Tuesday, December 31, 2013

Early Indications December 2013: A Look Ahead

Rather than issue predictions for the year-end letter, I am instead posing some (I hope) pertinent questions that should be at least partially answered in the year ahead.

1) How will enterprise hardware and software companies respond to cloud computing?

At first glance, this isn't a particularly fresh question: clouds are old news, in some ways. But whether one looks at Dell, IBM, Oracle, or HP, it's not at all clear that these companies have an assertive vision of the path forward. In each instance, revenues have been dented (or worse) by the shift away from on-premise servers, but what comes next is still in the process of being formulated, perhaps most painfully at HP, where Unix server revenues fell by more than 50% in just 5 quarters: Q4 2010 was about $820 million while Q1 2012 fell below $400 million. As of a month or two ago, HPQ stock had fallen roughly 60% since January 2010, in an otherwise bull market: the S&P 500 was up 64% over the same span.

Farther up the west coast, meanwhile, the leadership challenge at Microsoft relates as much to cloud as it does to mobile, does it not? Getting someone who can change the culture, the product mix, and the skills mix in the headcount will be a tall order. Absent massive change, the desktop-centrism of MSFT will be its undoing unless new models of computing, user experience, and revenue generation (along with commensurate cost structures) are implemented sooner rather than later.

2) Is Uber the next Groupon?

Before you explain how they're not comparable companies, here's my reasoning. Both companies are two-sided platform plays: Groupon enlists merchants to offer deals, and aggregates audiences of deal-seekers to consume them. Two-sided platforms are historically very profitable once they're up and running, but it's tough getting the flywheel to start spinning: no deals, no deal-seekers. No audience, no merchants. One side of the platform typically subsidizes the other: merchants who pay ~3% to accept credit cards are paying for your frequent flier miles.

Groupon ran into trouble after they scaled really really fast, and had lots of physical infrastructure (local sales offices) and headcount to fund. After a local business offered 2 $10 lunches for $10 (and paid $5 to Groupon), the $15 loss was hard to write off as new customer acquisition given that Groupon users frequently did not return to the restaurant to pay full price. Thus using local sales forces to recruit lots of new businesses to try Groupon once, with a low repeat offer rate, made the initial growth tough to scale.

Enter Uber. It's a two-sided platform, recruiting both drivers and riders. Because the smartphone app is an improvement on the taxi experience, customers use it a lot, and tell their friends -- just like Groupon. Meanwhile, getting the "merchant" side of the platform (in this case, the drivers) to stay happy and deliver quality service in the midst of rapid scaling is proving to be difficult: there are getting to be more riders than available cars in many localities. But Uber is not Amazon; it's more like Gilt, a [slightly] affordable luxury play rather than a taxicab replacement. Look at the company's ads and listen to the co-CEO, who calls the company "a cross between lifestyle and logistics." It can't, and has no reason to, meet the demand it's created.

Thus Uber charges "surge" prices, a significant multiple of the base fare when too many riders strain the system. It's presented as an incentive to get dormant cars into the market, but what's more likely is that the steepness of the price tamps down demand while conveying exclusivity. Given how reliably surge pricing is being invoked, it would appear that Uber is hitting some scale limits. One way to address this is to get more drivers into the pool, and Uber recently announced that it will help drivers buy cars. But like Groupon, this has the feeling of "fool me once, shame on me. Fool me twice, shame on you."  The indentured servitude that is Uber car paying-off will only appeal to a certain number of drivers, and for a certain amount of time. The transience of taxi-driver work forces is well demonstrated, and it's not clear that Uber can be immune to the same dynamics.

Meanwhile Uber is trying to expand its revenue streams: that same capacity of infrastructure (physical cars and human drivers) that's needed for a fraction of 24 hours needs to be utilized around the clock.  In early December the service offered a few Christmas trees ("very limited" availability in only ten markets) for the low low price of $135, at something less than "white-glove delivery" standards: the tree came to the "first point of entry," at which time you were on your own. A similar service was proposed for barbecue grills.

All that is a long windup for my Uber question: what is the ultimate scale this business can sustain, what is the revenue model for a 24-hour day during which the asset fleet is fully occupied less that 25% of the time, and what is the customer service guarantee for an impermanent labor force doing a hard job?

3) What is Google doing with robots?

The news that Google had acquired Boston Dynamics, a leader among DARPA robot-development shops, floored me when I heard it and continues to impress me. The shorthand version is that it feels as if Microsoft had acquired Google in 1999. That is, the leader in the current generation of computing invests heavily but astutely in something that's not quite here yet but will be big when it arrives. The buy doesn't get Google any current revenue streams worth mentioning, but there's astonishing talent on the engineering team and some very good IP, much of it, I suspect, classified.

