This is an audio transcript of the Unhedged podcast episode: ‘The dilemma of the supercompany

Ethan Wu
Rob, how do you feel about Meta?

Robert Armstrong
Well, I’m not on Facebook. I am on Instagram. It’s a palace of vanity. It’s slightly spooky, but I visit every day.

Ethan Wu
What about Walmart?

Robert Armstrong
Well, I don’t like what it’s done to American small towns necessarily, but man, I like going in there.

Ethan Wu
And how about Apple?

Robert Armstrong
I love my iPhone. I wish I could invent a world in which my daughter didn’t have one.

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Ethan Wu
Listeners, big companies like these, they generate mixed feelings and incredible investor returns. Today on the show, the dilemma of the supercompany. This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in the New York studio, joined by supercompany analyst Robert Armstrong.

Robert Armstrong
I think of myself as a supercompany, period. Supercompany Rob Armstrong. I have a monopoly position among Rob Armstrongs.

Ethan Wu
Or you could be the super space company analyst. You’re the top dog among company analysts. Well, Rob, on this show, we’ve talked ceaselessly about the Mag Seven, the Big Tech stocks, blah, blah, blah, blah, blah. But I think we wanted to zoom out a little bit. We’ve been writing about this in the Unhedged newsletter. You know, the American economy feels like — and it certainly from an investor perspective — it feels like it operates in a different way than maybe economies of the past did. And to be clear, there have always been big companies, right? Standard Oil existed. Sears was once a dominant retailer. What we’re talking about is companies where as they get bigger, they actually get better at producing the underlying product. They’re not just benefiting from scale, they’re actually getting more competent, more effective. And size is supposed to be in kind of a traditional Econ 101 model actually kind of a bit of a problem in a lot of cases.

Robert Armstrong
Yes. And competition, more important, competition was supposed to stop this. But if you had a great business and you were really printing it, somebody would copy you or compete with you or try to take your stuff. And so eventually your returns would be forced down over time just by the mere fact of your success.

Ethan Wu
And a lot of people will have the experience of I’m an iPhone user, I do like my iPhone. I’ve got some issues with it, maybe I have some issues with Apple as a company. And then when I go to buy a new phone, do I consider getting a Samsung? No, I don’t, not for a second.

Robert Armstrong
Yeah. Not for one second. In general, there’s a set of mixed feelings, right? We feel that there is something slightly creepy about the fact that all of us get all our online stuff from Amazon. But man, that stuff works well, right? You know, I order stuff from there like twice a week. So does everybody. When we’re shopping, in a lot of parts of the country, we’re going to Walmart. When we’re calling a ride, we go to Uber. We do our taxes on Intuit software. We get our financial data from Bloomberg. It’s like certain companies, they provide these services we all use. But there’s also a feeling like, is this real consumer choice? Do I feel good about this? Do I like an economy that is not necessarily as competitive as I think it ought to be?

Ethan Wu
Yeah. Think of social media, right? Everyone has opinions on Meta, on Facebook and Twitter, on Mark Zuckerberg personally or Elon Musk personally — and yet . . . 

Robert Armstrong
But we’re using it.

Ethan Wu
We just go back. You keep using it, one way or another. So in a recent edition of the Unhedged newsletter, we had a look at a recent paper from Morgan Stanley kind of looking at the economics behind these sort of businesses that create these tremendous, tremendous lock-in effects that are able to scale seemingly to infinity. Why does this happen? And it comes down to a key economic concept, which is increasing returns to scale.

Robert Armstrong
Yes. So the one we all understand is the idea that in some businesses, the more customers they have, the better the product gets. This is the famous network effect. So like Uber is a better ride company because a jillion people use it. That means there’s more Ubers around. When you hail one, it comes faster and the more people who use it because it’s better, there’s still more cars and more users and more rides, and it just gets better and better and better.

Ethan Wu
Yeah. But in this Morgan Stanley paper, a professor, Michael Maboussin, he goes into some other, maybe less-appreciated reasons why companies beyond just network effects, which people I think mostly know at this point, other reasons why companies experience increasing returns to scale. And so a few that we thought we’d talk about are learning by doing and recombination of ideas. So Rob, explain those ideas.

Robert Armstrong
Well, learning by doing — and this applies certainly to tech companies but to other companies as well — you just do more of the stuff when you’re the bigger company. When you’re Apple, you make a gazillion jillion phones. And in the process of making a gazillion jillion phones, you come up against problems and you eliminate them. And there’s this constant process of innovation where your production cost just comes down over time because you’re learning by doing. And it’s very hard for a small company to catch up because they don’t have the benefit of having to make a gajillion phones every day.

Ethan Wu
Yeah. The other idea: recombination of ideas.

