The Prof G Pod with Scott Galloway - Office Hours: Elon Musk and the Algebra of Deterrence, Amazon’s Third-Party Sellers, and the Dangers of Algorithmic Ads

Episode Date: April 18, 2022

Scott answers a question on why Elon Musk is able to get away with skirting the law, and shares his thoughts on why Musk’s Twitter takeover attempt may be a seminal moment for the SEC. He also answers a question about what might lie ahead for the companies that aggregate third-party sellers on Amazon’s platform, and weighs the pros and cons of subscription versus ad models. Music: https://www.davidcuttermusic.com / @dcuttermusic Learn more about your ad choices. Visit podcastchoices.com/adchoices

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NMLS 1617539. Welcome to the PropG Pod's Office Hours. This is the part of the show where we answer your questions about business, big tech, entrepreneurship, and whatever else is on your mind. If you'd like to submit a question, please visit officehours.propgmedia.com. Again, that's officehours.profgmedia.com. And again, I don't see these questions before you ask them. First question. Hey, Prof G. Tom calling in from Berlin, Germany, all the way over in Europe. On a recent episode of the pod, I heard you refer to Elon Musk talking about creating his own social media platform. The very next day, Elon bought almost 10% of Twitter, making him the biggest shareholder. We've also seen Elon

making comments about Bitcoin or Doge, followed not long after by him making trades. He's been in trouble with the SEC for making comments in public about Tesla. It strikes me that there's a pretty clear pattern of Elon using his platform to move a stock or an asset price and then trading on that move. So my question is this, what the fuck? As a regular schmuck, if I were to forget to tell the tax department about some of my earnings, or if I were to set up a lemonade stand and serve lemonade made with tap from Flint, Michigan, I'd get put out of business by the authorities in no time flat. How come moves like Elon's are allowed to happen so brazenly? Not to mention that many, many more happen behind closed doors. What options do I have as a regular Joe to kind of flaunt the law and make a shitload of money? Tom from the Berlin in Europe, thanks for the thoughtful question. Look, as nations become wealthier and more educated,

the reliance on a super being and church attendance goes down. And as a species, our competitive advantage is our brain. And it's big enough to ask very complicated questions, but not quite big enough to answer them. So into that void slips a super being. And as our dependence or reliance or faith on a super being goes down, we need other idols, other sources of answers to fill that void. And in the case of the United States and a lot of Western nations, but specifically the United States, we fill that void with something that feels God-like, that's magical, that's mystical, that we don't understand, that's incredible, that can answer questions, connect us with people, and that is technology. I kind of understand how a car works, so I'm not as impressed by it. I kind of understand

a Pop-Tart or how a Pop-Tart gets made. So the CEO of General Foods is just not that impressive to me. But technology is just so incredible and has created so much wealth and does these amazing things, whether it's finding me the answer to any question or potentially putting someone on Mars. It does feel godlike. And so as a result, the new Jesus Christ of an information economy are the CEOs of tech firms. And we afford them this idolatry that we traditionally haven't afforded other CEOs, much less other individuals. And it's very unhealthy because they get to live by a different set of standards. The SEC should publish new rules for billionaires. You're right, Tom. If you had said you were taking a company private at a certain dollar amount and that funding was secured and ended up you did not have funding, you would probably be prohibited from ever serving on a board or being the officer of a public company.

And to a certain extent, the SEC is saying, well, look, he is different. He adds incredible value, and we need to take that into account. I think that's a fair argument. But what's happened here is that over time, the key or the protocol or one of the keys to the protocol of a capitalist society and to America, and the reason why capital still flows in here, is that money and people believe that there's a rule of fair play here. And rule of fair play is supposed to apply to everyone. And right now, Elon is not right now, over the last year, he's just been waving his middle finger in the face of our government. And what you have is a loss of faith in our institutions, a lack of respect for how important it is or what a great role or positive role U.S. government has played. And if you want to try and buy stocks, and if you want to continue to raise money from the markets and have liquid markets and believe that when you buy a share of something, you're not going to wake up and find out that it was a fraud, or if people did steal money from you, they get punished for it, you're going to have to have an SEC that has some teeth, that has some resources. agencies, it is totally out of balance. Totally out of balance. The fastest growing expense line at tech right now is not AI. As a percentage of revenues or year-on-year increases, the

