Baidu – Headache of state.

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Chinese regulatory risk laid bare in Baidu’s latest earnings report. 

  • Baidu reported a difficult set of results where increasing government regulation of digital advertising has hammered its short-term growth.
  • Q3 16A Revenues / Adj-EPS were RMB18.25bn / RMB9.92 compared to forecasts of RMB18.21 / RMB7.34 and RFM at RMB18.5bn / RMB7.86
  • Headline revenues showed a decline for the first time but when Qunar (discontinued) is excluded revenue growth was 6.7% YoY.
  • This is a far cry from its rivals Alibaba and Tencent who are running at 40%+ this year and even Google which is in the high teens.
  • This is symptomatic of the crackdown by the Chinese government on digital advertising following the death of a cancer sufferer who used an experimental treatment that was found via a Baidu advertisement.
  • In response to this incident, Baidu quickly put safeguards in place demanding much higher standards from its advertisers but the number of advertisers has declined by 15% and revenue growth has taken a big hit.
  • In response to this decline, Baidu has had to reign in its marketing expenditure on Nuomi meaning that losses at the e-commerce platform were much lower than previously.
  • This is what contributed to the better than expected profitability reported.
  • However, as a result of lower marketing, GMV growth also slowed markedly calling into question the attractiveness of the platform for its 2.2m merchants going forward.
  • This would be a good time for Alibaba to go on a charm offensive and persuade merchants to deal exclusively on Alibaba rather than using both.
  • As a result of the new marketing regulations coming into force, Q4 16E guidance is weak with revenues of RMB17.8bn – RMB18.4bn well below consensus at RMB19.4bn and RFM at RMB20.6bn.
  • While Baidu is struggling to get its core business back to growth, it is really talking up its advantage in artificial intelligence (AI).
  • This is the right move to make as, like all search engines, it has an advantage in AI simply because it has been working on it for the greatest amount of time.
  • Baidu intends to deploy this everywhere to make its services deeper, richer and more intuitive as well as powering autonomous driving and its digital assistant Duer.
  • This could give it an edge over both Alibaba and Tencent and will certainly help it to keep Xiaomi, LeEco and Qihoo in the background.
  • The bad news for Baidu has been largely priced into the shares which still look fairly attractive as there is a good chance that growth should pick up again once it has re-onboarded its advertisers under the new regime.
  • Hence, Along with Tencent and Microsoft, it remains one of my top choices.

GOOG/AMZN/TWTR – Mixed bag.

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Solid quarter at Google but Amazon slips back into bad habits. Twitter in limbo.  

Alphabet

  • Alphabet reported good results as recent strength that it has seen in advertising from mobile devices and YouTube continued to underpin growth.
  • Q3 16A revenues-exTAC / adj. EPS were $18.3bn / $9.06 compared to consensus at $18.0bn / $8.61.
  • Excellent momentum from the core business was impacted somewhat by increasing investments in “Other Bets”, higher TAC due to the shift to mobile as well as an increase in GNA expenses as a percentage of revenues.
  • Alphabet is capitalising well on the increasing number of users of smartphones and from the shift in advertising spending from fixed to mobile but these trends are likely to start slowing soon.
  • This is why Alphabet must fix its problems with Android (see here) so it can increase the advertising spend per user which is currently less than half on Android than it is on iOS.
  • In my opinion Alphabet remains fully valued limiting its scope for strong capital growth going forward.

Amazon Q3 16A

  • Amazon reported disappointing results as it is once again ramping up spending at the expense of profits.
  • Q3 16A revenues / EPS were $32.7bn / $0.52 compared to consensus at $32.7bn / $0.78.
  • Spending on warehouses, on demand delivery and TV production was responsible for dragging down profits in Q3 16A and is likely to do so again in Q4 16E.
  • Q4 16E Revenues / EBIT are forecast to be $42.0bn – $45.5bn / $0bn – $1.25bn compared to forecasts at $44.6bn / $1.8bn.
  • Amazon Web Services (AWS) continues to be very strong (echoing Microsoft’s FQ1 17A results) but its scale is beginning to tell as growth has slowed to 55% and is likely to continue decelerating going forward.
  • Amazon is back to its bad habits of spending everything that it makes which has dashed hopes that this tendency was at last becoming something of the past.
  • Amazon’s valuation continues to reflect a level of profitability that it is very far away from achieving and until there is some stability in earnings, I still do not want to be involved.

