Post-Corona: From Crisis to Opportunity
BY SCOTT GALLOWAY
What will the world of business look like after the coronavirus pandemic? The pandemic will accelerate every trend by a decade and redefine entire industries. Foundational sectors like healthcare, education and transportation are on the verge of unprecedented disruption as the market rewards innovators like Tesla with massive valuations.
The market dominance of Big Tech giants like Amazon, Apple, Google, Facebook and Microsoft will increase, and they will leverage their size to enter and dominate new sectors.
Scott Galloway, a professor at NYU Stern School of Business, presents a clear-eyed overview of this great transformation, the new business environment, Big Tech’s dominance, and who stands to win and lose in this new age.
TOP 20 INSIGHTS
Ecommerce's share of U.S. retail, which had been growing by one percent every year, jumped by 11% within eight weeks of the pandemic hitting the United States. The strong performance of big companies fueled the U.S. stock market recovery. However, medium companies declined, and smaller companies got hit the hardest. While the S&P registered growth by mid-July 2020, mid-caps were down 10%, and small caps dropped by 15%. Brands that were already going down, like JCPenny and Neiman Marcus, got hit the hardest.
A large portion of the stimulus capital that entered U.S. capital markets went towards innovative firms. Tesla's valuation exceeds Toyota, Daimler, Volkswagen and Honda combined, even though it will manufacture only 400,000 cars rather than 26 million cars manufactured by the other four in 2020.
Sectors will witness market consolidation around innovators or market giants with solid balance sheets, high-value assets, cheap debt and low fixed costs. Firms like Costco, Honeywell and Johnson and & Johnson, which have $11 billion, $15 billion and nearly $20 billion respectively in their bank accounts, will have their pick of assets and customers when weaker competitors shut down.
A company's survival depends on the sector's health and its position within it. Non-dominant companies within weak sectors must leverage current assets to pivot to new lines of business. Thryv Holdings, America's largest yellow pages company, used its relationship with thousands of small businesses to pivot into Customer Relationship Management.
Companies must become capital-light and move to a variable cost structure by leveraging other people's assets. Uber rents space in other people's cars driven by non-employees. So when revenue went to zero during the pandemic, Uber's costs went down by 60- 80%. Despite the hospitality industry taking a huge hit, Airbnb is well-positioned to take a more significant industry share.
82% of corporate leaders plan to allow partial remote work, and 47% intend to offer full-time remote work in their organizations. But remote work has its share of drawbacks. Serendipity is key to innovation, and presence strengthens accountability. Companies must offer creative perks like home office supplies and grocery debit cards to support remote work.
After Covid, more employees will demand work from home from their organizations. Individuals with salaries over $100,000 will have an easier time making the demand. This will create a higher separation of classes after Covid. 60% of jobs that pay over $100,000 can be done from home compared to just 10% of jobs that pay below $40,000.
The Brand Age, where companies sold mass-produced products for irrational margins by creating emotional associations through advertising, has ended. The Product Age powered by online discoverability has begun. When advertising spends return, they will flow towards online platforms. Facebook and Google will account for 61% of the digital ad market in 2021.
There are primarily two digital business models. Companies sell products for a profit or monetize their users. Android offers cheaper, privacy-invasive smartphones, while iOS demands a premium for a product that respects privacy. As privacy becomes more central, these models will become incompatible. Apple will abandon Google search even when Google pays $12 billion every year.
Post Corona, Amazon, Google, Facebook, Apple, and Microsoft's market dominance will only grow stronger. Big Tech makes up 21% of the value of all publicly traded companies. Amazon and Apple added Disney, AT&T/Time Warner, Fox, Netflix, Comcast, Viacom, MGM, Discovery and Lionsgate to their market capitalization between Jan 2019 to February 2020.
Big Tech companies leverage their market dominance to create flywheels - virtuous cycles that generate growth without proportional costs. Apart from rapid delivery, Amazon Prime offers video streaming to increase the time spent on its platform. Apple dominated the wearables business (Apple Watch, AirPods and Beats) with $20 billion in revenue in 2019 because its flywheel connects phones, watches and wearables, an advantage that Rolex or Bose cannot compete against.
