Technological innovation produces at times big transformational waves that have a profound impact not just in the country where they originally started from, but around the globe. They they have modest origins (just take a look at the first transistor) and they can go unnoticed until suddenly everyone sees them. A transformational wave happens when a few dominant technology companies grow so much they become essential infrastructure in many countries. This is a technological phenomenon, but its impact goes beyond technology: industrial structure of economies, financial markets, productivity, labour, social mobility, national security, with its influence extending eventually to geopolitical alliances and international order.
We are taking for granted the ubiquitous presence of the mega US tech companies in our lives. Yet, this dominant presence built up on the back of a long, successful run will gradually fade as their growth diminishes. This slowing down occurs because of the suppression exercised by a natural ceiling that prevents companies from growing indefinitely, and because the new world they helped create is now turning against them. From being on the front page on reasons ranging from inequality, monopolistic behaviour, and privacy concerns to national security and excessive US influence, these companies will find it more and more difficult to sustain high growth rates.
Today’s world is very different from the one we lived in twenty years ago although it doesn’t feel that way. We are too busy to notice it, but if we take a helicopter view we can see it. One obvious difference is the size of the big US tech companies that have been the engine of this transformational wave. The relative size of these companies is at the heart of the argument that I am presenting here: they have become so big that large countries feel threatened, undermined and that they are compelled to take unusual regulatory measures which in turn will lead to the end of this transformational wave. We are now at the beginning of a transition phase characterised by volatility and intermittent shocks which will affect these companies, the financial markets, the international relationships between countries and their alliances.
Right now the financial markets are blindsided by the virus pandemic, still hanging on the big US tech, maybe as a reflex, seeking stability and assurance, but this investment narrative which favours the incumbents is fraught with significant risks. Buying on the dip strategy will not work this time because these transition shocks will weaken the dominant tech companies. In this article I am discussing in broad terms the economic reasons for this transition, the impact on investment strategies and the potential change of the relationship between the US and the EU. I believe the latter will bring to an end an alliance born in the aftermath of the World War II amidst strategic concerns of the overwhelming dominance of American technology companies.
The crisis bequeathed to us by Covid has made the big US tech companies richer than ever. Five of them have passed the trillion dollar mark: Apple, Microsoft, Amazon, google and Facebook. Tesla is almost there too. Fame always stirs up envy and invites backlash. There is only that much profit to be made at any one time without causing pain to too many other parties both at home and abroad.
The big US tech champions have seen their business operations spread around the globe being present in almost every country on Earth. Their rising profits are reflected in the seemingly unstoppable ascendancy of their share price. Investors large and small, institutional and retail are buying these shares with conviction.
Large funds love the big tech. The liquidity is limitless, they have a long history of growth, dominating their own space with virtually no significant threat, except potential negative changes in macroeconomic trends. Many investors are aware of regulatory risks, but they usually brush them off as past encounters left them unscathed even after receiving substantial financial penalties (substantial by smaller companies’ standards). This habit carries an increased risk as explained below.
Market Capitalisation and Revenue vs GDP and Exports
In the past few years the EU has been examining the business practices of the top US tech companies citing concerns for competitiveness, taxation and abuse of power. Recently another couple of reasons were added to the list: consumer data privacy and sovereign security. This signals that the relationship between the US and the EU is changing in a fundamental way, but that is the subject for another story.
It is interesting to note that these proceedings have been solely focused on the big US tech. Even the design of the digital taxation law was customised to pertain exclusively to these companies, and only at the US Treasury Secretary Jane Yellen’s insistence following the agreement on a global minimum corporate tax did the EU adjust the formulation of the law to make it more general (and then postponed it for another time, which will surely come soon).
The EU’s biggest concern is the lack of homegrown companies that can compete at that level. The fact that these US companies have become a critical part of the EU infrastructure and provide services essential to the running of many businesses across the continent makes the solution to this problem more complicated. The US tech companies have grown so much and so powerful the EU seems to think there is no choice but to use regulations to help local technology companies grow to competitive level.
To get a sense of how large these companies are from the EU perspective we compare them with the major European countries using market capitalisation and revenue as a proxy for GDP and exports. The comparison is not perfect, but it is good enough to help us get an impression of the relative size between companies and countries. We could think of GDP as a hypothetical ability of a country to buy a specific company by using all the expended funds recorded in a year. We can compare company revenue to country exports, as if the country is a company with its cash inflows generated by selling products and services to its customers (aka countries).
The table below compares the top five US tech companies with the top five EU economies using the 2020 reported financial data.
|Company||M Cap||Revenue||Country||GDP (USD)||Exports (USD)|
We could add Tesla to that list as Elon Musk is pushing it toward USD1t market cap, but that would not fit in with the rest of the big tech because Tesla is an emerging leader in a different paradigm shift onto the next transformational wave.