Twitter Q3 16A

  • Twitter reported good Q3 16A results and cut 9% of its workforce as it laid out a plan to become profitable in the absence of finding a buyer.
  • Q3 16A revenues /adj-EBIT were $616m / $81.3m compared to consensus at $605.2m / $68.1m.
  • On the headlines, these look like good profits but in reality, Twitter is still loss making as adjusted EBIT (above) in no way reflects all the costs that are being put through this business.
  • This is why Twitter has announced a cost reduction program where 9% of positions will be cut globally as well as the closure of Vine, the video platform it bought for $30m in 2012 which has suffered a significant loss of users and engagement.
  • This program is hoped to bring Twitter to real profitability during 2017.
  • Twitter remains excellent at what it does but that niche has been so well monetised that there is no real growth left.
  • Hence, Twitter is trying to expand its appeal into video so that it can attract more traffic to its site for monetisation.
  • The jury remains out on this strategy, leaving the company somewhat in limbo with an expensive valuation to boot.
  • I continue to believe that there will only be further acquisition interest in Twitter should things continue to go wrong prompting a share price decline to below $10.
  • I still see downside and remain un-enthused.

Microsoft – Wood for the trees.

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Microsoft is so focused on the future that it misses the opportunity in the present. 

  • Microsoft has moved even further away from the consumer with its Creators Update for Windows 10 and the launch of the Surface Studio complete with the Surface Dial accessory.
  • At the same time, Microsoft continues to ignore the huge opportunity presented to it by the obsolescence of the laptop form factor which I find strange as it claims to be all about creating new product categories.
  • Microsoft unveiled two new innovations as well as an incremental update to the Surface Book.
    • First: Windows 10 Creators update
    • In addition to a host of other incremental improvements, the Creators Update focuses on enabling 3D objects on the PC as well as in both AR (HoloLens) and VR, gaming and easier connections and sharing with close contacts.
    • None of this is desperately new except that the degree to which content now works across different devices is far superior to anything else that has been launched to date.
    • Microsoft hopes to include the mobile phone in this range of devices but how well it can do that on Android and iOS remains to be seen.
    • These platforms are now critical as Windows Phone is rapidly losing all of its remaining users.
    • Also key to this update is the focus on content creation as the upgrades in this update are aimed at improving functionality for those that draw, write, broadcast and so on rather than those that consume.
    • This is a tacit admission that the battle with iOS and Android for content consumers has long been lost.
    • However, it also shows Microsoft aggressively acting in both software and hardware to keep the content creator users and corporates on its platform.
    • Second: Surface Studio.
    • This is very high specification all-in-one PC with a 28” monitor that can transform to become a work surface exactly like the drafting table used by anyone that draws or designs for a living.
    • Surface Studio comes with the Surface Dial which is designed to go in the non-pen hand to alter characteristics such as ink colour, brush size, opacity and so on.
    • The Surface Dial works both on and off the screen and is backwards compatible with all Surface products.
    • This device is clearly aimed at professionals and it is priced accordingly at $2,999.
    • Third: Surface Book.
    • The top end i7 model has been upgraded to offer double the graphics capacity than its predecessor as well as 30% more battery life.
    • Microsoft now claims that the device can provide 16 hours of battery life.
    • However, the single biggest failing if this product has been carried through into the next version as the keyboard stops working as soon as the screen is detached.
  • The net result is an update to the Microsoft Windows proposition that is aimed at keeping content creators and corporates on its platform.
  • In that vein, this is a good update with nice looking and relevant products but I still think that Microsoft is missing the wood for the trees.
  • I have long argued that the laptop form factor is obsolete as having the keyboard, mouse and screen permanently locked together offers a substandard user experience that is both uncomfortable and unhealthy (see here).
  • This is why the Surface Pro line of products is a game changer as it enables a desktop like user experience to be enjoyed from anywhere.
  • This works by allowing the screen to be at the correct height and distance from the eyes with a wirelessly connected mouse and keyboard to be in the most comfortable and ergonomic position.
  • However, this does not work with the Surface Book as the minute the screen is detached from the keyboard, the keyboard ceases to function.
  • I think it would cost Microsoft less than $1 per unit to put this right and it would enable it to really push a whole new use case for content creators out of the office.
  • I have long believed that this could lead to a huge replacement cycle where ageing laptops are replaced with PCs in the tablet form factor which could even kick the PC market back to growth for a few years.
  • However, this failing indicates that Microsoft has still not realised the opportunity that lies before it.
  • Intel and the PC makers are equally guilty of this oversight but these companies have not taken it upon themselves to re-imagine computing.
  • I suspect that the main issue here is that these companies have been selling laptops for over 30 years and it is very difficult to break out of that mindset.
  • It would also require a big marketing campaign as laptop users are also so ingrained with this form factor that they have not realised that there is something much better on offer.
  • The net result of this event is a software and hardware update that goes a long way to keeping content creators faithful to Windows but continues to ignore the possibility to create a large replacement cycle in its core product.
  • Fortunately, Microsoft’s valuation does not demand this vision to come true in order to be attractive which is why I continue to like it alongside Tencent and Baidu.

