The second-order growth effects of Ford’s Model T

I recently read a book about the birth of the first credit card, and I realized that the second-order effects of a new invention can impact completely unrelated industries and far outweigh the impact on immediate industries.

For example, with Ford’s first affordable automobile, the Model T, suddenly, everyone was mobile, which transformed American manufacturing and changed urban planning. There were also seemingly unrelated industries, however, that were heavily impacted. The Model T meant that people everywhere could drive and stay at far away places that they couldn’t before —leading to the booming of the hotel and vacation industry.

Technological invention will only get you so far — you also need affordability

But you cannot transform the structure of an industry by purely inventing a new technology — it is also about affordability. Ford produced the Model A in 1903 for $900 — well beyond the reach of ordinary people. The Model A was still seen as an expensive toy for rich people. It wasn’t until ten years later that Ford was able to drop the price down to $260, that led to the mass adoption of the car, giving people the freedom and power that comes with mobility.

The correlation between cost and economic value that entrepreneurs get wrong

We often believe the correlation between cost and economic value is linear — $1 cheaper means 1% increase in economic value. But in fact, it’s only linear up to a point — and then its exponential, where $1 cheaper means 50% or even 100% more economic value. 

Default Choices and Monopoly Leveraging

As consumers, we tend to think that we have completely free choice — but the truth of the matter is, that many forces beyond our control frequently give us a default — the ultimate goal of any business is to become the default. In the past, the way to become the default choice was simple: land. Land helped propel McDonald’s into becoming the most popular fast food chain in the country. Land is also the reason you see two Starbucks within a block of each other. More storefronts translates into two things: (1) more convenience (easier to reach by proximity) and (2) increased familiarity (trust over unknown choices) — each additional store brings customers closer to making that business their default choice.

Winning with Proximity and Familiarity

Default choices are hard to resist. In 2002, Google reached a deal with AOL to guarantee a payment of $50m if AOL made Google its first-choice search engine shown to users by default. Today, Google reportedly pays Apple billions of dollars a year — $9 billion in 2018 and $12 billion in 2019 — to remain Safari’s default search engine. Google’s annual payment to Apple is an example of why proximity (convenience) remains important despite familiarity (trust) — I may believe Google is superior to Bing but will still use Bing if I have a browser that defaults to that because I am lazy.

Some businesses struggle to become the default, even though their product is already proximate to consumers everywhere. For example, shampoo is known for having poor brand loyalty — 73% of people change their shampoo occasionally. People change their shampoo sometimes because there are other options at the places they go to buy their shampoo. Shampoo brands cannot win with convenience. Contrast this with the automotive industry, where 61.5% of Subaru customers end up repurchasing another Subaru. A car is a large enough purchase that you’re willing to travel a little bit and there does not tend to be options at similar distances. For example, I live in San Francisco — there isn’t a Tesla on every corner while I have to drive all the way to LA to go buy a Ford. Proximity is less relevant for big consumer purchases. 

In the world of land, shampoo companies couldn’t simply take over proximity, except now in the new world with Amazon, they can because they can just pop up as the Amazon top choice when someone searches “shampoo.” This is what Amazon is doing with creating their own brands — if the first three things I hit on the search page have high ratings and there are several variations of Amazon shampoo, I’m going to choose the top ones listed. Ordering is something that the shampoo companies cannot do at CVS, because there are dozens of bottles next to each other. While it may help to be on the top shelf, a consumer is going to browse around and generally it will be very easy for them to switch — it requires no more thinking and no more effort to switch. Amazon, on the other hand, has set up a new store, where I actually have to scroll to switch. 

The Shift from Land to Digital Real Estate

Previously, land was the most important driver. Zara, for example, strategically positions its retail location in the luxury shopping district in order to target higher end customers. If a consumer’s default choice for jewelry is Tiffany’s, and Zara that is physically next to the default choice store they are already familiar with, they will be more likely to go to Zara than had Zara been located somewhere else. Retail stores play this game all the time by seeking to build themselves on the block where consumers already shop. In a similar manner, a consumer drives themselves over to Amazon to get the book because Amazon is the default. Once they get over there — surprise, they see the movie store next to it, Amazon Prime Video. This play is similar to the physical proximity that retailers were leveraging to win over consumers; however, this time, the proximity is taking place on a landing page.

Businesses no longer need physical real estate – the new battleground is now the internet. With this new battleground comes a narrowing of the number of pipes consumers can choose from. This phenomenon is already playing out in entertainment. Where someone used to spend time channel surfing or looking through the TV guide, now the default is to go to Netflix and watch a show recommended by Netflix. An increasing amount of watched content on Netflix is coming from algorithm-recommended content rather than a user clicking on something they had predetermined they had wanted to watch. Netflix seems like a one-stop shop because it has so much content, even though you end up just clicking whatever it recommended for you. We increasingly have only one portal not just for video — the same is also true for listening to music, as Spotify makes decisions for us about what to listen to. 

While consumers have more choices of goods, they also have less pipes from which to consume goods. Contrast this to the past, where monopolies used to be prosecuted because lawmakers argued that they led to less choice and left consumers worse off. Now, monopolies are democratizing content creation and arguably delivering more consumer choice. The number of movie titles released, for example, has been steadily increasing over time, and hit its record high in the US and Canada in 2018. The number of companies funding this content, however, has been shrinking.

The Three-Step Flywheel

So what is the key — how do you build an empire that becomes every consumer’s default choice?

