The $1 trillion company

It's the most expensive game of Snakes and Ladders in history. On Thursday the market value of Facebook dropped by around $100bn (£76bn) after the social media leviathan reported an unexpected decline in user growth numbers to the US stock market.

The very next day Twitter's shares fell 20 per cent, though this meant a slightly less impressive $6bn drop in market capitalisation. Meanwhile, Amazon shares were popping higher after reported quarterly profits exceeded $2bn, reigniting media speculation that it could beat Apple to become the first company with a $1 trillion valuation.

But what does a one trillion dollar valuation mean? Rather less than the media commentary would lead you to believe. The truth is nothing happens when the threshold is crossed. There's no prize awarded.

Shareholders don't receive a cent more in dividends than when the company's value was $1 trillion minus $1. At least not automatically. It's just a big and round number.

The significance of the first $1 trillion company even as a meaningful numerical landmark is overstated. In 1999, at the apex of the dotcom bubble, Microsoft was worth more than $613bn. Adjusted for inflation, that's $927bn in today's money; so in line with both Apple ($954bn), Google ($888bn) and Amazon ($877bn) today. This is not uncharted territory for corporate valuations.

What does "market capitalisation" mean anyway? There are two traditional ways of valuing a company.

The first is to simply ask what someone else would be willing to pay for its shares. If you can sell the share for $10 it's worth $10.

The second is based on calculations of the value of all its future expected profits, adjusted for how much those revenues would be worth today. So if a company makes $10 in earnings per share today and you think this will grow by five per cent a year for the next 50 years you might value the share today at around $200.

It's important to bear in mind the pretty speculative nature of this second method when considering media reports about the value of fast-growing technology companies. In a world of massive uncertainty over digital disruption and the potential for sudden shifts in online consumer behaviour such estimates are inevitably going to be highly volatile.

The valuation of a company such as Amazon is based not on its current profits but on its profits later this century when, many assume, the "everything store" will have pushed aside almost every other retailer on the planet. That's certainly the trajectory. But it may not work out like that. As we've been reminded this week, it can be easy come, easy go in the Silicon Valley valuation game.

But there's probably another motivation for the obsessive media interest in the ups and downs of tech company valuations, and that's the ability to personalise the stories. Amazon, Facebook and Google have outsize founder share ownership stakes. Jeff Bezos owns 16 per cent of Amazon. Mark Zuckerberg owns 28 per cent of Facebook. Larry Page and Sergey Brin own 11 per cent of Google. This lends itself to eyecatching calculations of swings in personal wealth on the back of share price movements. It makes for a striking headline to report that Mark Zuckerberg lost $15bn in wealth in a single day. Or that Jeff Bezos gained $12bn in an afternoon.

But these are not losses and gains in the way that most people understand them. There's nothing those two individuals could suddenly afford after a good day, or which they could not afford after a bad one. These are paper fortunes that they could never spend over their lifetimes, even if they shopped like Michael Jackson in Las Vegas.

This fixation on personal wealth is, in some respects, socially useful. With this kind of corporate paper wealth tends to come control. And with control, rightly, comes responsibility. It's good that when Amazon fulfilment centre workers strike over their brutal working conditions they have a flesh-and-blood person like Bezos to direct their complaints to, rather than an anonymous board. It's useful that, when Facebook becomes a vector for democratically damaging misinformation on an industrial scale, pressure can be brought to bear on a powerful individual like Zuckerberg rather than a committee.

Yet, at the same time, there's also something slightly socially unhealthy about fixating on the paper wealth of individuals, at least in the celebratory way that one often encounters in news reporting. As Adam Smith, the father of economics, wrote: "This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition is the great and most universal cause of the corruption of our moral sentiments."

Something to bear in mind next time you are invited to enjoy a game of Silicon Valley billionaire snakes and ladders.

Bundling is profitable for cable firms and internet streamers. But is it a bundle of fun for customers?

Imagine a business model that enabled your firm to compel customers to purchase things from you that they wouldn’t otherwise buy. To sellers it probably sounds like a dream. To buyers it sounds like a bad joke. But it’s neither a dream nor a joke. It’s called bundling.

Many people purchase a satellite or cable TV subscription for a particular piece of content – maybe live Premier League football matches or episodes of Game of Thrones – and watch none, or little, of the other stuff available as part of their subscription.

Even the most voracious devourers of entertainment will only ever consume a small fraction of what they have access to as part of their packages. There are, after all, only so many hours in a day, even for telly addicts.

Consumers would be better off financially if they only paid for what they actually consumed. But under this arrangement the media companies would be worse off. So instead of offering pay-as-you-watch deals, they bundle.

Sky in the UK and the big cable companies in the US have extracted large profits from this selling practice in recent decades. They’ve used their exclusive rights to some forms of sports broadcasting or other premium entertainment content to effectively compel customers to buy bigger packages.

But new technology in the form of internet streaming subscription channels now presents a commercial challenge to these bundlers. In the US, financial analysts talk of “cord cutting”, to describe Americans ditching their expensive cable connections in favour of cheaper streaming services.

The epic deal last week by Disney to buy most of Rupert Murdoch’s Fox movie and TV assets and also his share in the streaming service Hulu was heavily motivated by the rise of Netflix and Amazon Prime.

Disney is preparing to invest in its own streaming platform, leveraging its vast catalogue of exclusive films, TV shows and sports rights.

Yet streaming has not killed bundling, but rather re-invented it in a new form. The streaming companies, of course, have their own bundles. If you want access to their own burgeoning exclusive content, you have to buy the whole package. These are cheaper than satellite or cable bundles, though the cost soon adds up if you have more than one.

So what should we make of media bundling from an economic perspective? Bundling is essentially a way of firms to extract the “consumer surplus”, a reference to the difference between the maximum customers would be willing to pay for something and what they would be asked to pay in conditions of perfect competition.

Of course, as this implies, consumer surplus extraction is only possible because competition is imperfect and sellers have some degree of market power. So should we consumers be outraged at the existence of bundling? Should we be demanding regulatory intervention to prevent it happening?

It depends. High profits for media companies from bundling might be seen as socially useful if the surpluses are re-invested in quality cultural or educational content that might not otherwise be made. This kind of welcome cross-subsidy was common in the era when print newspapers (a form of content bundling) had a virtual monopoly on this distribution of written current affairs content. 

Plenty of superlative, but expensive, foreign and specialist reporting was sustained in that way in the pre-interent era. But if the excess profits from bundling only end up lining shareholders’ pockets this becomes a transfer that simply harms consumers.

And if the practice of bundling serves to stifle competition, blocking potentially innovative new firms from coming into the market, that’s even more damaging to consumer welfare in the long term.

This represents a huge challenge for market regulators in this revolutionary era of instant digital content delivery  and the penetration of online giants such as Amazon into a stunning range of new commercial sectors.

The competition authorities in the US and Europe took on the software leviathan Microsoft in the late 1990s and 2000s over its bundling practices. Are they prepared to do the same with the Silicon Valley giants and entertainment conglomerates of today? And should they?

A great deal of the coverage of the Disney-Fox takeover has been from the perspective of the companies themselves and their powerful leaders. Is this the beginning of the end of the Murdoch empire? How long will Disney’s veteran boss Bob Iger stay in his post? Reasonable questions. But a little more consideration to the economic interests of the little people – their customers – would also be in order.

This article appeared in The Independent on 17/12/17