Welcome to Stuff I Thought About Last Week, a collection of topics on tech, innovation, science, the digital economic transition, the finance industry, energy-storing concrete, and whatever else made me think last week. Please grab me on Twitter with any thoughts or feedback.

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In today’s post: Porter evolves his broken 5 Forces; Silicon Valley overheats; puzzling reversals in post financial crisis lifestyle trends; Internet capex and semi demand is on the rise; investing beyond conviction; LeBron James is right about Zuckerberg’s view of free speech, i.e., they are both wrong! and, lots more below...

Stuff about Innovation and Technology
Porter Topples His Own 5-Forces
At NZS Capital, we have always felt Porter’s 5 Forces, detailed his book Competitive Strategy, should be taught as a way to NOT run a company. As we wrote in Complexity Investing back in 2014:
“Michael Porter’s book, Competitive Strategy, published in 1980, has informed corporate strategy and security analysis for over 3 decades. However, the popular concepts outlined in the book are now out of place and often foundationally wrong in an age of free flowing information. Porter’s framework was based on mid-20th century oligopoly structures that largely existed as pre-information age artifacts. Written just before the popularization of the personal computer, it failed to anticipate the rapid evolution from high degrees of informational friction to virtually no barriers to information flow...The essence of Porter’s Five Forces boils down to avoiding competition and driving profits rather than focusing on the needs of the customer. This is the fatal flaw - barriers turn into crippling vulnerabilities in an age of instant and complete information. We are seeing these artificial “moats” destroyed one by one in the world of business, and even government regimes around the world.”
We felt that Porter’s way of thinking was zero sum at best, and in many cases, when considered on a net basis, negative sum for the world. It’s a 20th-century framework that only seemed fit for industries with regulated, unnatural monopolies, and in fact Porter’s own consulting firm failed. Well, times change, and Michael Porter is now realizing that positive social impact can be a powerful economic driver, as he describes in this long essay he co-authored in Institutional Investor. The post contains the following analysis of power providers:
“A Five Forces analysis would have correctly predicted a stable and profitable power industry, and many investors bought utility stocks with the expectation of a predictable long-term yield. Now, however, many markets have been deregulated. European governments have imposed descending limits on use of the fossil fuels on which most major power plants depend. Solar and wind technologies have reached price parity, enabling distributed generation with very low barriers to entry. Most European utility companies and their investors missed these major shifts as they ignored changing societal factors in their investment analyses. The result was the destruction of €500 billion ($551 billion today) in economic value.”
We heartily agree, and would like to say “welcome aboard” to Michael Porter. We expand on our concept of NZS, or non-zero-sum investing – that goes well beyond ESG – in our whitepaper here.

African-Made Smartphones
Mara is launching the first made-in-Africa smartphones with a goal of increasing the 15% phone ownership level in Rwanda.

Coffee Grounds Reimagined
Coffee-ground-based degradable plastics: after you press the oil out of used coffee grounds for biofuel, researchers are using the leftover dry, odorless material as an additive in 3D-printing substrates. The additive strengthens cornstarch-based poly-lactic acid (PLA), which also has many medical product and food packaging use cases.

Next-Level Baby Monitoring
Sound Life Sciences leverages smart speaker microphones and white noise to monitor baby breathing. The white noise is canceled out, leaving the baby sounds only, and movement/location can be pinpointed using built-in microphone arrays.

Energy Storage Caveman Style
Swiss company Energy Vault is using potential energy to store excess power from wind and solar. The idea is you use the green power to lift giant concrete blocks in the air, and when you need power you lower them down (think of regenerative braking in your hybrid or EV, but with vertically dropping concrete mass). The product isn’t yet proven out, but it's reported to get 80-90% round-trip efficiency. Softbank’s Vision Fund invested $119M into the company because “It’s not a science problem. It’s fifth-grade physics” - no comment on how this investment philosophy has gotten Softbank into trouble recently!

VC Bubble in Trouble from Over-Subsidization
We should start to see some rationalizing of the VC bubble in Silicon Valley, which has seen several unsustainable consumer Internet business models raise too much money at too high of a valuation. This slowing funding will also probably give some pause to advertising growth on social networks and infrastructure spend at AWS, though I suspect these will be blips in the long term. My proprietary, if anecdotal, ‘Silicon Valley Traffic Index’ is spiking off the charts with new traffic jams in new places up and down the 101 lately. Likewise, last weekend at the San Jose airport, there was no parking available for nine hours – not one single spot – as flyers in 2019 increased 15% to 14.3M from last year! This congestion is historically inversely correlated with where we are in the VC cycle. This Atlantic article points out the rather humorous fact that Millennials will have a reckoning coming to their VC-subsidized lifestyles: “If you wake up on a Casper mattress, work out with a Peloton before breakfast, Uber to your desk at a WeWork, order DoorDash for lunch, take a Lyft home, and get dinner through Postmates, you’ve interacted with seven companies that will collectively lose nearly $14 billion this year. If you use Lime scooters to bop around the city, download Wag to walk your dog, and sign up for Blue Apron to make a meal, that’s three more brands that have never recorded a dime in earnings, or have seen their valuations fall by more than 50 percent.”