fastest growing expense line is lobbying. There are more full-time lobbyists working for Amazon who live in Washington, D.C. than there are sitting U.S. senators. There are more people in the PR and comms department of Facebook than there are journalists at the Washington Post. So if you believe or if your instincts are that there are two sets of rules here, trust your instincts. I'd like to think that this is a seminal moment and that the SEC is going to step in here and hit pretty hard on Mr. Musk. Now, I might be hallucinating or might be wishful thinking, but I do think it's going to happen because with only a few thousand people and a low single digit billions budget, the SEC is outgunned here. So what do they need to do? They need to put in place an algebra of deterrence. What does that mean? They need to pursue some high profile cases and send a message to everyone after this high profile case is decided. So the SEC and the DOJ did this with Michael Milken. They said, he's broken the law. And if we put Michael Milken in jail, it is going to create a series of

invisible cops all over the beat. The most powerful cop on any beat is deterrence. And we have lost that deterrence because the parking meter in front of our house costs a hundred bucks every 15 minutes and the parking ticket has been 25 cents. The algebra of deterrence is very basic. It's the likelihood I get caught times the fine has to be greater than the expected upside of violating the law. And right now, the algebra of deterrence is negative, meaning you are encouraged not to file a disclosure because you get to buy shares for 140 million less because any fine you pay is probably going to be less than that 140 million, or it's just going to be less than that 140 million, or it's just going to be, who cares, the equivalent of buying a charger. And the reason I bring up the charger metaphor is that if you look at Elon Musk's purchases of these shares and what it cost him,

it's the equivalent to him of buying a laptop for the average US household. In other words, the price of a MacBook relative to $120,000, which is the average household wealth in the U.S., is similar to Elon Musk spending $2 billion to buy Twitter shares. So what do we need here? We need the government to step in and create an algebra of deterrence. And I'm hopeful they're going to do that. So to summarize, yeah, they get to play by different rules than us. When I say they, I mean billionaires and specifically, specifically tech billionaires get to play by much different rules than us. And when I say they, I mean billionaires and specifically, specifically tech billionaires get to play by much different rules. I am hopeful. I don't think the world is

what it is. I think the world is what we make of it. And I think government agencies, specifically the SEC, are in fact going to step in here. Thanks for the question. Question number two. Hi, Scott. This is Clint Lazenby calling from the Silicon Valley of retail, Bentonville, Arkansas. I have been watching the staggering amounts of capital being raised by Amazon aggregators with a great deal of interest and more than a little skepticism. There are a lot of funds who are raising money to buy these Amazon sellers to exploit some great back-end synergy and more efficient advertising. In concept, this makes some sense to me. Having said that, I cannot help but wonder about the risks in not owning the distribution channel, as you have rightly pointed out a number of times with respect to Apple, Google, and Facebook.

It seems like this is a way to try and arbitrage the Amazon ecosystem and use it in a way that may not be aligned with Amazon's overall interests. Do you have concerns about the risk these companies and funds are taking by investing on top of Amazon's platform and set lack of control over their distribution channel? Looking forward to hearing your point of view. Thanks, Scott. Yeah, so this is a great question. Thank you. More than half of the units on Amazon come from third-party sellers. So the business of being a platform for other retailers is now a bigger business than actually Amazon being in the business of retailing. That is taking license to stuff, actually owning it, and then shipping it out and taking responsibility for it themselves. Although they offer

fulfillment, they offer advertising and slowly, but surely if you want to be on their platform, they have increased the rents from 19% on the dollar to 34%, see above monopoly power. Between Black Friday and Christmas of 2021, U.S.-based third-party sellers sold an average of 11,500 products permitted on the platform. Aggregators buy up those third-party sellers and operate them under one umbrella company, relying on Amazon's fulfillment services to store, process, and ship orders.

So, you know, you can see that there's a business here. There's a subcategory in this ecosystem that could create value through scale. So, according to the Economic Times, aggregators raised more than $700 million in the past year alone. The leading aggregator, Thrasio, has raised a total of $3.5 billion to date, and there are currently 96 active Amazon aggregators, a third of which have raised at least 100 million. That's up from 69 just last July. So the market is getting more crowded, and we're likely going to see some consolidation here. But strategically, what you're asking is, are they putting themselves in a vulnerable position?

You're 100% right. You don't control the distribution. When you're Facebook and you don't have a device that has gotten any traction, and so you can't control the end user, someone can pop up. Tim Cook can pop up and say, I don't like Meta or this guy, and basically turn off tracking. And overnight, you take a huge hit. So controlling or lack of control of your distribution puts you kind of in the crosshairs of someone else's blood sugar level. And it's the same thing here. I'll give you some examples. I was on the board of the New York Times, and they had purchased about.com, which I said we should sell.