Apple FQ4 16A – Margin gadfly

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Margin pressure from product mix is not a problem. 

  • Apple reported results that broadly met expectations although slight weakness in profitability is an indicator that some users are buying the cheaper iPhone 6s rather than the 7.
  • FQ4 16A revenues / EPS were $46.9bn / $1.67 compared to consensus at $47.0bn / $1.66.
  • Apple sold 45.5m iPhones which was in line with consensus at 45.0m but pricing was weaker than expected at $619 compared with consensus at $625.
  • Mac shipments fell 14% YoY 4.9m units mostly due to the overall weakness in PCs and iPad was also weak declining 6% YoY to 9.2m units.
  • Guidance was mixed with FQ1 17E revenues / gross margins expected at $76bn-$78bn / 38.0% – 38.5% compared to consensus at $75.4bn / 38.9%.
  • It is the miss on gross margin that has triggered the disappointment as a combination of higher overall revenue bringing greater scale benefits and a full quarter of the iPhone 7 should help profitability more than Apple is indicating.
  • This is especially the case as improving costs was the main reason for FQ4 16A gross margin strength which came in at 38% at the top of the guided range of 37.5%-38.0%.
  • Although Apple remains supply constrained on the iPhone 7, I suspect that the reality is that there is a slight mix shift towards the older and cheaper models.
  • Despite the new colours and no headphone jack, the new iPhone is not very different from last year’s model and the ecosystem experience for the consumer is the same as they run the same software.
  • Furthermore, I think that some consumers are put off by the lack of a headphone jack which could be driving them to upgrade their older models to the iPhone 6s rather than the 7.
  • Older devices have lower gross margins than new devices as the price falls more quickly than the cost to make them which could be responsible for this slight weakness.
  • Overall, the weakness is very slight and Apple is continuing to increase the number of users that it has in its ecosystem.
  • This is critical for its long-term outlook which I think remains pretty rosy as Google’s Android is still unable to offer much to induce users to switch away from iOS.
  • Gross margin variation due a mix shift is a normal factor in every business and this is what I think Apple is dealing with.
  • Gross margin pressure from competition is a far more serious problem and with Samsung is disarray and no real competitive threat from Google, I do not see this happening in the short-term.
  • The net result is a company in a commanding position but one that is struggling to find growth as it has high share in the segments that it addresses which are themselves increasingly saturated.
  • I do not see Apple going to lower tiers to find growth but instead it is looking for new product categories.
  • Of these there is little sign meaning that the medium term is likely to be one of very low growth but mighty cash flow generation.
  • For an income investor, this is a great place to be but anyone looking for short term capital growth should probably look to Microsoft, Tencent or Baidu.

Wearables – Deadly drift.

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Still, no one knows why they should buy one. 