Step One: Become the one-stop shop

The first step is to become the one-stop shop for many choices — instead of going to individual sites or stores, consumers only need to go to one place. The convenience of on-demand – whether it’s being able to instantly watch a movie or being able to instantly cook a delicious homemade meal — further helps spin this flywheel to retrain consumer behavior.

Step Two: Retrain consumer behavior

This one-stop convenience leads to retrained consumer behavior, where consumers are conditioned towards particular brand or service. Changing consumer behavior is the key to unlocking billion-dollar businesses. In 2011, I discovered a new service where I could stay at someone’s house, rather than a hotel when I was visiting a new city. When I told my friends about it, they all replied similarly, “I would never use it.” That quickly changed as Airbnb began to override previously socially accepted norms and learned behavior.

Step Three: Leverage your monopoly

This retrained habit leads to the third step: monopoly leveraging. A business can further become an entrenched monopoly by bundling products together to create leverage. Amazon, for example, has a monopoly in online retail and bundles Amazon Prime Video with Amazon Prime to move towards securing a monopoly in video. As a consumer, you already go to Amazon for retail and now you think, “Oh, I can start going to Amazon for my entertainment too.” This is how companies use monopoly leveraging to retrain consumer behavior. Amazon implicitly tells consumers, Why not stay here and you can do it all. Monopoly leveraging is naughty — it’s a way for companies to get an unfair advantage in a completely different product category and essentially get customer acquisition for free. Twenty years ago, Microsoft employed this same tactic when they dominated the operating system (OS) space. They took advantage of their monopoly in operating systems to get into the browser space, replacing Netscape and instead packaging its Windows operating system with their own browser, Internet Explorer, to win the browser market. Essentially, Microsoft used one monopoly to create another monopoly. This is a great deal for Microsoft because get essentially free customer acquisition – whereas the customer acquisition cost (CAC) would have been very costly for a business that did not already have a monopoly.

A Coming Shift

Increasingly, a fewer number of businesses are owning more and more categories. Simultaneously, there will be entire categories where consumers are eliminating their need to choose and instead empowering online portals to do it for them. However, there is a missing element that made brick and mortar businesses a default choice that has not been perfectly replicated in the digital space yet.

It is not sufficient to have a web presence or even a very popular one. A digital brand can become familiar, and can make its varying services proximate to each other (e.g. Google Search and Google Shopping Express) – and yet, if it cannot serve the customer in a timely manner, it will fail. Put differently, internet producers have not yet overcome one brick-and-mortar advantage: physical proximity of good to customer. Amazon recognizes this — the reason for Amazon’s acquisition of Whole Foods was not the Whole Foods grocery business, but the real estate footprint. Amazon now has Whole Foods locations that can double as distribution centers all over the country. Where many businesses have failed and gone out of business because of high shipping costs and mismanaged distribution, Amazon has succeeded.

In the next essay, I will dig deeper into this next battleground and cover the qualities of those who have failed and succeeded.

Thank you Mike Ng, Chris Pagliarella, Savannah Perkins, Alexis Kim, Suthen Siva, Jessy Lin, Ash, and David Perell for reviewing earlier versions of this essay.

Sitting down with Li Hongyi, Singapore Prime Minister’s grandson

I recently had the opportunity to sit down with Li Hongyi and discuss Singapore’s approach to government and technology. I’ve been fascinated by Singapore since reading From Third World to First by Lee Kuan Yew, the nation’s founding father, and how he took a poor and corrupt country and built it into one of the richest countries in the world — where the average per capita income is nearly twice that of America’s.

Some takeaways:

1. Singapore is nearly twice as efficient with government spending as America is.
Their government expenditures make up 17% of total GDP — and not only do they have universal healthcare, but also the government manages the retirement savings of all its citizens (and invests that money). The US’s government expenditures are 38% of total GDP. A Rube Goldberg machine is an example of how an arbitrarily simple task can be arbitrary complex. This is how most governments work.

2. What worries you about the culture in Silicon Valley?
He responded that despite all of the wealth and abundance in Silicon Valley, people tend to accept wealth disparity and move to higher levels of esoteric consumption (taking on more interesting hobbies, eating at nice restaurants, traveling to more exotic places). Buying experiences is not better than buying things. People here look at the homeless and accept that that’s the way things are going to be. This is not the case in Singapore — people in Singapore expect a lot out of their government and will complain about even the smallest things — and the government is quick to respond.See the response to a citizen’s complaint about a grocery store not carrying a yogurt drink for his children (1):

3. “One way to see countries is as companies — what are the main pillars of government strategy?

  1. Li Hongyi runs the Data Science and AI division of the government — he responded that AI itself isn’t the main source of value, rather, it is automating all the things leading up to that.For example, the police was having a hard time tracking down peoples’ addresses when they would call to track down crimes.  The police thought AI would solve their problems — in actuality, all they needed was a faster way to query. Hongyi used Amazon ElasticSearch to bring the query time from 2 minutes to a speedier 0.5 seconds, and their issues were resolved.
  2. AI as a national strategy resource does not exist. Their competitive strategy is to attract smart people. What do smart people care about? Having a good quality of life.
    1. Two competitive strategies:
      1. Develop an edge – e.g. China focuses on IoT, manufacturing, electric, and autonomous vehicles; Japan similarly cherry picks industries
      2. Just get the most successful people in our country – e.g. Singapore

View full set of notes at Google Docs link.