Small countries don’t have too much of a choice, but large countries with global status aspirations will feel compelled to take action if a foreign company is too big. It is one thing to be influential in Andorra and another to be influential in France. How big is too big? Perhaps the country’s GDP is one point of reference. If we make a list containing top US tech companies and EU countries ranked by the indicators I mentioned earlier, we get an interesting arrangement: in the GDP/market capitalisation ranking Germany, UK and France are on top, followed by Apple, Italy, Microsoft, Amazon, Google, Spain and finally, Facebook. The list is pretty compact. Revenue wise, the companies clearly top the list, bar Facebook, for now.
It must be concerning for the EU not only how large these companies are now, but how fast they can keep growing. Five years ago the share price of these companies was much smaller (and so was their market capitalisation and revenue). For instance Amazon was roughly five times smaller, Apple six times, Google 3-4 times, Facebook 3 times, and Microsoft 5 times. Extend this trend and you see the prospect of having the top five US tech companies clearly dominating the entire EU in the near future. That is a real problem.
The EU Imperative and the Invisible German Line
Recent earnings reports for Q2 2021 announced by the top five US tech are very strong. The dominant narrative in the financial media commentary is one of anticipation of further growth for Google, Facebook, Microsoft, Apple and Amazon. Hypothetically, assuming nothing changes, according to this trend they will reach valuations of 3-4 trillion dollars by 2025 and 10+ trillion before the end of the decade. That is unlikely to happen not just because they may fail to grow their revenues that fast, but because they will not be left unchallenged by both the EU and the US. Can Apple become twice the size of Germany? Maybe. But four times? Hmm. If this company can sustain, theoretically speaking, the growth of the past five years, Apple would become as large as the EU. That is definitely an unacceptable situation for the EU. If you add the other four big US techs, their combined power is certainly something the EU cannot accept.
Apple’s growth rate in the past two decades amounts to over 1,100% compared with a meagre 86% growth of Germany’s GDP. Even if Apple’s growth slows down to an aggregated 130% over the next decade, its market capitalisation will easily surpass Germany’s GDP. I don’t have historic data or other reports on the relationship between companies’ size and Germany’s GDP, but I suggest this figure could be used as a key point of reference to determine if a company is reaching a critical juncture in the growth of its EU operations. When this line (we can call it The Invisible German Line) is crossed expect the regulatory risk to start ramping up under the pressure of the major governments (Germany, France) and business lobbyists in the EU (Spotify is an example).
When a company is targeted by a government with specific laws, it will stop growing not only because of the dampening effect of the law(s), but because of the collateral damage that follow: increased spending on regulatory issues, oversized compliance and risk departments, and fighting fires unrelated to the creative part of the business. Innovation spending will be defensive, aimed at protecting the existing customer base rather than seeking new opportunities and top talent will start looking elsewhere.
The importance of exceptional talent and the micro-social environment in which it operates is underestimated so often. A successful, large company can temporarily do away with less exceptional talent because of the lasting effect of the original system and its ability to attract average to good talent (but not exceptional).
A good example is Facebook. A few years back, Facebook was on top of the list of companies where people wanted to work for. Not today. The social media giant is facing huge pressure from regulators and competition from a new crop of vertical social media outlets specialised in specific industries. Facebook is trying to copy them, but it is increasingly difficult to compete against nimble companies that have motivated and exceptional talent with specialised knowledge when its own staff is under a barrage of compliance issues. There will be a point when its users’ time spent on Facebook drops considerably compared with the time spent on the new generation specialised social media because they offer something that users love and Facebook is unable to offer. It is a negative spiral that I believe Facebook cannot avoid because of the limitations imposed by its size and the regulatory scrutiny that comes with it.
The Mood Is Changing in US
If the EU is alarmed at the level of power and influence of the big US tech for reasons of security, the US government is growing concerned for reasons of economic and political risks.
Apple’s clout is making the US regulators uneasy. When you have an entity with revenue larger than entire industries, there is a limit to how much of that growth could be left unchecked no matter how socially responsible is that company. It will be interesting to see how Apple’s entry into health care, a goal described by the CEO Tim Cook as having the potential to be Apple’s most important legacy, will be received considering that its total revenue is larger than the entire US medical devices industry.
Recent appointments by the Biden administration point to a protracted legal battle aimed at breaking these companies. This is not a matter of infringements, but a matter of principles: these companies are too big, too influential, (“Facebook is killing people!” – Biden). They may be on the wrong side even if they do the right thing by the customer. The problem, it is argued, is the negative impact on competition and innovation in the long term (FTC chair Lina Khan). It is tempting to think this is a typical ideological approach of the left, but that is not the case. The big US tech have managed to attract the ire of the right as well, making it an unusual story of bipartisan unamicable attitude toward big business. It is a safe bet that governments in the US and across Atlantic will take measures to reign in the big tech.