Supposedly, we could have got about a billion dollars for it. And I said, why on earth do we own about.com? sort of this digital arbitrage where they were very good at buying Google keywords on Southern cooking and then driving traffic to this kind of content farm around Southern cooking. And then we would run digital marketing against it and arbitrage. We could make more money running ads for chili cooking utensils, whatever it might be, versus what it costs to drive traffic. Overnight, Google said, you know, we don't like this and we'd rather figure out a way to starch out that margin. That's their job. They don't want people arbitraging their platform. They want to arbitrage it. And overnight, with a panda or whatever the hell they called it, when they redo the algorithms,

we woke up and our revenues were down 40%. We ended up selling about for, I don't know, 250 million or 220 million. My point is, if you don't control your distribution, you are absolutely vulnerable. And at any point here, if this business becomes big enough, Amazon is going to go, you know what? We can figure out a way to capture this additional margin. So they'll let them survive just long enough until the margin is juicy enough to warrant the investment in engineers, and they can do whatever they want. It's their platform. So I think this is a very dangerous business to be in. I think you are kind of subject to the whims of Andy Jassy. I would not want to invest in one of these companies.

I think you're absolutely right that these companies show an incredible ability to be unemotional about these decisions, regardless of who it impacts. And it's their ecosystem. You just live in it. We have one quick break before our final question. Stay with us. The Capital Ideas Podcast now features a series hosted by Capital Group CEO, Mike Gitlin. Through the words and experiences of investment professionals, you'll discover what differentiates their investment approach, what learnings have shifted their career trajectories, and how do they find their next great idea? Invest 30 minutes in an episode today. Subscribe wherever you get your podcasts.

Published by Capital Client Group, Inc. Hey, it's Scott Galloway, and on our podcast, Pivot, we are bringing you a special series about the basics of artificial intelligence. We're answering all your questions. What should you use it for? What tools are right for you? And what privacy issues should you ultimately watch out for? And to help us out, we are joined by Kylie Robison, the senior AI reporter for The Verge, to give you a primer on how to integrate AI into your life. So tune into AI Basics, How and When to Use AI, a special series from Pivot sponsored by AWS, wherever you get your podcasts. Welcome back. Question number three.

Hey, Prof G. This is Shane, and I'm an electrical engineer working just outside Baltimore, Maryland. My question gets at the balance between the advertising industry and subscription-based business models. In recent episodes of both Prof G and Pivot, you have been especially critical of companies such as Google and Facebook for the algorithms behind their advertisements and how those algorithms corrupt society. I get what you're saying, but I want to challenge you on that. Don't get me wrong. I'm very keen to the harm that has been born from radicalization on both platforms.

However, there have been many instances during which I found ads served across Google and YouTube helpful, and as such, bought those products. On the flip side, I'm fortunate enough to afford multiple subscriptions, but there are millions upon millions of consumers who cannot.

As you laud companies like Netflix and Neva, as well as potential moves like subscription Twitter, I want to know how you would address the advertising industry. Your recent rhetoric suggests you would eliminate the entire business model, and yet it strikes me as foolish and unrealistic such a scenario would even happen.

How would you balance algorithmic-driven ads versus subscription revenue moving forward and into the future? That's a really thoughtful question. And first off, let me just acknowledge that I think that there's some common ground here. And Shane, I think you're, I just think there's a lot of credibility and common sense in what you're saying. And I, and I really appreciate and value respectful pushback because I get it wrong all the time and I learn and I think part of progress is civil debate and discussion. So UBS predicts that the subscription economy, which covers everything from home delivery to digital entertainment, will grow to

$1.5 trillion by 2025, more than double the estimated $650 billion it's worth now. So people seem to be finding money for subscriptions. The issue here, so there's a couple issues. One, the algorithms. I think of an algorithm serves you up a pair of on-running tennis shoes, which Instagram did. And I purchased them and I love them. More power to them. And I think algorithms are a great thing. I'm not against algorithms. What I'm against is misinformation that's elevated by an algorithm solely because that misinformation will create rage or novelty travels faster. It's more interesting when you get a piece of information that claims on Facebook that

the vaccine is all to your DNA, which is false. People are interested in that. They're not only interested in it, they're interested in saying that's not true, and it creates more interaction, more attention, more Nissan ads. So the algorithms have incentive to spread misinformation that results, in my view, or one of the factors that have resulted in the wealthiest nation in the world having some of the lowest vaccination rates of any wealthy economy and unnecessary death, disease, and disability. So I believe when an algorithm elevates a certain type of content, and that content is obviously harmful to people in the Commonwealth, that's similar to every other media company, the person who programmed that