Big Tech has transformed entire industries into features. Amazon has outperformed FedEx and made the delivery industry into Prime feature. The media industry, worth hundreds of billions of dollars, will become a customer acquisition vehicle for Apple and Amazon's core business.
Massive market capitalization also creates problems for tech giants. Investors expect Big Tech companies to add nearly a trillion dollars in revenue over five years. Only a few sectors can provide that growth: Healthcare, Life Insurance and Education. Big Tech firms will have to enter these markets and compete with each other.
Amazon's signature move is to transform cost centers into revenue heads. It does this by leveraging its scale and access to limitless cheap capital to make massive investments that others just cannot match. Amazon built the best data center capabilities in-house and sold them to other companies through Amazon Web Services(AWS). It leveraged its warehouse and distribution expertise to launch Amazon Marketplace.
Amazon has more customer insight than any insurance actuary. It can leverage that to foray into insurance. Further, it can enter healthcare and offer telemedicine services through Alexa as the pandemic has removed regulatory bottlenecks. Combined with its retail, pharmacy and wearables, Amazon can offer an integrated healthcare product to rival hospitals.
Companies must find ways to create recurring revenue models by offering bundled services. As a product manufacturer, Apple should have taken a hit during the pandemic. However, it had transitioned into a software company with recurring revenue through massive investments in iCloud, Apple T.V., Apple Cloud and Arcade. Recurring revenue contributed 23% of Apple's 2019 revenue, cushioned it from the pandemic and doubled its valuation.
Most products depreciate. To dominate, companies must build Benjamin Button products that become more valuable with every use. The Benjamin Button effect is the result of more user data and network effects. Spotify adds more users every year, attracting more artists and giving the company more data to improve its personalization. Similarly, Netflix's recommendations improve each time a user watches a movie or a T.V. show.
Evolutionary psychology says that brands can appeal to customers in three ways. They can target the "brain," the "heart," or "genitals." Brands that appeal to the brain make rational claims of higher value or lower prices like Amazon. Companies like Facebook tap into the heart's instinct to care for friends and family. Finally, brands can appeal to the sexual instinct to feel more attractive to sell premium products at irrational margins like Tesla.
Academia, healthcare and insurance are waiting for disruption. Industries are open to disruption when there is a dramatic increase in price without a corresponding increase in value, a heavy reliance on brand equity or customer ill-will. College tuition has increased 1400% over 40 years without significant value addition. The average family coverage premium has increased 54% in 10 years.
After Covid, Big Tech will move into academia. Clayton Christensen predicted that 50% of colleges and universities would go out of business in the next 10 to 15 years. Big Tech firms may partner with academia to offer 80% value of a four-year degree to thousands at 50% of the cost. MIT and Google could jointly design a $50,000 two-year program that enrolls 100,000 students to generate $5 billion every year.
The pandemic has accelerated every social and business trend by ten years and opened the floodgates for disruption in multiple sectors. This book tries to predict the future of business, education and society in the post-pandemic world.
THE GREAT ACCELERATION
Ecommerce's share in U.S. retail was growing at about one percent every year. Within eight weeks of the pandemic, the number jumped from 16% to 27%. A decade of ecommerce growth took place in eight weeks. Apple took 42 years to reach $1 trillion in value and just 20 weeks to grow to $2 trillion. Trends in economic inequality and unemployment have accelerated as well. Twenty million jobs were added over the last ten years. Forty million jobs were lost within ten weeks. Forty percent of households with income below $40,000 were laid off or furloughed compared to just 13% percent of households over $100,000.
The pandemic opens opportunities for innovation as well. The three largest U.S. consumer categories - healthcare, education and grocery are being fundamentally disrupted. Most people were forced to access healthcare and remote learning and order groceries online. A decade's worth of habits became forged in a matter of weeks.