Impact on Financial Markets, Investment Strategies
One of the frequent assumptions made by many of the commentaries in financial media is that companies grow based on their own ability to strategise, attract talent and execute in markets governed by permanent rules. Thus, Apple could grow on forever if they make more phones, offer new services and expand in new markets, such as cars, movie making, games, and health care. Same with Microsoft and the others. If you listen to investment experts speaking to the mainstream media you hear frequently the expression “buy X (where X can be any of the mega US tech stocks) because it is a solid, proven business that gives you exposure to multiple new technologies”. There is a foregone conclusion that by buying Microsoft or Apple you also get a piece of action in the emerging technologies by way of acquisition or big tech’s own venture capital. Regulatory risks are either ignored or considered as small nuisances that are easily resolved by paying relatively small fines.
In effect regulators will curb the big US tech firms’s rate of growth. This will have an impact on the main market indices, which in turn will affect the performance of the myriad of index based investment funds. The big US tech firms will cease to be “growth” companies and become more like an exotic class of utilities.
The confidence in the US market leaders has abundant this year through large inflows ($900 billion) into the US market for purchasing stocks and bonds. Despite this optimism there are concerns citing regulatory risks and overcrowding making some fund managers consider re-directing some of this money to Europe. These companies are still exceptionally well run but their domination will come to an end when new leaders emerge. The central bankers have flooded the markets with cash and a noticeable retreat will not occur in the short term.
I anticipate that changes will occur underground gradually as more money start shifting towards promising new technologies and new business models. The big US tech will enter a period of small advances, peppered with corrections some small, some sharp and deep, resulting over a long period in relative stagnation. This will produce a mediocre market performance compared to the past two decades. During this time passive investment funds will underperform funds actively managed by competent leaders focused on disruptive, innovative growth companies. Cathie Wood style of investment (deep research, selective, focus on innovation) will outperform the Vanguard Index style. It is hard to predict the timing of this evolutionary step because there are other factors at play. The pandemic could last longer and have some other unforeseen effects, we could enter a period of higher inflation which favours the incumbents with pricing power. Nimble innovators could on the other hand surprise them with lower cost, higher performance products and services, undercutting the incumbents. Regardless of how these market fluctuations will occur, I believe the big US tech will see their stellar growth stop before the end of this decade.
If data is the new gold, then the EU is the poor cousin of the US and China. To compete in the future and prosper, the EU needs to redesign its regulatory framework. It needs a total redraw. Fast. Just patching the system with fines and new digital taxes is not working in the long term for the EU.
The redesign of the EU framework will have profound implications for the trans-Atlantic relationship. The era of post-Marshall plan is ending because it is simply out of date. Perhaps Biden’s acceptance of the Russian gas pipe to Germany is a sign a new order is on the way. The excessive dominance of the big US tech is not the cause of the change in global power, but it is certainly one of the important factors that will trigger the EU’s transformation. It is too early to say what will replace the big US tech in Europe, but one thing is certain: the future of the domination of the American technology in Europe is incompatible with the long term strategic interest of the continent.
The tension will likely accelerate the formal re-organisation of the EU and its emergence as a global power. There will be an increased scrutiny of foreign technology companies in Europe. This will not be as draconian as the Chinese regulations, but nonetheless they will demand adherence to stricter rules in relation to competition, data storage, privacy, security, and advanced technologies such as AI research, AI applications, robotics and space.
The EU will find a renewed enthusiasm in the idea of a stronger union of its members advancing a more centralised legal, financial, and taxation system which in turn will strengthen its ability to influence the global affairs. The big US tech will be a central target in the EU remake (the Chinese companies too) in the broad context of security, employment, labour skills, industrial policies, trade and key initiatives (climate change, human rights).
It is impossible to forecast the timing of all this, but my best guess, based on the earlier company/country projections and current developments in the area of taxation and trade, is that the transition from today’s big US tech dominance will occur over the next five years. By the end of the decade we will see new emerging leaders defining the next wave of innovation. The big unknown (and a captivating one) is Africa. I am tempted to believe the big US tech will expand its presence on that continent more rapidly to compensate for the loss in the EU and China, but that depends on how quickly Africa’s new pockets of prosperity will absorb the surplus of supply, and also how quickly the US government is able to adapt. Will the African financial markets mature during this time? Will fund managers believe this expansion will provide adequate returns? It seems a remote possibility, but a heightened competition between the three large blocks, US, EU and China can accelerate that process faster than we are ready to accept as possible today.