The twin threats facing the internet giants

Google sign headquarters
By Angus McCrone

20 April 2018

The online giants have avoided a forcible challenge, but for how long, asks Angus McCrone.

The “Landlord’s Game”, precursor of the board game Monopoly, was invented in 1903 by an Illinois-born pro-competition campaigner called Elizabeth Magie.

Her brainwave was very much of its time: this was the period when US President Theodore Roosevelt got stuck into the country’s dominant corporations with what looks, from today’s perspective, like extraordinary decisiveness.

In 1905, the company that controlled 50% of America’s beef industry was broken up and the process began that would lead (in 1911) to the splintering into 32 pieces of the biggest mammoth of all, Standard Oil.

The question facing investors in early 2018 is whether these US-listed but internationally entrenched corporations are setting up difficulties for themselves with their growth and market dominance.

Arguably, western business is now more dominated by a few, super-influential giants than at any time since the heyday of Standard Oil.

This time, the industry concerned is not hydrocarbons, but the internet. The power – and momentum – of the US-listed internet-era giants stood out a mile in 2017.

Age of the internet giants

Incredibly for such big beasts, and despite the fact that this decade’s bull market was already long in the tooth, the share prices of Apple, Alphabet (parent of Google), Microsoft, Amazon and Facebook climbed by an average of no less than 46% last year.

By the start of 2018, Apple was capitalised at $864bn, Alphabet at $730bn, Microsoft at $661bn, Amazon at $568bn, and Facebook at $517bn. Combined, the five easily outcapitalised the whole of the UK’s FTSE100 index.

The question facing investors in early 2018 is whether these US-listed but internationally entrenched corporations are setting up difficulties for themselves with their growth and market dominance.

Will increased altitude bring dangerous exposure?

At first sight, the answer would seem to be “no”.

For a start, Donald Trump is no Teddy Roosevelt. Trump’s presidency, notably the big tax-cutting package passed just before the end of 2017, is unfettering big business rather than bringing it to heel – and his speeches and Twitter outbursts have been more about persuading giants to repatriate offshore profits than about curbing their market power.

Just as importantly, the case for breaking up the big five on competition grounds has not really been made. In 1903, it may have been obvious in the prices of beef, oil and other products that monopolistic power was hurting the consumer.

In 2018, the equivalent is not so: Google’s search and Facebook’s network are free to consumers, albeit certainly not to advertisers; Microsoft and Apple face competition from each other, and from open-source rivals based on Android and Linux operating systems.

Amazon may be the closest to ringing alarm bells at competition authorities, due to its large and growing share of online retail (an estimated 44% in the US) and expansionary moves such as the takeover of Whole Foods for $13.7bn in June last year.

Amazon may be the closest to ringing alarm bells at competition authorities.

However, online sales still represent only a small part of retail (16% in the UK, for instance) and Amazon’s global operating margin, at 3.1% in its most recent 12 months, is far from fat.

Hazards on the horizon

In the short term, the main hazards for the big five may come from other directions. For Apple, it may be technological change, the very thing that has powered it since the millennium.

The company enjoyed a hefty operating margin of 27% on its revenues in the year to September 2017, remarkable in almost any industry, let alone one based on technology and fickle consumer taste.

Its success has been based on genuine product innovation, sheer marketing and brand power, a profusion of available apps and a perception that its products are resistant to viruses.

However, in a product business, you are only as good as your next product.

Perhaps Apple, even without Steve Jobs, can go on avoiding problems, keep innovating successfully, and continue to convince discerning buyers in the west that a relatively expensive iPhone or iPad is better than a relatively cheap Android.

But the chances are that, at some point, a competitor will come up with something that radically changes the calculus.

Politics is another source of hazards for all the big five. Their wings could be clipped by regulations that make it more difficult to minimise tax payments by reporting a large share of profits in low-tax jurisdictions. Or by legislation that forces social networks to be liable for content they carry – online “trolls”, incitement, criminality, fake news or whatever.

The compliance costs associated with that could make a serious dent in profitability, as could any legal action for damages that is allowed.

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