediction post …

We’re at a special place in the consumer technology cycle. I’ve seen this movie before. Consumer technology trends are often described as waves, but I like a movie metaphor better, because it captures the notion that I actually saw these events when they were first released in the theater, and that we keep seeing the same plot points, themes and character types. I’ve lived through three really big waves of consumer technology. The third wave – the third movie – is finally coming to an end, which is a relief, because it kinda sucked. I’m really looking forward to the next show.

I’m a fan of the franchise generally, despite the repetitive plots. Each movie starts with the introduction of products that clearly show the possibility of what’s to come, although these are not the products that actually survive the revolution. Those products depend on a crucial underlying technology trend, which is not itself the consumer-facing technology. There is a spectacular platform war that decides the big winners and losers. The story ends, until next time, when the business patterns in the field have matured, and outsized returns for investing in those businesses have therefore disappeared.

The Origin Story: Personal Computers

pirates-of-silicon-valley

Like the first movie in a series, this one defined many of the patterns, tropes and heroic character types of the sequels to come. In a digital desert, a lone gunslinger appeared on the horizon, known only by the mysterious name Altair. The story really picks up when the Commodore PET, the TRS-80, and the Apple II appear on the scene. That trio of bandits opened up the Wild West, only to be dominated by the strongman IBM PC. But IBM only won a hollow victory, as it turned out that they’d unwittingly given the keys to the kingdom to Microsoft, the ambitious vassal that became the overlord. The story of the rise of the PC is the classic foundation of everything that came after in consumer technology.

But it would be a mistake to only pay attention to the foreground. In the backstory, the silicon chip is the key enabling technology that’s powering the other players. Moore’s Law is the inexorable force of progress, and Intel was the master who kept on top of the industry despite laudable challenges by AMD, Motorola, Texas Instruments, and a host of international competitors. This global tale of intrigue and ambition is a worthy accompaniment to the marquee narrative. In fact, the invention of Silicon Valley can be considered the prequel to this series.

The Worthy Sequel: World Wide Web

the-matrix

Many people say The Empire Strikes Back was a better movie than Star Wars. The Godfather was in many ways outclassed by Part II. The explosive success of the World Wide Web was at the very least a worthy sequel to the PC story. A knight in shining armor, Tim Berners-Lee, led a devoted band of heroes on a worthy quest to unite all of the world’s information. Early services like Prodigy and CompuServe leapt on the ensuing opportunity, but latecomer AOL won the day by sending a CD to every mailbox it could find. That was only the first act, as Netscape and Yahoo emerged as the real heroes … until the third act, when eBay and Amazon and Google trampled the field.

It’s usually not worth the effort to make a distinction between the Web and the Internet, but it makes sense to do so here because “World Wide Web” is the story with a beginning and an ending, while the technologies of the Internet are the more enduring enablers of that story. As protocols, the details of TCP/IP, DNS, HTTP and the like are not exactly gripping narrative. But like silicon chips powered the PC revolution, and could be considered the more enduring story, the Internet will live on long after the Web sinks into irrelevance.

The Failed Trilogy: Smartphones

phone-booth

Return Of The Jedi was a very successful movie. And it did have some awesome special effects for the time. But it was all of the same characters, and pretty much the same plot, soiled by dominant commercial motives and treacly pandering to a younger audience. By which I mean, fuck Ewoks. And Godfather Part III? The less said about that, the better.

The story of the last dozen years or so has been the move of personal computing and the Internet to smartphones. There’s some compelling pathos in the storyline of the death of the Web, overrun by mobile apps. But it was mostly dull to watch the Treo and Blackberry reprise the role played in prior movies by the Altair, Prodigy and CompuServe. I’ll admit it was great fan service to see the Apple character repurposed, and maybe there hasn’t been a more colorful personality than Steve Jobs, so that part of the story was pretty entertaining. You could say that the return of Jobs was as momentous as finding out about Luke’s father.

Let’s face it, it just wasn’t that exciting to watch Google and Amazon continue to grow. Facebook is a great new character as a flawed hero, and that whole subplot with Twitter and the rest of social media was a very strong B story. Other new characters like Uber and AirBnB have their minuses and pluses, but I don’t believe they’re going to be big characters in the next movie. (“Uber for X” companies are the goddamn Ewoks.) The overall experience has been like coming in to watch a huge blockbuster mega-sequel: you can really see the dollars up there on the screen, and there’s a certain amount of entertainment value that comes through, but the whole exercise just lacks the originality, joy and passion of the earlier entries.

Not a bad backstory though, and as in the other movies, this one will continue to be meaningful in all future sequels. Cloud computing, software as a service, the evolution to microservices – these things fundamentally changed the way that new businesses start and grow. They reduced the capital costs in starting a new information technology company by orders of magnitudes, letting in many more characters. Unfortunately, most of those new characters are Ewoks.

The Force Awakens

So what’s the next movie going to be about? Will it reinvigorate the franchise? Or will it be a terrible prequel (or worse, prequel trilogy) that we’ll all have to agree to pretend never happened?