Robert Armstrong
Yeah, well, if you’re in a business where you make computer code or you make chemical formulas — you’re a drug company — where the product is essentially intellectual and you do a lot of this, you come upon new applications for your intellectual property that you didn’t think of before. And sometimes this turns into a bonanza. There was a heart failure drug that Pfizer was working on that was going OK, but they discovered it had this interesting side effect. And that drug became Viagra. So this is just one example. Like when you deal in intellectual property, as many of these dominant companies do, ideas beget ideas and find new applications. And it’s a self-reinforcing process.

Ethan Wu
Yeah. And kind of like a related concept to learning by doing and recombination of ideas is the notion that once you already have momentum in your kind of core business, you have like a lot of optionality to spin off something else.

Robert Armstrong
There’s a couple of ways to think about that. One is just very, very large companies have a lot of information about the world. If you’re Walmart, you have an incredible amount of information about consumers. If you’re Uber, you have an incredible amount of information about people, where people wanna go and when. And you can just figure out ways to sell that stuff, put it to use doing something else. Another way to think about it is once you have all those users, you can sell them other stuff. And so there’s just these opportunities come up. Amazon was using an incredible amount of computer power running its website. They said, hey, you know, we use this computer power in a very uneven way. Some of the times, lots of it’s idle. Maybe we can sell it to other people. Now that’s a more valuable business than the retail business.

Ethan Wu
Amazon Web Services, absolutely huge.

Robert Armstrong
So all of this helps explain why in a modern economy, big profitable companies become bigger and even more profitable.

Ethan Wu
Yes, yes. That size is actually an advantage, not an impediment.

Robert Armstrong
Or used to be you’d think size will attract competition. But now size, like, destroys competition in many cases.

Ethan Wu
And you know, you have ideas like the innovator’s dilemma, that like the big companies struggle to be at the cutting edge of technology because they’re afraid of cannibalising their core product. That’s not really the case.

Robert Armstrong
Doesn’t seem to be happening. (Laughter)

Ethan Wu
Doesn’t seem to be happening. So between these phenomena — network effects, learning by doing, getting better as you make more, recombination of ideas, being able to iterate, and also the ability to cross-sell people to your existing products, spin off new ones from what you already have going — this paints a picture of, man, once you get big, you’ve got a lot of advantages.

Robert Armstrong
So let me ask you this, Ethan: why do so many of us have mixed feelings about these megacompanies?

Ethan Wu
Yeah. I mean, you can take that from so many different angles, right? There is just kind of an intuitive consumer perspective that while these products are good, useful, they solve a problem for me, and yet I don’t feel on some level like there’s some choice to what I’m doing. There’s not necessarily a market, or if there is, it’s thinner than I might like.

And then there’s, you know, I think regulators have been struggling with this too. The traditional way to think about antitrust, right? To think about corporate concentration and size is OK, size may or may not be good, may or may not be bad, but is it hurting the consumer? This is the so-called consumer welfare standard, which has been the kind of standard doctrine in US antitrust law. And the problem is a lot of these companies from like a price basis, from a cost basis are good for consumers. Amazon cuts the prices you spend buying stuff.

Robert Armstrong
But it’s almost like you don’t know what the alternative universe looks like.

Ethan Wu
Right. Exactly.

Robert Armstrong
So in a world where they weren’t so dominant, what would be the fantastic cornucopia of new ideas we would be living in? And so the people on the other side of this, like, you know, Lina Khan.

Ethan Wu
Who’s the head of the Federal Trade Commission in the US — the main antitrust enforcer.

Robert Armstrong
You know, she says a more competitive economy is a good in itself for society — creates more ideas and options and also gets you out of problems around political power and consumer elimination. In this context, I often think of an old Devo song called “Freedom of Choice”, (laughter) and it does feel sometimes that we have an economy where we have freedom from choice. We feel good, we like what we’ve got, and we’re free from the pesky problem of having consumer options. (Laughter)

Ethan Wu
Yeah. And the other, the flip side of that, as Cory Doctorow wrote in the FT recently, is that when the company decides they’re going to mess a little bit with the consumer product they’re offering you, because it’s so good and you have so much good experience with it, they’ve got a decent amount of latitude to mess with it and you can’t go anywhere.

Robert Armstrong
Yeah. So Twitter has recently gotten way worse. More ads, less relevant content, more junk, generally. I’m still there just as much as I was. I tried to switch to one of the others. They didn’t have this good a network. I’m sticking with Twitter.