Wind Drives Renewable Energy in UK
Thanks to a rise in offshore wind power, the UK received more power from renewables than fossil fuels. Renewables were 40% compared to 39% fossil fuel, with the remainder coming from nuclear.

Supersaturation of Residential Delivery
Many investors conceive of the US residential delivery market as a duopoly of FedEx and UPS combined with the government-subsidized postal service. The reality is much different: depending on where you live, you might get deliveries from a dozen companies such as USPS, UPS, FedEx (Express, Ground, and Home), DHL, Ontrac (or other regional carrier), Amazon, Instacart, Uber Eats, Doordash, Postmates... In this WSJ article, I still get the sense FedEx is living in the “duopoly” past as they struggle to face heightened competition in this part of their business and CEO Fred Smith calls Amazon’s ambitions “fantastical” and Amazon’s head of logistics a “smartass.”

Anatomy of a Ghost Kitchen
Here's an inside look at DoorDash’s ghost kitchen concepts, which are staffed by employees of various restaurant brands with shared infrastructure and services. Partner restaurants are paying “modest” rent plus the normal order commissions, and presumably their employee costs, but are obviously saving on a lot of other costs of running a standalone restaurant. And, it’s a way to outsource capex to DoorDash, which further increases ROI for brands.

Old Habits Die Hard: Cars and Coca-Cola
Despite the rise of transportation services like Lyft and Uber, car ownership has climbed for the last decade – largely because it dipped in the great recession. Ownership levels are now back to where they were before 2008, but that still raises the question of why we haven’t seen a greater shift toward the ride-share alternatives and less car ownership. Perhaps the cyclical rebound is masking a different underlying trend. Another unexpected consumer shift is the rise in soda consumption, with Coke reporting 15% growth in smaller can sizes. I can't help but wonder if many of the health and lifestyle trends post the 2008-2009 financial crisis were temporary reactions, while human behavior itself remains stubbornly entrenched in its evolutionarily-driven desire for sweets and concentrated calories? Or, perhaps it was undulations in demographics as Millennials were postponing household formation, which obscured the lifestyle trends?

Internet Platforms' Dramatic Capex Increase, Spending Cycles, and Semiconductor Demand
Rising capital intensity at the big Internet platforms is notable. According to a report from Empirical Research Partners (report available for their clients), Facebook, Amazon, Apple, Netflix, Google (FAANG) and Microsoft have driven 25% of returns for large-cap stocks over the last five years, and they now account for 14% of large-stock market capitalization. The stocks also account for 14% of large-cap free cash flow (roughly double what it was 10 years ago), and 10% of large-cap earnings. Over the last three years, the share of capex from these six stocks has tripled from 3% to 9%. As demand grows for everything from machine learning to same-day shipping, Internet platforms are not as high ROIC businesses today as they once were. It’s perhaps time to dispel the myth of capital-light Internet businesses.

Rising capital intensity at cloud platforms is in part related to businesses shifting from owned data centers to the cloud. Going back to the early days of the client/server architecture, we often saw cycles of new hardware advances spawning new operating system releases driving new application demand. These cycles ran in several-year increments. Nowadays, with the shifting spending to the cloud, we might expect faster cycles of building large, physical data centers followed by outfitting those centers with chips and hardware. In the off years of investment, companies are seeing rising efficiencies from existing hardware through advancements in software and AI. Gavin Baker made this point on cyclical cloud capex recently.

TSMC, the world’s largest foundry for advanced semiconductors, is certainly predicting a robust data center spending cycle as leading-edge chips are in high demand. The company raised capex several billion to $14-15B and was also optimistic for the 2020 outlook. 5G and AI are drivers of this growth, as well as picking up share from AMD. All that said, it’s a little hard to know how much stockpiling going on in China given the escalating trade tensions.

Brave Browser’s Privacy-Driven Share Gains
The privacy-focused Brave browser (highly recommended) has passed 2.8M daily and 8M monthly active users. 290,000 sites have joined its token-based support platform and their attention ads are seeing a 14% click through rate vs 2% for the industry.

Video Games as Neuro PT
Quadriplegics are looking to use video games – and esports tournaments – as a form of recovery. For now, this is about kickstarting neural rewiring and the ability to use other muscles, but I can’t help but wonder if Neuralink or something similar will create a whole new type of video game interaction for esports down the road. Related: DARPA is working diligently to read minds to control drone swarms.

