Sassoon Saleh, FCA MIoD Globalisation

www.sassoon-saleh.org.uk

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Understanding technological advances,
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The following is an extract from a paper on the impact of large hi-tec businesses operating on a global basis, and the importance of competition and regulation to ensure an economy works fairly, in the interests of all stakeholders.

If you want to discuss this further, or have any points for me to consider, please get in touch. The people likely to benefit from this information are senior managers in large businesses, entrepreneurs, and legislators.

Competition & business specialist

It is reported that huge amounts of revenue are raised in the UK by new-age technology businesses, such as Google, Facebook and Amazon. At May 2013, the market capitalisation of Google, Facebook and Amazon were $289 billion, $65 billion, and $118 billion respectively. Yahoo a smaller internet business, still has a market cap of nearly $20 billion. These valuations make conventional bricks and mortar businesses look like dwarfs. As a comparison, Tesco in the UK, as a premier supermarket chain, has a market cap of £30 billion(or $46bn). Later in this document, I explain why these new-age companies have become so valuable.

They have attracted large networks of customers/users for their specialised services (at relatively low average costs per user). These businesses were tiny to non-existent only some 10 years ago, which shows the speed with which this change has happened, almost without anyone in power realising the financial impact of their presence. These companies have become leaders in their chosen markets.

The success of new-age businesses in the 21^st Century

The spin-off gain is to attract huge indirect revenue flows from advertisers and third parties seeking to tap this proprietary (unique) knowledge, and get their products and services to individual targeted customers. Other types of businesses use this knowledge themselves to target selected customers with special offers or services (eg major supermarkets, airlines, banks, etc).

The size of these revenue flows are now reaching £billions of pounds annually (directly or indirectly). The impact on the UK needs consideration.

As the new-age businesses grow their customer/user base to millions of people, they increase their economies of scale and scope, potentially squeezing out alternative suppliers or competitors (in these markets). Effectively, we see a ‘winner takes all’ or a ‘winner takes most’ feature in these new high-tec information markets. For example, in Internet search, Google is said to have a 75% share, with Microsoft (although very successful) only having a small share from its equivalent service.

Often, in these markets, a dominant player with huge market share emerges, and a few niche players might only be able to win small shares at the edges, from specialised services. Sometimes a first-mover advantage can be critical to long-term success.

Some large established companies expand their market share or enter markets where they are weak, by strategic acquisitions or purchasing technologies and patents that they hope to exploit. They still might need to invest strongly to take-on the market leader.

Why are new age businesses so valuable?

When we think about the value of the information captured by new-age companies from their interaction with millions of customers/users, intrinsically, the information they glean may be seen as something of no importance. That is an error. Although the information is a by-product of people using the company’s service or technology platform, often for no direct charge, its value is not negligible. That information is of great benefit to the businesses capable of harvesting and using the data.

· As can be seen from the size of revenues achieved by these companies over the last 10 years, the information they hold and are able to sell or use directly in their business activities, is highly valuable. The modern information technologies and instant low-cost broadband or WiFi communications also helps new-age businesses sell goods and services to a world-wide customer base.

In the case of Facebook, the social network is good and useful because its users supply the up-to-date content. And their personal information makes the platform valuable. This explains why a company that employs fewer than 5,000 people is worth more than $65 billion today, far exceeding the value of historic well established business on the stock exchange. This value makes it appear that each worker is worth $13 million, but that too is an error in thinking. In effect, the site’s value is derived from its hundreds of millions of 'free or unpaid' users, who are so productive that all the employees really have to do is keep the system on, and the servers running. The users do the real work, and the company harvests the profits.

So in effect, the inventors (and financial backers) of these new-age technology platforms are reaping the benefits of all the value that can be obtained from the ‘free’ work and interaction of millions/billions of people around the world who use their platform for their convenience. That is an insight, which has missed many people in the globalised world economy of the 21^st Century. It is a new business paradigm.