THE STRONG GET STRONGER
After a brief plunge, markets continued to climb even as the death toll hit 100,000. This "recovery" is due to the outsized gains of Big Tech and a few other giants. By July 31, the S&P 500 had recovered to January 1 levels, but mid-caps in the S&P 400 were down 10%. Small-caps in the S&P 600 were down 15%. Firms with weak balance sheets were being slaughtered, including prominent names such as Neiman Marcus, JCPenny, Gold's Gym and California Pizza Kitchen. When weaker competitors shut down, the firms like Johnson & Johnson, which has $20 billion in the bank, will choose the best assets and customers. The most significant damage from an economic standpoint will come from medium and large companies with weak balance sheets and many employees.
Markets make big bets on vision and growth narratives over hard numbers, leading to significant gains for innovators and market giants and steep declines for smaller firms and incumbents. Companies that have been doing well have benefited remarkably while weaker competitors have been shut out of capital markets had debt ratings cut, and customers worried about long-term deals. Firms that are deemed innovative are seeing valuations that reflect estimates of cash flows ten years from now discounted back at low rates. That's why Tesla's value exceeds the value of Toyota, Volkswagen, Daimler and Honda combined, even though it will produce just 400,000 cars in 2020 while the other four will build 26 million cars.
ADAPTING TO THE CRISIS
The company's sector and relative strength within the sector are critical determinants of survival. Companies in weak sectors without market dominance will have to explore pivots into more substantial sectors. Are there assets that can be leveraged to create a new line of business? The country's largest yellow pages company successfully leveraged its relationship with many businesses to pivot into a Customer Relationship Management(CRM) company. If the business is in structural decline, generate the last drop of revenue from the brand instead of giving it another lifeline. Plan a graceful exit by using those profits to ease the transition for employees and customers.
RADICAL COST CUTTING
For weak companies, survival depends on radical cost-cutting. Get to the lowest cost-base as fast as possible by suspending rent-payments, selling inventory at reduced prices and reducing compensation, beginning with the highest earners. Explore alternative means of compensation like equity and vacation. Apart from cutting costs, try to do more with assets that cannot be shed. Universities have high fixed costs due to tenure, solid unions and facilities. However, many of them are investing in technology to lower costs per student by reaching more students.
CLOUD COVER FOR BIG DECISIONS
Now is a good time for businesses to start afresh and rethink their value proposition for a post-corona world. Companies get the cloud cover to make big decisions and bold bets as there is no pandemic playbook. Use this to reimagine market strategy, labor composition and place big bets for the future.
THE COVID GANGSTER MOVE
The killer move is to have a variable cost structure by leveraging other people's assets. Uber rents space in other people's cars driven by non-employees. When revenue hit zero in the pandemic, Uber's cost correspondingly went down by 60% to 80% and its share price held value. For similar reasons, Airbnb is well-positioned to survive the pandemic and take advantage of the work-from-anywhere model enabled by a boom in remote work.
THE FUTURE OF REMOTE WORK
The open question is whether technology can disperse work without sacrificing innovation and productivity. Ideas emerge from serendipitous conversations, and presence is key to fostering accountability and building relationships. However, presence is costly in terms of real estate, commute and other costs. As of June 2020, 82% of corporate leaders plan to allow remote working some of the time, and 47% intend to offer full-time remote work going forward. Companies need to think of creative ways to support employees. Reduce office snack spends and offer monthly grocery debit cards.
Offer gift cards for office supplies to set up good home offices. While remote work offers flexibility, a reduced commute and more savings, it also has its share of risks. A job moved out of metro areas can be moved overseas. Presence has implications for who is on the top of the executive's mind for promotions and opportunities. Remote work benefits will distribute unevenly to society. 60% of jobs that pay over $100,000 can be done from home compared to just 10% of jobs that pay below $40,000. Flexible satellite offices, distributed across the country, where people can work alone or in teams, could be the future.