  • Apple Watch 2 has failed to revive the flagging smartwatch market in yet another sign that wearables remain a solution looking for a problem.
  • The latest data from IDC shows that the smartwatch market (a subset of wearables) declined by 51.6% YoY in Q3 16 with Apple Watch shipments declining by 71.6% to just 1.1m units.
  • The overall wearables market is growing around 25% but it is the cheap and cheerful pedometers and basic fitness trackers that are making all the running.
  • To make matters worse, these are already commodity products with most priced well below $100 where no one is making a sustainable return.
  • I think that the reason why there is so little differentiation remains that no one has really figured out how to make a wearable product a must have.
  • Even Apple, which has a legendary ability to come up with compelling use cases, has struggled and the main question asked by potential users is: “Why would I buy it?” rather than: “How much is it?”
  • Fitness tracking is already a commodity and one with which many users rapidly tire.
  • Health tracking is also in its infancy as the sensors are still not close to being good enough to provide safe and secure health monitoring although Philips is making every effort to make its devices medical grade.
  • Outside of that, wearables are little more than remote controls for a smartphone providing no reason for mass market adoption.
  • The market will grow this year but at a much slower rate than the triple digit growth it experienced in 2015
  • Furthermore, the value of the market will be very challenged with brutal price erosion potentially driving the value of the market into negative territory.
  • Of all the wearable players, Apple is likely fare by far the best as it has a very strong ecosystem which is critical to ensure differentiation.
  • Even Fitbit, which currently leads this market, is likely to struggle as it does not have the scale nor the experience outside of fitness tracking to put together a user experience compelling enough to keep its gross margins where they are.
  • Hence I think that 2017 will be even more difficult for wearables in general as the ravages of commoditisation bite despite some unit growth.
  • Apple is the only company with exposure to this market that has the capability to maintain its pricing and not feel the problems of this market in its income statement.
  • Microsoft, Tencent and Baidu are my top picks but I think that Apple remains a safe place for long term income based investors.

Qualcomm vs. Intel – Storm in a teacup.

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Qualcomm thrashes Intel but not where it really matters. 

  • It appears that Qualcomm has once again demonstrated superiority over its peers when it comes to radio but I think it highly unlikely that users will notice.
  • Radio performance analysis specialists Cellular Insights have run a series of tests on the iPhone 7 powered by Qualcomm’s MDM9645M modem and the iPhone 7 powered by Intel’s XMM7360 modem to compare radio performance.
  • The results are startling and much more so than in the infamous “chipgate” episode where the A9 (iPhone 6s) made by TSMC resulted in 5-7% battery life than the same chip made by Samsung.
  • In this case the Qualcomm modem has consistently outperformed the Intel modem on 4G by 30% when the signal was moderate and 75% when the signal was at its weakest.
  • When the signal was at full strength, both modems performed similarly.
  • This does not come as a huge surprise as Qualcomm modems have for years been consistently better at performing in non-ideal radio environments giving it a major point of differentiation.
  • This difference is far greater than it was for chipgate but I doubt whether this is going to have users scrambling to check the model numbers of their devices prior to purchase.
    • First: Battery life is a major issue for every smartphone and is a concept that is very easily grasped by the consumer.
    • As long as there is a connection and the service works, most users will be satisfied, meaning that a difference in speed is less likely to be noticed.
    • A device that does not turn on or fails right at a critical moment is far more noticeable.
    • Second: Bleeding edge.
    • What Cellular Insights has measured is performance at the bleeding edge.
    • For example, in band 4 at -120dBm (very weak radio) Qualcomm manages around 30Mbps while Intel does around 12Mbps.
    • When I look at the Digital Life pie of smartphone usage there is not a single service that I think will be noticeably degraded by that difference to the point where the user will blame the radio.
    • Furthermore, almost all networks still have an underlay of 3G meaning that user will have some data coverage even in the advent that 4G fails completely.
  • Most tellingly of all is the fact that the iPhone 7 has been widely available for over a month and there has been not a single murmur from reviewers or users that one version of the device has a better radio than the other.
  • Consequently, I think that posterity will take note of this difference and move on with no real impact being felt in shipments of one variant or the other.
  • However, for Qualcomm this is an important demonstration that it remains peerless when it comes to radio modems.
  • This is critically important as this test is likely to influence device makers when they are selecting which modems to use in their products giving Qualcomm slightly better pricing power.
  • The general consensus out there is that radio modems are beginning to commoditise as LTE matures as a standard but this test clearly shows that this is not the case.
  • Despite this good news, Qualcomm still needs to expand its horizons into other device categories to keep growth going as smartphones are grinding to halt.
  • This is where its smart drone, IP camera reference platform and potential purchase of NXP semiconductors come into play.
  • This is bad news for Intel but I think it can quite easily shake it off as its performance inside the iPhone 7 is clearly good enough.