Currently, the fruits of the work of all the people using, for example, the Facebook media platform, or Google’s technology are going to relatively few people who invented, financed, or are employed to service these technological marvels. They are lucky people to have been at the right time and place, with the right technological, educational, and business skills. It must not be forgotten however, that their success is built on, inter alia:- (a) the collective work of thousands/millions of people before them; (b) innovation around the world; (c) massive government investment programmes in technology and education in the last 50 years, and (d) the millions of people compelled to use their platforms (as nothing better exists to supersede them)!

· Specifically, without the Internet, there would be no Google, ITunes, Facebook or the other mass networks of joined-up consumers/users. Their time had come by the early 2000’s, once the basic technologies reached a critical point to enable global interactions at fast speed, and relatively low costs. Currently, getting these beneficiary businesses to pay corporation tax in the countries where they earn their revenue is receiving a lot of attention in the press, and with the public.

· What is currently happening is the equivalent of the inventors of the Internet being able to take royalties from all users around the world, for the foreseeable future! Effectively, those who were able to develop technologies and sites to reap benefits from the internet, are often able to hold onto the gains/profits. Will this happy situation be allowed to continue, unchecked?

Some of these businesses have been so successful that they have changed the way competition works in their markets. Some historically successful businesses have been forced to urgently adapt their business model, or die through fast loss of customers, or loss of large volumes of business.

Moreover, the users of their networks are commoditised as unpaid ‘providers’ of information that enables the platform to earn substantial revenue (either directly from sale of services, or from commissions paid by advertisers for links to potential customers). Some have called this a parasitic business model ie taking advantage of the unpaid providers of the raw data, which is then packaged and used for commercial gain.

· It is clear that the size of the network is a key success factor to earn huge returns. A second key factor is users remaining on the network and; thirdly continuing to provide up to date information and interactions. Once, successful, some businesses mis-describe or disguise their profits, especially when able to operate on a global basis. Western Governments are beginning to wake-up to this issue, especially when the multi-nationals operate in their jurisdiction.

Also, once the networks or technology platforms are established with millions of users/customers, their continuation is likely to be self-perpetuating. This could be because the owners/management will operate in a self-interested way, to protect their monopoly, rather than act for the welfare of the wider community. We are seeing examples of this tension or one-sided power, for example where Google has told its Gmail users that they have no rights to data privacy over their platform! But once customers have been hooked onto a technology network, moving elsewhere is not so simple, especially if the users have invested time and effort in the chosen network.

The biggest threats faced by these businesses are:
(a)   the loss of users on their network;
(b)   their advertising customers moving away from them,
(c)   any technology shifts that make their platform redundant to users, or
(d)   damage to their reputation from misconduct being publicised.
Potential monopolists will do whatever is necessary to remove or eliminate these threats. As these businesses become more powerful, will their employees or management think they can do as they like, and escape challenges by critics, or potential competitors.

It is easy to recall the unaccountable hubris in the banking sector, before the global collapse in 2008. Since, investigations have identified many reckless decisions and apparent misconduct as causes of the collapse. But many banks were thought to be too big to fail – so they escaped accountability but required huge publicly funded support for years. Is this something that managers of large new-age businesses might equally enjoy ie ability to make gains with low personal risks?

And when things go wrong, governments will be forced to step-in to stop the effects of systemic collapse and loss of public confidence in the existing regimes, and accepted ways of doing business. For example, one gigantic fraud over the internet could potentially shut down e-commerce for a considerable period until safety measures are brought into play. Who is defending against these systemic risks? What backup measures do large businesses have, in case their existing model for doing business is impaired for several months?

I see significant issues arising in terms of:
(a) copyright;
(b) patents;
(c) access to the software coding;
(d) sharing the revenues (between countries) on an equitable basis;
(e) regulation to ensure the businesses do not harm the public interests;
(f) protection of private data across the world; and
(g) relationships between countries that host the parent companies of these new-age corporations, possibly to the detriment of other countries (from which money and revenues are extracted).