Amazon Waves Goodbye to Oracle from the Cloud
Amazon has switched off the last of its expensive Oracle databases in what has proven to be a long and difficult accomplishment. However, the end result is a 60% cost decrease, 40% latency reduction, and 70% reduction in database admin overhead for Amazon. The migration was no doubt prompted by the religious war between the companies, but it's an important milestone for others who want to do the same (and likely the reason Oracle is cozying up to Microsoft as I wrote about last week).

Improving Robotic Manual Dexterity with Rubik’s Cubes
OpenAI has used reinforcement learning and simulations to teach a physical robot hand how to solve a Rubik’s Cube.

Samsung Joins the RISC-V Bandwagon
Samsung is rumored to be working on a 14nm Exynos processor based on the open-source RISC-V instruction set. Previously, all Samsung processors have been ARM-based.

Lots of $$$ in Streaming as User Shift Accelerates
Viacom-owned South Park is near a $500M deal for the exclusive streaming rights to it’s past and future episodes. This follows recent high-profile digital “syndication” deals for Friends and Seinfeld. The reality of consumers spending more time watching more premium content on more devices is settling in, and high quality content is increasingly more valuable, even when it’s library content that goes back decades. An accelerated shift to streaming is underway, spurred by price hikes for digital versions of cable packages – AT&T is raising their streaming live-TV service to $65 following price hikes at Hulu Live and YouTube Live to around $50. These services are thought to be breakeven in the high $50s monthly ARPU range. Further, the explosion of consumer streaming apps coming from Disney, WarnerMedia, and NBC Universal along with existing apps from Hulu, Netflix, CBS, and a long tail of niche content providers is likely to drive a faster shift away from linear TV, but it will be balanced by older demographics, who watch live cable news, and sports fans who are likely to cling to legacy TV bundles. Netflix said this week that they expect new offerings to speed up the shift to digital as well. This leaves consumers desperately needing a common universal interface and universal search to manage the increasingly complex ecosystem. Absent a good UI, it’s possible one of the existing streamers, like Netflix, creates a winner-takes-all video service for users fed up with the unbundling fragmentation.

Miscellaneous Stuff
Waxing Poetic about Honesty and Conviction
Nick Cave outdid himself with these words in his Red Hand Files this week:
“My duty as a songwriter is not to try to save the world, but rather to save the soul of the world. This requires me to live my life on the other side of truth, beyond conviction and within uncertainty, where things make less sense, absurdity is a virtue and art rages and burns; where dogma is anathema, discourse is essential, doubt is an energy, magical thinking is not a crime and where possibility and potentiality rule.” This made me think of Dylan’s line in Sweet Marie: “to live outside the law, you must be honest,” which for me has always meant that doing things differently than others requires you to always do the right thing. And, the words “beyond conviction” from Cave resonate loudly with how we try to invest: going beyond the cognitive bias traps and trying as hard as possible to have no solid, immutable views of how the future might play out.

One Cookie Now, or Two Later? A Better Predictive Model
Many of you enjoyed the Farmer’s Fable, an interactive graphic that explains the power of combining arithmetic with geometric compounding (more on that in SITALWeek #202). A new paper attempts to put some of that same logic to the test in discounting of future rewards. Standard exponential discounting, used in most economic models, doesn’t explain many actual behaviors by people with regard to future rewards. This paper explains discounting without psychological biases: instead of changing expectations being a symptom of the mind, they are instead a symptom of changing circumstances.

Ditching Plastics for Aluminium: A Supply-and-Demand Disequilibrium
Can giant Ball Corp discusses the market dynamics as consumer drink brands increasingly want to shift away from plastic to aluminum: The firm is “just trying to keep up with existing customer demand, because we have very little inventory; it’s a high class problem, but it’s a problem nonetheless,” Hayes said. “The biggest challenge we have is procuring the necessary aluminum and having our own production capability.” Ball also announced a partnership with Kroenke Sports to bring their new aluminum cup to Denver’s Pepsi Center.

Stuff about Geopolitics, Economics, and the Finance Industry
Squawking about OOTMO
I was on CNBC’s Squawk Alley on Tuesday squawking about the out-of-the-money optionality (or OOTMO as we call it) in Uber and Lyft along with the risk of regulation for the giant Internet platforms.

Benioff Needs to Walk the Talk More
Benioff penned an editorial in the NYT, coinciding with his new book launch, about new capitalism recommending a “broader vision of [corporate] responsibilities by looking beyond shareholder return.” I'm glad to see this idea, which we put forth last February in our NZS whitepaper (Non-zero Outcomes in the Information Age: Broadening the Definition of Fiduciary Duty for the Mindful Investor and Company), voiced by others. However, Marc could be doing so much more to further the cause if he means what he says. As I discussed in SITALWeek #210, tech companies are in an unprecedented position to incentivize social change by companies that use their software and hardware platforms. I don't want to be too critical here – Marc has accomplished a lot, and I have great admiration for him as an operator at Salesforce and the causes that he has supported over the years – but I do wish he would take advantage of his position and go beyond suggesting how people should act and actually set a benchmark for incentivizing good behavior.