LeEco – Priced to go.

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LeEco’s real disruption is price. 

  • LeEco launched its assault upon the US market with a glitzy but confusing press event where the real standout was the prices of its new devices.
  • LeEco is a Chinese media streaming company that is hoping to build upon its media heritage by creating an open ecosystem powered by the cloud and delivered through the phone, TV, VR, Bicycle and the car.
  • It already has some traction in China with its media assets and it is this heritage that it is attempting to leverage into the US market.
  • The company has correctly identified that no one is really able to make different device categories work together in a seamless and fun to use way.
  • This, it hopes to fix with its LeCloud platform which drives the EUI user experience on all the devices the company offers.
  • Here the degree of data integration and the AI that it has running its recommendations as well as look and feel will be critical to driving engagement.
  • To get the ecosystem into the hands of users LeEco launched a series of devices including phones, TVs, bicycle, VR and a car.
  • However, the ones that really matter are a high end Android device (LePro3) coming at $399 and an 85-inch (uMax85) TV coming at a staggering $4,999.
  • These prices can be reduced still further by signing up to be part of LeEco’s UP2U membership program which gets the user $100 off the device and $1,000 off the TV.
  • The idea of UP2U is to drive engagement with its media consumption assets and to use the data generated to improve the quality of its service as well as to define its future roadmap.
  • This combined with limiting itself to selling over the Internet in the first phase of its development is how it hopes not to lose vast sums of money from selling these devices at such low prices.
  • LeEco is following the Amazon model of almost giving the devices away with the hope of making a return by selling content and services over its platform.
  • In this regard it has added an interesting twist which is allowing its platform to be open such that anyone can sell their content and other device makers can make use of it.
  • This completely rules out any chance of ever making a return on the hardware as the ecosystem will never be exclusive to LeEco devices but there is an opportunity in the ecosystem.
  • However, it is here in the ecosystem where LeEco’s vision falls short.
  • The average user in developed markets spends just 10% of his time engaged in media consumption meaning that LeEco is ignoring 90% of the opportunity.
  • Furthermore, the TV is not a driver of the user purchase decision when it comes to selecting an ecosystem which is why LeEco has to sell this product at such a good price and encourage engagement with further discounts.
  • LeEco has a reasonable line up of launch partners for its media consumption offering including Lionsgate, Netflix and Showtime but there are a notable number of exceptions.
  • This means that purchasers of the TV and the phone will still need to go outside of its ecosystem to get access to things like YouTube, Facebook video, HBO and so on.
  • RFM research indicates that to have a viable ecosystem in its own right LeEco will need 100m users outside of China and 300m to make real money.
  • However, if it manages to generate real engagement with those that buy its devices then these numbers could be lower as it will be supplementing the network effect through the revenue share that it will get from selling content.
  • This is going to be a tall order as developed markets are already well penetrated with media consumption offerings meaning that EUI will need to be compelling to create the stickiness from which LeEco can earn a return.
  • This is why the key metric to watch is not necessarily the number of devices it sells but whether those users engage with its software and content assets.
  • This is where RFM’s 7 Laws of Robotics will be crucial as a good score against these measures will give a good indication as to whether users will like the service.
  • This is where Xiaomi has fallen over as engagement with its ecosystem is weak meaning that users buy its products in China and then use the ecosystems of the BATmen.
  • LeEco has given users plenty of incentive to try the service but whether it can get them to stay is another matter.
  • Hence, the real beneficiaries of these launches are Google, Netflix and Qualcomm.
  • Google and Netflix benefit by having more capable hardware in the hands of more users and Qualcomm benefits as it has supplied most of the hardware differentiation that LeEco is using.
  • Whether LeEco can also benefit remains to be seen but it is certainly putting its money where its mouth is in pulling out all the stops to get users to try its products.