In the UK, there is also a debate on whether the large company corporate tax procedures are keeping up with this change in relative profitability between new age, and old age businesses, and those operating on a global scale. The UK Public Accounts Committee carried out an investigation into Google in 2013, and noted that the UK tax system has not adapted to the advances in technology and ways of doing business globally in the internet age over the past decade. Whether the competition and regulatory regime is also keeping up to date with these technological and behavioural changes are other open questions.The Public Accounts Committee on page 5 of its June 2013 report, noted that Google generated US $18 billion revenue from the UK in the five years between 2006 and 2011. It noted that information on the UK profits derived from this revenue is not available but the company paid the equivalent of just US $16 million of UK corporation taxes in the same period. This tax paid is 0.1 per cent of the revenues ie 1 thousand times less than the revenues. If Google paid only 1% of revenues in corporation tax over this period, the UK would have received $180 million. If it paid, say a 15 per cent rate, this tax recovered would have been around $2.7 billion, an enormous sum.

How are monopolists controlled?

Many say that light-touch regulatory scrutiny in the UK, Europe and USA over the last decade, led to the Banking crisis of 2008/09; and potential failure of major global Banks when allowed to run themselves in this misguided way. Without government intervention and massive financial support, many banks would have gone bust in recent years, and with severe or damaging side-effects for the rest of the world's advanced economies.

It became apparent that the banking sector had become excessively independent from responsible regulatory control, with some large banks becoming ‘too large to fail’ ie their collapse might damage the economy of the countries in which they operated. As banks became increasingly globalized in recent years, the consequential damage from some banks failing (because they under estimated risks) became a systemic problem because of their inter-dependence across countries.

Effectively, regulators and legislators in positions of responsibility did not sufficiently consider the downside risk of human behaviour eg loss of confidence to put money in banks; or sub-prime borrowers failing to repay loans on a large scale; or the risk that derivatives trading might go seriously wrong (and the economic paralysis that happens thereafter). These are problems which are almost impossible to model in a reliable scientific way because they depend on variables (known and unknown) that impact on the behaviour of large groups of people. Governments are still struggling to devise ways to control reckless behaviour, lack of accountability, and rewards for failure.

It is now common practice in developed economises such as the UK, that where structural potential monopolies exist, that these industries and sectors are proactively regulated and licensed in the public interest eg telecoms, utilities, railways, airports, banks, etc. The companies provide essential services to customers or the public, which they could exploit, hence the need for regulation and licensing. The regulation also helps governments raise revenues from these monopolies in a responsible way, to benefit the public.

In many cases, the maximum revenues the licensed [monopolistic] businesses can charge is capped for up to several years ahead, based on forecasts of costs, demand, investment, and sensitivity analysis under various scenarios. This is aimed at giving customers the benefits of competition, and an incentive for their managements to innovate and provide higher service levels. Regulation is seen as the best trade-off between allowing monopolies/oligopolies to continue, whilst still protecting the public from exploitation (eg bad service and over-charging). It arises because of a realisation that effective competition will not happen (for many reasons), to drive rivalry in price, service, quality and innovation. But, even regulation is no magic bullet, for example:-

The rules may be weak, or the regulators found to be ‘not up to the job’, or they don't properly consider structural problems which the regulated companies choose to ignore.
Regulatory asymmetry of information is a problem that never goes away. Also regulated companies could still find ways to overcharge or exploit customers, and excess profits may not get clawed-back.
Some regulated businesses might be mismanaged and need to be wound-up, with negative impacts on the public. Also the managements might overpay themselves or concentrate efforts and investment excessively on non-regulated activities, to the prejudice of investment and efforts to develop the regulated businesses.

I comment more on some problems from regulation in the paragraphs below. Naturally, those doing the regulating need to be skilled, capable of good judgement, and able to see the big picture, rather than get bogged-down in minutea, bureaucracy and buck-passing. The effects of poor regulation over the last decade are apparent in major economic and business scandals affecting the UK; eg in Banking, Railways, Energy and Consumer protection.