I think we don’t know all of the elements, but we do know some of them. Let’s first recap what we saw in the first three installments:tfa-chart

And here’s what I think we know about the chart today:

tfa-chart-f

Main Story: There is a flood of products that don’t have an agreed category name yet – Siri, Google Assistant, Amazon Alexa, Microsoft Cortana, chatbots, chatbots and more chatbots. Some industry terms that are cropping up are intelligent personal assistants, virtual assistants, conversational search. Or chatbots, fer chrissake.

The point is, you will have things in your house (your car, your pocket, etc) that you talk with, and these things will talk back to you in a way that makes sense. You’ll regard your interaction as a conversation rather than button punching or screen swiping. Until people converge on another name for all of these things, I’ll call them “conversational devices” – this captures that you have a productive back-and-forth with a physical object. Yes, you can already do something like this on your smartphone, but those implementations are only a hint of where this will go.

As early as it is, there are plenty of curmudgeons who don’t see the point. Smarter people have said we’ll never need more than five computers, no one wants a computer in their home, the Internet is a fad, the iPhone is going to be a flop. Predictions are hard. But screw it, here’s mine: within 3 years, it will be apparent that the adoption curve of conversational devices is in the same category as PCs, the Web, and smartphones.

Conversational devices will be the story of the next decade in consumer technology. Not that there won’t be other stories, it’s just that this one will be the lens by which we understand the era. I still love virtual reality, but it’s still not time yet. The blockchain isn’t consumer-facing, and  I don’t believe in Bitcoin. Not Internet of Things, not 3D printing, not self-driving cars, not wearable devices (unless they are also conversational devices) – some of these will be big stories, but not the biggest story of the next dozen years.

Backstory: Conversational devices rely on this chain of technologies: Machine Learning -> Natural Language Processing -> Speech Synthesis. These technologies are complex and interrelated, and rather than explain why this is their moment (the foregoing links give that explanation), I’ll just skip to the punchline: People will be able to speak to machines, machines will understand and speak back. Most people already have experience with primitive versions of these technologies, and find those experiences frustrating and unsatisfying. (“Press 9 to go back to the main menu.”) But the rate of improvement here is at an inflection point, and this is about to become undeniably apparent on a mass consumer level.

Platform War: The most successful conversational devices will be on a common platform of delivery. Amazon Echo and Google Home are devices that sit in your home and listen to everything you say, and respond back to help you. Facebook Messenger has bots that will have a conversation with you. Each of these is currently displaying only the limited strengths available in their existing businesses (Amazon:Shopping, Google:Search, Facebook:Brands), but they are all trying to expand to become a delivery platform for third-party conversational devices. Amazon and Facebook already offer developer platforms, Google is focusing on partnerships.

This platform war will have elements of past wars, in hardware vs software, apps vs operating system, open vs closed. That complexity makes it very interesting, but remember, this is theme rather than story. The platform war is the Empire vs the Rebellion, the Mob vs America, it’s the thematic texture that gives the story meaning. You shouldn’t mistake it for the main narrative though. In Mac vs PC, Microsoft won, not Apple or IBM. In open vs closed web, Google won, not Tim Berners-Lee or AOL. Ok, the winners in iOS vs Android were also the platform owners, but that’s yet another reason that movie sucked, maybe it’s the fundamental reason that movie sucked. I hope everyone involved is smart enough not to let that happen again.

Pioneers and Winners: We are far enough into the story that we can guess at pioneers, but we can’t be sure until the extinction event happens: in all previous movies, the early pioneers proved the market, and then died, crushed by an onslaught that included the eventual winners. I’m convinced that this plot point will repeat in the new movie. Look in the chatbot space for potential pioneers – it’s certain than one of these will become historically important. And then it will die.

I’m hoping the platform war victors aren’t also the heroic winners of the main story, as happened in the smartphone movie, because it’s boring and tends to result in Ewoks. Facebook is the pivotal character to watch, as it has a platform opportunity with Messenger, but has huge weaknesses relative to Google, Amazon, Apple and even Microsoft in hardware production and delivery, and hardware will be key to platform ownership. So it will be interesting to watch whether Facebook dives into hardware, or partners with one or more of the other platform players, in the hopes that there’s a bigger opportunity in the main story than the theme.

Well, that’s all I have to say about that. Enjoy the show!

the price they paid

Cue the background music [link to a streaming music play].

Watching the gyrating reports on the price paid for Apple’s purchase of music streaming service LaLa reminds me that acquisition prices are widely misreported and often misunderstood even when correctly reported.  Some people only want to know one number – the price paid – without caring about the many other numbers that are relevant to understanding who got what:  the company’s cash on hand, outstanding debt, financing history, and other numbers relevant to the capitalization of the company.

Even the best reporting often misses one important element of the analysis:  newly issued options (or other equity) shortly before the deal.  I like to call this the “options icing” – and it’s a very important concept for understanding what really happened.  For company founders, management and especially employees, it can mean the difference between a happy and tragic outcome for their startup.  The “icing” is both icing on the cake for employees, and also a good way to ice a bad cap table.