Google – Brain distribution pt. II.

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Samsung presents Google with a unique opportunity 

  • The combination of more than 10m potential buyers and surprisingly good reviews coming in from the Internet presents Pixel with a great and unexpected opportunity.
  • On first glance, the Pixel is a mediocre looking device coming at a premium price but there is far more under the hood than one would presume.
  • I am certain that this is because, for the first time, Google has been able to control both the hardware and the software and make them work seamlessly together.
  • The fact that Huawei declined to manufacture this device is a good indication of just how much control Google has over this product.
  • Furthermore, I think that this is just the first iteration as the Google hardware business has not been formed very long and there are parts of the Pixel that are off the shelf.
  • A good example of this is the processor.
  • Google is hard at work developing its own silicon but because this is not ready yet, the Pixel uses the Snapdragon 821 from Qualcomm.
  • This in itself is an excellent product but the iPhone benchmarks clearly show the advantages in performance that can be achieved by designing hardware and software together in house.
  • When it comes to differentiation, Google has clearly put a lot of effort into the camera with good results but it is the software ecosystem where the opportunity lies.
  • At the top of this list is Google Assistant which is deeply integrated into the device (unlike it is on iOS) and its performance leaves everything in its wake.
  • This is because Google Assistant is powered by Google’s AI which is easily more clever and intuitive than anything else on the market.
  • This leaves Google with the classic software / hardware problem.
  • One can have the best software in the market but if the software finds its way into the hands of only a tiny number of users (as Nexus has done) it is effectively useless.
  • This is why the combination of good reviews from commentators highlighting the screen, camera, design, software and ecosystem combined with Samsung’s woes (see here) offers Google a unique opportunity.
  • Samsung would most likely have sold over 10m Galaxy Note 7’s during the next 6-9 months and these buyers will now all be looking purchase another device.
  • I continue to believe that these users are unlikely to switch to the iPhone (see here) leaving the way open for both Google and Huawei in particular.
  • The key to this will be execution.
  • Google needs to massively ramp up its launch plans and ensure that when these users turn up to buy a device, it is present and available.
  • The fact that it is exclusive with Verizon will help with those users but AT&T and T-Mobile users will have to go to retail.
  • If I was Google, I would also be running a lease scheme like the operators do to make it easier for users to purchase the device through retail.
  • I see the aim of Pixel being to put Google’s brains as close to the user as possible and to make it very easy to access and use.
  • The real return will be earned through what Google learns from users making use of its brain which will be used to generate targeted advertising as well as improve the quality of the services themselves.
  • Google has the best AI but has really been struggling to get it properly into the hands of the user which is why the volumes that these devices ship will be of critical importance.
  • Outside of this perfect world, Google’s ecosystem runs on horribly fragmented software over which Google has no control and no ability to add new features or fix problems.
  • This is why I continue to believe that Google will make Android effectively proprietary (see here) as only then will it have a chance to challenge the dominance of the Apple ecosystem and hold off the threat posed by Facebook
  • Alphabet shares are still reflecting all of the good news and none of the bad which is why I remain cautious on their performance.
  • I prefer instead Tencent, Microsoft, Baidu or Apple for the long term.

Facebook – The dunce.

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AI is emerging as a major weakness for Facebook. 