Sometimes, regulators gave-up their right to control prices of monopoly goods and services, or allowed the licensed businesses to do minimal infrastructure improvements, with the effect that there was lack of storage capacity (eg in gas), or traders were able to manipulate wholesale energy prices. Mistakes have led to supply and demand spikes, price inflation or service deterioration. Human factors should never be under-estimated.

In the energy sector, for example, it is suggested that the six largest UK energy suppliers operate as an oligopoly, under the eyes of the Regulator. Even customer switching is no threat to them making ‘excess’ profits from pushing-up prices on customer who remain static. Some commentators have noted the companies’ ability to buy wholesale gas and electricity from their vertically integrated businesses at prices which are not disclosed to the public. So the lack of transparency enables them to keep the bulk of profits in unregulated wholesale operations, and blame the wholesale market for price increases, whilst disclosing relatively low profits in their retail operations! Published research suggested that the companies in 2012 made average profits of around 2 to 4% from their retail operations, but the generation arms made average profits of around 20% (ie 5 times higher). Overall, the big six energy suppliers made £3.7 billion profits in 2012 from electricity generation and supply, and gas supply in the UK. Clearly, it seems that better regulation has a long way to go in this sector.

Is more government supervision necessary!

First it needs to be said that businesses with technological monopolies arising from massive network benefits are not strongly regulated (except via anti-trust actions to prevent clear market abuse when this has become self-evident). They can thus earn substantial excess returns, which go to their owners (or favoured employees), and may never be brought to account for their behaviour, in the absence of convincing evidence or whistle-blowers.

The theory is that where there are high-tech monopolies, they will be eroded over time, by development of further displacement technologies and innovation. During the period of the monopolies (which can be from 5 to more than 40 years), we can see that the beneficiary businesses can reap huge revenue returns, just like drug companies enjoy from patents (which are a licensed way to protect intellectual property for a defined period).

We have seen in the last decade that innovations from new technology have created huge new global businesses (on a scale not imagined in 2000). I have noted the huge market capitalisation values of companies in the US, such as Google, Amazon, Facebook, Apple, etc which show what competitive advantages have been achieved by such global businesses. In this period, ordinary people have changed the ways they shop, work, play and enjoy their leisure time, eg via using PC’s, (very) fast internet, smartphones, small wireless gadgets, and data streaming. Long-term business survival and economic success for many businesses now depend on producing products and service with a significant proportion of intellectual property and software intelligence to stand out from the competition. Moreover:-

a) Businesses that aim to grow need to ensure their new-age technologies, products or services can get into the hands of potentially hundreds of millions of people around the world, at a price they can afford.

b) The convergence of media and communication technologies in the hands of individual consumers, augmented by quick internet searches, puts huge power into the hands of those businesses with the established large networks of customers using their technologies. Once the initial investment (including marketing) is paid-for, profits accumulate quickly, especially if prices/subscriptions or charges (i) are not driven-down by new competitors, or (ii) are at monopolistic levels. Further investments in software updates, and add-on services could be a small marginal cost to spread over millions of users, but with massive private gains to the owners and workers of these businesses.

c) Where the business benefits from networks of dedicated ‘free’ users (providing valuable intellectual knowledge for resale to advertisers), it may not be easy for other businesses/competitors to get into this market with equivalent ‘free’ products, even if the competitors are large and successful.

d) Once a company captures a niche (eg as a property search specialist or heredity search specialist, etc), it may be difficult for new businesses to establish themselves in such sub-markets. Reasons for these entry/expansion barriers are user inertia in changing their behaviour, and the cost of developing and advertising an equivalent service which might need to be ‘free’ to compete and attract users. Marketing costs may also be prohibitive unless low cost innovative ways are found to attract users, eg via social networks and word of mouth.

e) If the home country does not have a robust venture capital industry to finance new-age start-ups, the likelihood is product innovation will come from abroad, or possibly foreign-owned businesses. They would most likely treat the countries where they operate as a sales opportunity environment to exploit, and remit their profits back to their home country. [For example, the UK is considering whether the corporation tax regime applicable to multi-nationals is too generous, and open to abuse.]