There are several back-stories here. One is that Andy Rubin, formerly at the helm of Android, has been tasked with ramping up a real robotics business. He's been both hiring (quietly but effectively: I know some of the folks, and they're A+ players) and acquiring. The other key person might be Regina Duggan, a Cal Tech PhD who ran DARPA from 2009 until 2012, at which point she joined Google. At the time it was speculated that her expertise in cybersecurity would make her a prized hire, given the massive attacks on Google's worldwide networks (and, as we learned later, sizeable NSA demands for data). Now, however, her insight into the DARPA robotics pipeline no doubt accelerated Rubin's discussions with Boston Dynamics and perhaps other firms or individuals.

What could Google do with robots? Plenty:

-Work on battery issues. Cross-fertilization across Android and robotic research on this one issue alone could produce massive license revenue opportunities.

-Work on power and motor issues. Getting the physical world to connect and react to the "Internet of things" requires locomotion, a space where Moore's law-scale acceleration of performance has yet to be discovered.

-Automate server farm maintenance. Swapping out dead hard drives, to take just one example, would seem to be a local task worth doing with robots.

-Tune algorithms, something both Google engineers and roboticists do somewhat regularly.

-Scale down the machine vision, path-planning, dynamic compensation, and other insights gained in cars to smaller robots.

-Apply the same machine learning insights that allow Google to "translate" foreign languages -- without knowing said languages -- to other aspects of human behavior.

-Learn more about human behavior, specifically, human reactions to extremely capable (and biomimetic) robots. There's a great piece on the deep nature of "uncanny" resemblances here, and who better than Google to extend the limits of observed machine-human psychology.

One article mentioned a potential unintended side-effect. Some investment funds have screens that exclude tobacco companies, defense contractors, firms that do business in boycotted/embargoed nations, etc. Unlike iRobot and its Roomba division, Boston Dynamics has no consumer businesses; it appears to be almost entirely funded by defense research. Thus (much like Amazon building a computing cloud for the CIA), Google is now sort of a defense contractor. Apparently that status might change after the current contracts are completed, but even so, will the acquisition change Google's standing as an institutional stock holding?

4) What happens to the smartphone ecosystem as the developed world hits saturation?

For carriers and handset makers, this could feel like deja vu: once everyone who wants a cell phone (which happened around the year 2000 for the U.S.) or a smart phone (very soon in the U.S.) has one, where does revenue growth come from? New handsets would be one potential stream, but with subsidized phones, that turnover is unlikely to be very rapid. Content deals with HBO, the NFL, and other rights-holders will be a factor, much as ringtones were 8 or 10 years ago. ARPU, the all-important Average Revenue Per User metric by which the cellular industry lives and dies, is unlikely to grow any time soon in the EU or U.S., according to the research firm Strategy Analytics (http://www.totaltele.com/res/plus/tote_OCT2010.pdf -- see p.8).

Apple, Verizon, Disney, Comcast, Microsoft -- some very large companies in a variety of industries will be forced to change product strategies, internal cost structures, and/or revenue generation practices, the latter harder to do as competition increases (and thus one possible impetus for rumored merger talks between Sprint and T-Mobile).

There's also the geographic expansion move: focus on developing markets, selling lower-priced handsets in much, much larger numbers. That move, too, is hardly a sure thing, exposed as it is to competition from firms such as Hauwei that are not encountered as often in the U.S./EU. Supply chains, sales channels, regulatory compliance, and many other aspects of business practice can surprise a U.S. firm when it seeks to expand outside its traditional markets.

Honorable mention questions:

-How fast will 4K super-definition TV catch on? What geographies will lead the way?

-Will the US see any player gain momentum in the mobile wallet space?

-What will be the fallout of the NSA revelations?

-What will the consumer and B2B 3D printing landscape look like in 18 months? is there a single killer app that could emerge?

-How will crowdsourcing and especially crowd funding settle into well understood patterns after the current wild-West phase?

-What will the cryptocurrencies that follow Bitcoin mean -- for money laundering, for taxation, for developmental economics, for customer convenience, for alternative trust frameworks?

-When will we see a hot Internet-of-Things startup emerge? Given that AT&T networked lots of phones, then Microsoft eventually ran (and sort of) connected hundreds of millions of PCs, then Google indexed all the Internet's documents, then Apple shrunk and refined the PC into a smartphone, then Facebook connected massive numbers of personal contacts, it would appear that whoever can connect (and extract a toll from) some large number of the world's sensors and devices stands to be important in the next chapter of tech history.