Investors Flee Active Equity
Active equity funds saw the biggest withdrawal for any quarter since 2009 at $60B in Q3 as the 'bubble of fear' continues to inflate. Bond funds took in $118B, up 2x over the same quarter last year, and money market funds took in a ten-year record of $225B.

Cracks in Communist China
Are China’s “tantrums” done intentionally with justifiable outcomes, or simply like a bully on the playground who gets called out and backed into a corner? When we think of the range of outcomes in our investment process, we put a meaningful credence on the risk of Chinese communism completely failing. The world might view that as a 1 in 10,000 chance, but we’re likely to invest as if it’s a 1 in 10 because non-zero-sum forces apply to governments just as much as they apply to businesses. From an article in the Atlantic: “China might be experiencing its own form of failure and weakness, with a more and more centralized rule pushing a cult of personality around the leader. After all, China has its own problems with decadence, corruption, and inequality. Many high-level officials have families with multiple passports and expansive overseas wealth. A mixture of authoritarian malaise and loss of agility might be causing the country to lash out, without proper strategic analysis. This same dynamic seems to be at work in China’s approach to the Hong Kong protests, which could have been defused early through a few symbolic concessions. It’s as though China doesn’t even understand a city that is under its own jurisdiction.”

This long article in the FT is a great tutorial on the civil war for freedom in Hong Kong. “If we burn, you burn with us.”

LeBron James and Mark Zuckerberg are Wrong About Free Speech; Tim Cook is Just Wrong; but, Quentin Tarantino is Right
A bipartisan group of senators expressed concern to Apple this week over the Chinese censoring of apps in the Apple app store. And, it’s been reported that Apple won’t be bidding on those South Park streaming rights, fearing repercussions from China. But, hopefully Tim Cook doesn’t channel “Taco Tuesday” LeBron James or Eric Cartman in his defense: “Yes, we do have freedom of speech, but at times, there are ramifications for the negative that can happen when you’re not thinking about others, when you only think about yourself...So many people could have been harmed, not only financially but physically, emotionally, spiritually. So just be careful what we tweet and what we say and what we do. Even though yes, we do have freedom of speech, it can be a lot of negative that comes with it.”

Much was written about Zuckerberg’s speech on freedom of speech this week (including his re-writing of the entire origin story of the company!). This piece in The Week was the smartest take I read on the Zuckerberg speech: “This is all emblematic of a man who is employing pre-web thinking in a post-web world. Facebook — and other sharing platforms — have indisputably made it easier to share one's views with the world. But the original idea of free speech didn't account for the dynamics of virality and algorithms. Platforms like Facebook are designed to favor and amplify certain kinds of speech — the reassuring, the inflammatory, the controversial — even if the claims being made and the views being shared aren't true.”

I'd like to make some important distinctions regarding the last couple of paragraphs: when LeBron James says that freedom of speech is wrong because it can hurt people, that misses the point of freedom of speech – if the truth hurts, it's still the truth. When Zuckerberg says more speech is better, he's wrong because his platform can't consistently identify intentionally weaponized misinformation. When Tim Cook checks his moral compass at the door for more money for Apple shareholders, he's simply being unethical, and his actions seemingly have nothing to do with his views on free speech. And, when Quentin Tarantino refuses to re-edit a movie for China because they don’t like a parody of Bruce Lee, it's the right thing to do on behalf of free speech – he's protecting a truth, or satire, not intended to harm or manipulate.

Erratum: Zero-Fee Trade Scenarios
Last week, when I was discussing the ability to create synthetic indices, a reader kindly pointed out a math error I made. Recreating the S&P index (500 trades at $5 a trade) would cost $2500; a 10 bps fee on an index backs into $2.5M investment breakeven, not $250,000 as I stated. A 5 bps index fund would likewise suggest $5M. So, my point is weakened, but for now I remain intrigued that you could more cheaply create custom index-like funds, or recreate elements of indices more thoughtfully for much less money. The reality is, indices are backward-looking by their very nature in the way they are rebalanced, and now even more so with the rising pace of disruption; but, now with free trading, there should be much better opportunities for investors and advisors to actively and cheaply beat indices going forward.

-Brad

Disclaimers:

The content of this newsletter is my personal opinion as of the date published and are subject to change without notice and may not reflect the opinion of NZS Capital, LLC (“NZS”).  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 often I try to make jokes, and they aren’t very funny – sorry. 

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