FROM BRAND AGE TO THE PRODUCT AGE
From World War two till the rise of Google, the formula for shareholder value was to create compelling brand associations for mass-produced products. Branding injected emotion into inanimate products resulting in consumers willing to pay irrational margins. In 2020, the Brand Age gave way to the Product Age. In the Brand Age, a traveler to New York would go to the Ritz because that's the brand she knows. In the Product Age, a Google search reveals that the Ritz is overpriced, and instead, she finds a boutique hotel based on crowdsourced recommendations. The losers in this transition are the media companies and advertising firms. When advertising spending returns, it will flow only to Product age firms like Google and Facebook and not traditional media. Predictions put Google and Facebook's combined share of the digital ad market at 61% in 2021.
TWO CONFLICTING BUSINESS MODELS
There are two fundamental business models. A company can sell a product for more than the cost of production. Otherwise, companies can offer subsidized products to sell customer attention and behavioral data. Most digital industries will bifurcate along this divide. Android phones offer a great product for low upfront costs but at the cost of privacy, while iOS offers a luxury privacy-conserving product for premium margins. These models will become increasingly incompatible as privacy becomes a core issue. Apple could give up its $12 billion a year contract to make Google the default search engine and develop a competitor. Similarly, Shopify leveraged exploitation by Amazon to offer a simple product to sellers. Sellers control the data, branding and the customer while Shopify gets a simple fee.
THE MONOPOLY ALGORITHM
Five months into the pandemic, major American companies like ExxonMobil, Coca-Cola, JPMorgan Chase and Disney were down 30%. But Amazon, Google, Facebook, Apple and Microsoft were up 24% in mid-2020. These five companies make up 21% of the value of all publicly traded companies.
THE FLYWHEEL MODEL
Companies like Apple and Google leveraged the lead given by innovation to create effective monopolies. They did this by concealing their market position and exploiting outdated antitrust laws. Finally, they have a flywheel to grow revenue without increasing input or cost. Amazon Prime attracts shoppers who want rapid fulfillment. The subscribers enjoy Amazon Prime Video, which increases Amazon Prime's stickiness and time spent on the platform. This business model makes sense for Amazon as the Net Promoter Score is zero for eCommerce companies, but it is strong for streaming video. This revenue model, combined with a lack of antitrust action, has led to massive companies that turn entire industries into loss leaders for protecting their core business.
Similarly, Apple dominates wearables, becoming the largest watchmaker by a factor of four. Apple's wearables business generated $20 billion in 2019, making it one of the 20 most valuable firms in the world. Apple has created a Flywheel of connecting phones, watches and headphones, an advantage Rolex or Bose cannot compete against.
FROM INDUSTRIES TO FEATURES
Tech turns entire industries into features. Amazon has turned the delivery industry into a Prime feature. Amazon has leveraged its online penetration into 82% of American households to beat FedEx.
With hundreds of billions of dollars in value and massive cultural influence, media is being "featurized." Media firms like Comcast, AT&T and Verizon will bleed value to Apple and Amazon, to whom it is not a core business. Between January 2019 and February 2020, Apple and Amazon added Disney, AT&T/Time Warner, Fox, Netflix, Comcast, Viacom, MGM, Discovery and Lionsgate to their market capitalization. Media has become a customer acquisition vehicle, not a standalone business.
Size creates its own problems for Big Tech firms. Investors expect them to add nearly a trillion dollars to their revenue over five years. They have to enter new markets and compete with each other. There are only a few sectors large enough for this appetite: Education, Healthcare, Life Insurance and Education.
TURN EXPENSE LINES INTO REVENUE LINES
Amazon's killer move is to turn expense lines into revenue lines using scale and ultra-cheap capital. Amazon took advantage of its massive data center volumes and its ability to invest nearly unlimited capital to build the best data center management capabilities. Then Amazon turns it around and sells it to other companies through Amazon Web Services. Amazon did the same thing with warehouse and distribution and launched Amazon Marketplace.