algorithm or the company should have the same liability as every other company. Now, I don't think algorithms are necessarily all bad. I don't think if you're buying stuff, I think probably 80%, 90%, maybe 99% of the stuff that's elevated by algorithms and targeting you and saying, hey, I saw that you're searching for safaris. I'm going to run an Abercrombie and Kent ad against that. I don't think there's anything wrong with that. I think capitalism is a wonderful thing. Or if you're doing searches for a gun and the NRA serves you an ad, I don't think there's anything wrong with that. But when you are serving extreme dieting sites, our algorithms have said, go down that rabbit hole and spend a disproportionate amount of time on Instagram, which is what we want, even though that may not be the best content for her.

Put another way, that might be the worst type of content for her to be consuming. And we might find that the moment that Instagram gets adopted by teen girls in the UK, that our own research shows they have a greater propensity to self-harm and depression. I think they should be liable for that, just as any other company is liable for it. We no longer distribute this podcast on Spotify because I was upset and

still am that Spotify decided to not put in place any moderation or fact-checking on some of its most popular podcasts that influence tens of millions of people. And I'm not suggesting that's not their right, although I think they should be accountable. And as a capitalist, I say, I don't want to traffic in that. I don't want to make money for an organization that's taking that money to spread misinformation because they think it's going to result in more downloads, even though they know that is misinformation. I think on certain issues around health, around government, around anything regarding elections, I think that stuff is sacred and warrants an additional level of scrutiny. Should the dissenter's voice be heard? Should people be able to say, I think the vote was stolen? Yes. But the moment that content is elevated and gets more reach than it would organically, you're subject to the same libel laws as any other

media firm. Now, with respect to your question around subscription, you bring up a good point, and that is what happens, does the world bifurcate into a group of people that can afford fact-checked information via subscription, and then another community that can afford that fact-checked information, and we have sort of can afford that fact-check information, and we have sort of an underclass of people being fed misinformation all day. I think that is a viable argument. The UK tries to get around this by charging every household, I think it's 100 or 200 bucks a year, to fund the BBC, and the BBC is trusted and tries to call balls and strikes on both sides. The most trusted are the two organizations I think they're sort of seen in

the middle are neutral arbiters. One is the Wall Street Journal, believe it or not. The other is PBS, which gets government funding. So you could argue there's a role for government to fund non-ad supported information that attempts to demonstrate some level or at least nod to both viewpoints. I do think that ultimately there is a bevy of options at a fairly limited price. I don't think it's access to truth, access to fact-checked news is that expensive. I think you can find it. The cost to society of elevating novel content, I think, has been greater than the relative downside of that kind of bifurcation, if you will, of that underclass of people who would be subject to more misinformation. I do think, I don't want to just totally discount the ad model. You're seeing a lot of streamers who are now saying, they're under the impression

that consumers have run out of breath with subscription. I actually don't think that's true, but they're worried they are. So they're talking about advertising on HBO. Even Netflix for the first time hasn't ruled it out. And Roku is advertising. So the ad model may be, may be dying, but like most businesses that are going away or business models that are going away, it'll die more slowly than people think. For example, I went on the board of a Yellow Pages company. Why? Why? Because we could buy these things at two times earnings. And we know the Yellow Pages business is going out of business, but it's not going out of business in two years. So the decline of the advertising industrial complex will happen. It probably won't happen as fast as I think. But I don't think this bifurcation or this underclass is going to be

as big a danger as we think, because I do think think this bifurcation or this underclass is going to be as big a danger as we think, because I do think there are organizations and possible government funding of fact-checked information. And I even think there's a pretty big market for reasonable fact-checked information that is ad-supported. But that is a really thoughtful question. I appreciate you reaching out, and I appreciate the polite pushback. That's all for this episode. Again, if you'd like to submit a question, please submit a voice recording by visiting officehours.propertymedia.com. Our producers are Caroline Shagrin and Drew Burrows. Claire Miller is our associate producer. If you like what you heard, please follow, download, and subscribe.

Thank you for listening to the Prop G Pod from the Vox Media Podcast Network. We will catch you on Thursday. What software do you use at work? The answer to that question is probably more complicated than you want it to be. The average U.S. company deploys more than 100 apps, and ideas about the work we do can be radically changed by the tools we use to do it. So what is enterprise software anyway? What is productivity software? How will AI affect both? And how are these tools changing the way we use our computers to make stuff, communicate, and plan for the future?

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