  • There are signs that Facebook is really struggling with automation as it is clear that its algorithms are inferior to those used by Google, Baidu, Yandex, Microsoft, Apple and almost everybody else.
  • This will become a major problem as I am convinced that differentiation in digital ecosystems over the next 10 years is likely to be largely determined by AI driving how intuitive, rich and useful digital life services become.
  • With 1.6bn active users, Facebook simply cannot afford to do very much manually, meaning that how well its AI develops will determine its ability to challenge Google and take share of advertising revenues.
  • Every indication I have seen points to the fact that as soon as Facebook removes people from the equation, things go badly wrong.
    • First: bots. Facebook’s messenger system is a great system for person to person and business to client communication but the automated bots are so stupid as to be effectively useless.
    • Early interactions with Facebook M and the bots that have been launched (see here) show machines that are far too dim to be of any real use.
    • If I was a company looking to build a bot to interact with my customers, I would not be using Facebook’s.
    • I would instead be looking at Google, Baidu or Yandex as a foundation for my machine intelligence.
    • Second: news curation. Testing by the Washington Post found that the removal of humans from the news curation process led to fake news being displayed as trending.
    • In the weeks following the move to automation, Facebook trended old news, fake news and conspiracy theories and was also found to be slow when it came to picking up the real news.
    • This can be hugely problematic as enough people use Facebook for news that bias is becoming a big issue.
    • Facebook needs to be as neutral as it can and while its AI throws out spurious stories and ignores others, it can easily be accused of bias when all is really happening is bad algorithms.
    • It is these errors and unintentional bias that the human curation weeds out as well as being able to quickly tell what is important and what is not.
    • Put simply, this is another example of how Facebook’s AI is not up to the task of automation meaning that an awful lot more work needs to be done.
  • The net result of these problems is that Facebook’s services will fall behind those of its competitors unless it can get its AI up to scratch and do so quickly.
  • This will be very difficult as good AI takes a long time to train meaning that it Facebook will need to acquire both talent and algorithms rather than create them from scratch.
  • In terms of the short-term outlook, this is not a problem as growth is still being underpinned by the increasing dominance of digital in users’ daily lives.
  • Over the next 2 years or so, this will slow markedly meaning that AI will have to take up the slack in order to keep growth going.
  • This is one reason why I remain cautious on Facebook in the short term as I think consensus is assuming success in areas where Facebook has huge amounts of ground to make up.
  • Tencent, Microsoft and Baidu look like better places to be in the short term although I am keeping an eye on Facebook for the long term.

Amazon Music – Table stakes.

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40m tracks and a search box does not a service make. 

  • Amazon has plugged an obvious hole in its push to create a consumer ecosystem with the launch of a music service that brings its catalogue into line with that of Apple Music, Spotify and so on.
  • The new service called Music Unlimited costs $9.99 per month ($7.99 for Prime members) and features the now standard 40m tracks and a search box.
  • In addition, Amazon is also clearly reacting to the very real threat posed by Google Home by offering the music service for just $3.99 a month on the Echo.
  • For $3.99 the service is only available on the Echo and I see this as Amazon attempting to compensate for the fact that Google’s Assistant is far brainer and more useful than Alexa (see here).
  • I also suspect that Amazon had a very easy time licensing the music as I see the labels being keen to democratise music streaming as much as possible.
  • This is because the writing is on the wall for the music labels as the music streaming companies will soon be able to distribute music from artists much more effectively than the music labels can.
  • Furthermore, once the artists have figured out that distribution via streaming can be just as good, if not better and they get to keep far more of the revenues, then an exodus will begin.
  • However, the more the labels can keep the market fragmented, the less power each service will have to replace them slowing their inevitable obsolescence.
  • Consequently, I think that it is easier than ever to licence all the music a service needs which will hasten the commoditisation of music streaming.
  • This is why I have long believed (see here) that the music itself is incidental and what really matters is the data that the service generates and the algorithms that make sense of it.
  • This is what allows a music streamer to understand its subscribers and match them with great accuracy to the bewildering 40m items that are available for them to listen to.
  • This also allows the addition of innovative features to be deployed on top of the service which is becoming an important area of differentiation.
  • On this front, I do not see Amazon doing very well.
  • The Alexa digital assistant underperforms Google, Cortana and Siri indicating that a vast amount of work is required to improve it.
  • This is a major reason why I think that as long as Google executes well, it should be able to dominate the segment that Amazon has created.
  • The net result that Amazon is a me too service that will have some attraction for existing Prime members but is not going to cause Spotify or Apple Music to lose much sleep.
  • Hence, I see no change to the landscape where Spotify is adding subscribers at double the rate of Apple Music despite Apple Music being installed on over 1bn devices.