The options icing doesn’t come into play very often, but it is more common when the acquiror is a large, sophisticated tech company that historically rewards employees with equity incentive.  This kind of acquiror understands that the future success of the acquired product is less about the technology and more about the personnel continuing to prosper in the big company environment.

Let me make up an example.  A big company has got a problem if the market value of a 50-person company they want to acquire is only $20 million, while the investors have already put in $35 million into the company.  Typically, the investors have to be paid back first before anyone else gets paid, which means that employees would get nothing, which means that the big company would spend $20 million and get a bunch of seriously disgruntled employees, who will probably leave the company pretty soon after the deal. Even if the investors agree to restructure their liquidation preference, say by half, you still have very little left over:  $17.5 million to investors, $2.5 million for employees.  Let’s say that 1/2 of the employee stake is owned by 2 founders, and then you’re down to only $1.25 million for 48 other employees.  Nobody is happy with that outcome.

Here’s where the options icing comes in.  The company could issue a huge pool of options to employees who would be critical to carrying the product forward (in any scenario, whether acquired or not).  Say they issue $10 million worth of new options.  The magic here is that a smart acquiror will be willing to pay for some or all of those new options.  Even though the company is still only worth $20 million, the acquiror could be happy to pay $30 million if the options are issued to the right folks with the right terms.

The “right terms” include typical vesting terms, so the employees receiving options are incented to do great work for the acquiror.  From the employee’s perspective, this is fair because it is a whole lot better than the stick in the eye they would have been getting under the $20 million scenario.  From the acquiror’s perspective, this is a good deal because rather than flushing $20 million down the toilet, they are making a rational $20 million purchase, with a nice $10 million compensation package that addresses the compensation disadvantage that big companies face in competing with startups.

One of the key reasons that people work in startups is that you can really move the needle for the company’s value.  In financial terms, if you are part of a startup that creates, say, $100 million in value, then it’s a pretty neat feeling to have made nothing into $100 million, and you can get rewarded handsomely for that.  But if you are in a big company that is worth $100 billion, nobody will really notice, or even be able to tell, that you added $100 million in value – it certainly won’t make much of a difference in the stock price.  And that creates a compensation disadvantage for big companies that are trying to motivate their employees with equity grants.

But in the scenario above, the big company can pay for $10 million in stock grants to motivate a relatively small number of employees to execute on a product they clearly understand.  If these employees can turn that $20 million business into a $100 million business, they will be rewarded for it in a manner comparable to their rewards if they had remained an independent company.  That kind of compensation is generally not possible to award in a big company other than in this scenario because of internal “fairness” issues.

The beauty of all of this is that it is one of the few situations in this rotten ol’ world that deal dynamics favor the rank-and-file employees.  Most corporate dynamics, especially in big deals, have a tendency to screw the little guy.  But in order for this situation to be a good outcome for everybody, the rank-and-file employees have to be rewarded in a fair manner.  Coming back to my example above, the options icing can be win-win-win all around:  The investors can get a little tip for agreeing to the restructuring and the new equity; let’s say they get $18 million, just a bit more than they would have made otherwise.  That leaves $12 million for the employees – say the two founders take $3 million, more than twice as much as they would have made under the $20 million deal.  The other employees get $9 million, more than 7 times as they would have made.  The acquiror paid $10 million more, but as described above, this is money that really makes sense to spend, and it’s more like incentive compensation than it is acquisition consideration.

And this deal gets reported as a $30 million price paid.  But really from the right perspective it should be regarded as a $20 million deal.  Now, I am not saying that anything like this is what happened in the Apple-LaLa deal – actually the discrepancy in the reported numbers is too large to be explained by options icing alone.

man bites App Store

A study that most iPhone apps fail is being picked up by credible news outlets.  This is a classic abuse of the “Man Bites Dog” principle:

When a dog bites a man, that is not news, because it happens so often. But if a man bites a dog, that is news.

The fact that most new efforts fail is not news.  In recent years, we’ve seen amazed reporters discover that corporate and brand Facebook apps fail as FB developers struggle.  Shockingly, most businesses fail in virtual worlds.  Although small business failure rates are often exaggerated, the real numbers show that most startups fail.  Without going to the trouble of actually doing research, I will make the following guesses:

  • most Google advertisers fail.
  • most blogs fail.
  • most eBay sellers fail.
  • most television shows fail.
  • most movie producers fail.
  • most book authors fail.
  • most cave drawings fail.

I look forward to the startling exposes crafted by hardworking reporters on these topics.

Sarcasm aside, it’s interesting to consider the underlying assumptions of those who would find news in high failure rates.  If these stories really are about man biting dog rather than vice versa, then the assumption must be that there is a new means of business delivery that ensures success for the majority of its users.

That of course is a flawed assumption.  There is not now and never has been any way of delivering new business efforts that guarantees success in a free market.  Apple does not make businesses successful, Facebook does not make businesses successful, even mighty Google does not make businesses successful.  Instead, each of those companies have enabled some businesses to become successful – which is just another way of saying that they’ve given most businesses a new way to fail.

So the ultimate test for these companies is not whether they magically improve failure rates for others.  The test is whether the company itself operates a profitable business.  Apple and Google have passed that test with flying colors, Facebook has yet to do so.