Ethan Wu
Yeah. Or with Apple. I was a Samsung Galaxy user for years and years and years. And once I moved to New York, the burden of not being on iMessage became so insurmountable that I reluctantly switched to iPhone. And I have not and probably cannot switch back. And, you know, I think that central tension is something consumers face, is something regulators face. But then from an investor perspective too, it sort of inverts the question almost. Investors love companies that have increasing returns to scale.

Robert Armstrong
Yeah, boy. Yes.

Ethan Wu
And yet companies that in the past have looked like they’re going to have increasing returns to scale forever have turned up to naught.

Robert Armstrong
So in a way, what you’re saying is you’re raising the question against the Lina Khans of the world. Are these businesses really so impregnable and indestructible? So the examples I always think of in this context, which I’ve probably rattled on about in this show before, are Nokia and BlackBerry, which were incredibly dominant companies for a brief period back when I was an equity analyst, and it seemed like Nokia was gonna dominate low-end handsets and BlackBerry was gonna dominate what we now call smartphones forever. And they were just printing money and there was no significant competition in sight, and they were just growing and growing. And then like, it felt like a matter of weeks and they just evaporated. And you know, those companies are much smaller and totally transformed now. So is that kind of thing ready to happen in other areas?

Ethan Wu
Yeah, I think you’re seeing some of that now. You’re seeing it with Meta is lagging behind in short-form video to TikTok. You’re seeing Amazon retail get challenged by new low-cost Chinese retailers like Temu and Shein and those guys. It’s possible that these sorts of businesses operate in some kind of like punctuated equilibrium where it looks stable, the dominant player is dominant and then, oh, all of a sudden, not so much.

Robert Armstrong
Yes. Yeah. It’s not like a competition between two steel producers where they grind away at each other trying to make their cold-rolled steel one penny less than the others, you know, and eventually the lower-cost producer wins.

Ethan Wu
Which then kind of puts investors in a weird position because investors love the returns on these increasing-returns-to-scale businesses. They’re, generally speaking, some of the best-performing stocks on any market. However, you have to, implicit in that, you have to make a guess about how sustainable it is. And it’s really, really hard.

Robert Armstrong
To know in advance. So, W Brian Arthur, in his famous paper on this topic, talks about the “halls of production”, which is like the stable world of production businesses, and the “casino of technology” where you just don’t really know in advance which company is gonna burst forth in a given area of technology and become the dominant player because they have to have the right technology at the right time. They get a few more customers, some application takes off in some way that was unexpected and (zooming sound).

Ethan Wu
Yeah, and I think AI is going to be a great example of this in the next couple of years. Everyone now is betting on who the big winner’s going to be.

Robert Armstrong
And if that business, from what we understand about what it might be, it checks every box for the kind of business that might be dominated by a single really good player — the player with the most computer power and the most users and the most input, the greatest data — it will just compound and compound and compound.

Ethan Wu
Yeah. But I think as we’ve been doing reporting on this, it seems like the sure-fire bet on Nvidia being like the seller of the picks to the gold miners. There’s a lot of dissent on that point, right? How much challenge is there gonna be from the Amazon, Googles of the world or AMD, other chipmakers? 

Robert Armstrong
I mean, the analogy . . . I mean, to extend your analogy, it’s like we’re betting on who’s gonna sell the picks and shovels and there’s not even a mine yet. Right? Like it’s in the ground somewhere or you know, and . . . 

Ethan Wu
We’re at there’s gold in them hills. (Laughter)

Robert Armstrong
(Laughter) Let’s go!

Ethan Wu
All right, I’m with you. Let’s go. (Sound of shutting door)

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Rob, we forgot to do Long/Short in our haste to go get the gold in the hills. What are you long?

Robert Armstrong
I am long American gerontocracy. I read this utterly depressing article by my great colleague Edward Luce about how the fact that we have gerrymandering in America means less congressional districts and Senate seats are competitive, and the result is people just saying these things forever. And so, like, we’re all sitting here complaining about we have these two old presidential candidates and everybody’s old and da da da. That’s gonna go on forever, I realise. Like, just get used to being ruled by the 80-plus crowd. I don’t know what that implies, but that’s the new America. So I guess that means I’m long adult diapers.

Ethan Wu
Yeah. (Laughter) The trade of the millennium. Well, Rob, I’m short the rest of the world ex-US. I mean, we just got two GDP reports in the UK and Japan, both in recession at the end of 2023, it turns out. Mild recessions, to be clear, but you pair that with the picture in Europe, with the picture in China. Where’s the growth at? It’s in America. It’s the only place that’s got growth.

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Robert Armstrong
USA number one.

Ethan Wu
Yeah. And India, I guess. But I’m short the rest of the world; US the best place to be. All right Rob, thanks for being here. We’ll have you back soon. And listeners, we’re back in your feed on Tuesday with another episode of Unhedged. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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