First-mover incumbents with large networks of customers/users may enjoy persistent barriers to entry and expansion in their markets for extended periods. Where the risks for potential competitors can be too high to erode the incumbents' market power, only external intervention and monitoring by governments (or their agents) can overcome potential market abuse.

a) As an example, lets think of how long Microsoft has enjoyed the benefits of its Windows platform on PCs (personal computers). Microsoft started around 1979 and developed the DOS operating system for the IBM PC, and later specialist Office business programs for the Mac platform. Its PC operating system became the de-facto standard operating system on personal computers manufactured in the 1980s and 1990's. Moreover, most developers wrote software to work on the Microsoft operating system, which reinforced its success as the de-facto standard.

b) Microsoft grew massively; especially from the early 1990s with the expansion of the PC market from technology advances at the time. Windows 95 continued as the de-facto PC operating system (around 1995) with a graphical user interface to rival the more expensive Mac platform. As computer take-up spread around the world, Microsoft expanded and became even more powerful. Its Office software also became the de-facto personal productivity tool for businesses and office workers.

c) Microsoft cleverly priced its operating system [confidential - ask for missing text].

d) Microsoft [confidential]. Android phones now account for some 75% of the smartphones market, although Apple was first to bring-out this new smartphone technology.

e) Apple’s premium pricing has meant it does not now dominate the smartphone market with its operating system (Mac IOS), but it is regarded as an innovative market leader. Some 3 years ago, it introduced its IPad, further extending its innovations into this important new market. iPad take-up using Apple's operating system has been huge around the world. But Samsung, for example, caught-up rapidly with huge growth in the far east emerging markets.

f) The volume of business, in terms of hundreds of millions of units sold, shows the immense wealth that players who dominate a high-tec market can achieve. Only major technological innovations, or transforming new technologies may eliminate the lead of the incumbents. Hence, potential monopolists are very protective of their market position, intellectual property, and know-how through litigation, patents, trademarks, and unreported secret business practices, etc.

Anti-competition investigations do potentially also produce results in upsetting market leaders, but only after considerable effort to find evidence of anti-competitive behaviour. During the time of these extended proceedings, incumbents can still reap great rewards, for example:-

In the US, Microsoft came under threat of break-up into 2 businesses, but survived this examination in 2001.
It has been fined [confidential - contact me for more information].
In 2013, the EU fined Microsoft [confidential].
Companies like Samsung and Google [confidential].

In April 2012, the US Justice Department filed an anti-trust lawsuit against Apple and a group of book publishers, saying they colluded to fix e-book prices. It was said their plan was created, in large part because they feared Amazon was selling e-books at below cost, and thereby gaining a monopolistic control of this new market. Several of the publishers agreed to settle the case. Apple [confidential]. This is the sort of scrutiny that legislators may need to consider when dealing with powerful and potentially unaccountable massive ‘information age’ businesses, even if they are apparently doing a good job for their customers. Not everything they do could be seen as benign and customer-focussed.

Apple in the US was also accused by a Committee in the Senate of aggressive US tax avoidance, which it has denied.

The above scrutiny is however, ‘reactive regulation’ and may not be sufficiently effective to remedy the risk of large-scale, unaccountable, and abusive behaviour in the future by multi-nationals, or large companies backed by foreign governments. This globalisation of trade and ability to attract customers and users around the world will continue to make these new age and multi-national companies extremely powerful. Now, many are based in the US, and are joined by Asian and Chinese multi-nationals. These companies will have obligations to their home countries, and their conduct may not always be in the best interest of the UK and its economy.