Amazon will likely foray into healthcare, leveraging its massive customer insights to disrupt a bloated and much-reviled industry like insurance. It could also move to reduce the financial cost of healthcare by providing telemedicine services through Alexa. Amazon's healthcare platform could integrate with its retail, pharmacy and wearables platform for a "holistic approach" to health. The opportunity is open as the pandemic removed regulatory bottlenecks to telemedicine.
THE TRILLION DOLLAR DNA
The T Algorithm lists the eight essential elements for a company to have a shot at a trillion-dollar valuation.
APPEALING TO HUMAN INSTINCT
The most potent firms target the "brain, the heart, or the genitals" of a customer. Rational claims appeal to the brain. Brands that target knowledge (Google) or rational claims of value like Dell tend to have small margins. Brands that target the heart exploit the instinct to care for our own. Facebook appeals to the heart exploiting our need to connect to our friends and family. Luxury brands leverage the instinct to improve our sex appeal to sell products that make us feel more successful and good-looking.
Career Accelerant: A company seen as a potent career accelerant attracts top-notch talent leading to higher innovation and greater success.
Balancing Growth and Margins: Usually, fast-growing firms sell high volumes of low-margin products while luxury brands sell high-margin products at low volumes. Only a few firms can combine both.
Bundle: A bundle of goods and services that create recurring revenue.
Vertical Integration: This is a firm's ability to control the end-consumer experience by controlling most of the value chain. Apple controls end-user experience through controlling both the iPhone and the App Store.
Benjamin Button Products: Unlike traditional products like cars, some digital products become more valuable with time. Facebook and Spotify become more valuable over time as the number of users increases the richness of personalization and data profiling.
Visionary Storytelling: The ability to demonstrate progress against a bold vision motivates employees and attracts cheap capital.
Likeability: The ability to insulate a firm from media and government scrutiny and create positive brand associations in customers' minds.
Elon Musk's vision, storytelling and far better products have provided cheap capital that other players can't beat. The firm is vertically integrated, selling cars directly. However, its core advantage is appealing to "sexual instinct" through every aspect of its strategy. Owning a Tesla is the ultimate status symbol indicating that the owner is wealthy with a conscience. Further, it makes its customers perceive themselves as innovators and visionary rebels.
With recurring revenue and a "Benjamin Button" product, Spotify has all the ingredients of a trillion-dollar firm. However, it has a valuation of just $47 billion. Apple Music has most of the music available on Spotify, along with the advantage of vertical integration. If Spotify and Netflix merge and acquire Sonos for vertical integration, they could control video and music and establish devices in America's wealthiest homes.
DISRUPTING HIGHER EDUCATION
In the past 40 years, college tuition has increased 1400% without any remarkable value addition or innovation. Premium universities have leveraged scarcity(low admission rates) to increase prices. These price rises have been enabled by federally subsidized student loans, leading to a total student loan debt of $1.6 trillion. In 2012, Clayton Christensen predicted that 25% of colleges and universities would go out of business over the next ten to fifteen years. By 2018, he raised the number to 50% pre-Covid.
In exchange for time and tuition, a college offers a credential, education and the college experience. The pandemic gave most institutions a fiscal shock. Schools like Harvard that have low acceptance rates and offer exceptional credentials will be fine. So will schools that offer solid education at a great price without an emphasis on experience. However, schools that offer an elite-like experience at premium prices without credentials will face the heat.
Online education holds tremendous potential as it can scale. Top professors and administrators in the top 10 universities will see classroom sizes expand and revenues rise. Almost everyone else in academia will make less. The most significant disruption could be Big Tech firms partnering with academia to offer 80% of a traditional four-year degree at 50% of the cost. MIT and Google could offer joint 2-year STEM degrees, enrolling 100,00 students at $25,000 per year in tuition, yielding $5 billion for a two-year program. In August 2020, Google began offering courses with career certificates that it and other participating employers will consider equivalent to a four-year degree in that domain.
There is no going back to the previous normal. This pandemic will reshape entire industries, and the way we work and learn will change. Iconic old brands will die, industries will consolidate, and newer innovators like Tesla will see their fortunes rise. The world has fast-forwarded decades in one year.