To conclude, once technologies become essential to vast sections of the public, government scrutiny and control, via the law and regulations becomes inevitable in a modern advanced economy. Such restrictions may include price controls, and obligations to provide a minimum standard of service, or a duty to provide services on fair, reasonable, non-discriminatory and transparent terms. Regulation is effectively an admission that a market does not operate in a competitive manner; or can not be trusted to do so, in the foreseeable future.

Legislators in major advanced economies like the UK need to be sure that the benefits of technological progress (ie innovation) get widely dispersed, rather than, as some commentators fear, lead to middle-class unemployment, and/or concentration of wealth in a relatively small elite, and those businesses providing special services to them. That scenario, if it happens, will take us back to earlier 'dark ages' of relative poverty and inequality. I expect the next 10 to 20 years to show the impact of the technological trends on work, and employment opportunities we are seeing emerge for the majority of the earth’s populations. Those people who are well educated will have massive advantages over those not so well skilled in intellectual pursuits.

The advance of globalisation and technology will spread into new applications and work-practices, currently not known about. Some new technologies will displace people doing jobs which today we consider as essential and high-powered, or the jobs might become deskilled by use of new intelligent software and robotics. The potential disruption to their lives, and their dependents, still has to be understood.

Whatever may happen, it is important that the UK maintains its economic policies to enable paid employment (on decent terms) for some 30 million people, as happens now. Legislators and business managers in advanced economies should not ignore the risks from displacement technology advances over the next decade; and put into effect policies and investments to take advantage of the opportunities, whilst avoiding the threats of the future. Competition policy and control will continue to play its part in this evolving world, and may become even more critical to people's well-being in advanced economies.

Some commentators think that the future technology-based world order will bring more wealth for eg the US economy.

Applying this thinking to companies like say Google, or Facebook, it should be clear that their value arises from the cumulative interaction over a considerable period, by hundreds of millions of users, whose actions have given the companies the raw data to earn their revenue. Clearly once that technology has been invented, and adopted as the de-facto standard platform for the particular services offered, the companies are in a monopolistic position to benefit their owners and employees. We know Google achieved revenues in the UK alone from its activities of some $18 billion over the 5 years to 2011.

I add that with the advance of technology, those who provide innovative products and services deserve to be rewarded, but should foreign controlled large or multi-national businesses be able to operate with low effective corporation tax liabilities in advanced economies like the UK. Legislators are beginning to say NO. And some existing well established bricks-and-mortar businesses are complaining that they suffer from an unfair playing field.

There is clearly a paradox for politicians to grapple with. Legislators in developed economies like the UK need to ensure money is put into the hands of people (ie consumers) so they can spend on goods and services, and drive a ‘virtuous circle’ of economic development and prosperity for the broad majority of the population. The alternative of putting money into people’s hands eg by welfare (as opposed to paid work/employment), is not ideal when it breeds hard to solve social problems from the idleness imposed on the effected population, and their dependents.

It is the objective of governments to ensure too many people don’t become ‘losers’ who develop anger/envy, and find little scope for improving their position in a situation of globalisation and advancing technologies that displace well paid jobs, in favour of low paid work, requiring medium or low-level intellectual skills.

It can also be argued that the companies that invented the technology to exploit information should get a return on this investment, but the value of the information they hold, for example on the behaviour of the UK population, which they sell to advertisers, could be seen as a UK national asset. But that debate is for separate discussion.

For further comments on the above, please contact me.

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Mr Sassoon Saleh on phone: 020-8202-9796 (London)

or email me at: s.saleh@btinternet.com

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Many of these information age businesses use an interesting model to attract users, and earn revenue. In effect, they offer a ‘free’ service to the public, in exchange for the benefits of information they gain from the actions of the users on their digital sites or platforms. They can also use technology to track and store vast amounts of data, via the Internet or GPS devises (global positioning). Their 'free' services or Apps (software) attract large networks of users, across the world. These networks can comprise activities from hundreds of millions of people – something unique in the history of the world. The users in each country display their particular cultural differences, which makes what they do very valuable to analyse (called data-mining) and understand. Moreover: