1
What’s Wrong with Silicon
Valley’s Growth Model
Tim O’Reilly
Founder and CEO
O’Reilly Media
@timoreilly
UCL MPA Lecture
October 29, 2020

You’ve Probably Seen Headlines Like These

You’ve Probably Seen Headlines Like This Too

What makes the difference?
“In the short term, the market is
a voting machine. In the long
term, it’s a weighing machine.”
-Benjamin Graham,
The Intelligent Investor (1949)

If you weren’t betting, which of these
businesses would you rather own?
Uber – Revenue $13B, lost
$8.6B
WeWork – Revenue $1.8B,
lost $1.9 Billion
Microsoft – Revenue $130B,
profits $41B
Apple - Revenue $259B,
profits $55B
Alphabet (Google) –
Revenue $155B, profits $33B
Amazon – Revenue $265B,
profits $11B

A Share of Stock is a Claim on Company Profits
Uber – ??? No profits
WeWork – ??? No profits
Its price is a bet on what those profits will be.
The Price/Earnings Ratio shows how many years of
future profits are reflected in the price of a share
Microsoft – 37.6
Apple – 34.99
Google – 35.16
Amazon – 123.20
S&P 500 avg – 31.24
S&P 500 in 1950 – 7.22
S&P 500 in 1929 – 17.17

Why Jeff Bezos Is The Richest Man in the World
There is an operating economy, where a dollar of profit is worth a dollar
to a small business, and a “supermoney” betting economy where a dollar
of profit is bid up to absurd heights
A dollar of Amazon profits delivers $123 of stock market value – almost
4x what a dollar of Apple, Google, or Microsoft profit delivers, and 123x
what a dollar of small business profit delivers.
That is, people are betting on Jeff, big time. What are they betting on?

What if you’d bought Apple shares at its IPO
in 1980, Microsoft in 1986, Amazon in 1997,
or Google in 2004? Or even better, Apple in
1997, when a share (split adjusted) cost
about 60 cents vs $319 today?
That’s where growth comes into play in the
price. People are betting on the future.

How Long Should It Take To Reach Profitability?
Apple – $250,000
Microsoft – $1 million
Google – $36 million
Amazon – $108 million*
Uber – $24 billion, and still not even on a path to profitability
WeWork - $22.5 billion, and still not even on a path to profitability
Total Capital Raised pre-IPO

In 2018, 83% of IPOs were for companies
with no profits

Betting might not seem so bad if you can cash
out before the business gets weighed…
Uber founder Travis Kalanick WeWork founder Adam Neumann
$2.7 billion $1 billion

Many of today’s Silicon Valley startups are
not really companies. They are financial
instruments created and sold by VCs, much
as Wall Street bankers created and sold
collateralized debt obligations (CDOs)
leading up to the 2009 crash.

The goal is an “exit”,
not an operating business

How I tell if an entrepreneur or VC is bluffing
Me: How’s your company doing?
Entrepreneur or VC: “We just
raised our D round!”

The Venture Capital equivalent of fake news

The big company equivalent of fake news

This isn’t “investing” – it’s extracting
85% of so-called
investment no longer
goes towards the
creation of new
capabilities, jobs,
products, or services. It’s
just money being traded
for money, in the
highest-stakes poker
game in the world.

“It wasn’t the way Steve Jobs would have done
it…. Jobs focused relentlessly on creating
irresistible life-changing products, and was
confident the money would follow. By contrast,
Cook pays close attention to the money and to
increasingly sophisticated manipulations of
money.”
Rana Foroohar,
Makers and Takers (2016)

How dangerous is a bubble?
“Speculators may do no harm as bubbles on a steady
stream of enterprise. But the position is serious when
enterprise becomes the bubble on a whirlpool of
speculation. When the capital development of a country
becomes a by-product of the activities of a casino, the job
is likely to be ill-done.”
John Maynard Keynes,
General Theory of Employment, Interest, and Money (1936)

“The lightning-fast path to building
massively valuable companies.”
Derived from the blitzkrieg or “lightning
war” strategy of Nazi general Heinz
Guderian
Aims to “achieve massive scale at
incredible speed” in order to seize the
ground before competitors do.
“Prioritizes speed over efficiency”
Risks “potentially disastrous defeat in
order to maximize speed and surprise.”

Go for growth even if you don’t know how
you are going to make money
“I remember telling my old college friend and
Paypal co-founder/CEO Peter Thiel, ‘Peter, if you
and I were standing on the roof of our office and
throwing stacks of hundred-dollar bills off the
edge as fast as our arms could go, we still
wouldn’t be losing money as quickly as we are
right now.’”
22
Reid Hoffman,
co-founder Paypal, LinkedIn

Somehow morphed into a winner-takes-all
philosophy
“As you all know, first prize is a
Cadillac Eldorado. Anyone
wanna see second prize?
Second prize is a set of steak
knives. Third prize is you’re
fired. Get the picture?”
-Alec Baldwin, in
Glengarry Glen Ross,
quoted by Reid Hoffman in
Blitzscaling
23

What went wrong in the ride sharing market
Sunil Paul, the visionary who’d patented the use of GPS for ride
hailing back in 2000, launched Sidecar with the peer-to-peer driver
model in 2011.
Uber and Lyft, which had already been funded by VCs with more
traditional models, jumped on the new innovation, and took in massive
amounts of capital to “blitzscale” the market. Sidecar went out of
business.
By coincidence, Sidecar had raised $35 million, about the same
amount it took to launch Google. But Uber and Lyft raised billions.
Customers didn’t pick the winner, the VCs did

Ride-hailing, a transformative innovation,
was stunted by the false incentives of too
much capital and the race for a profitless IPO

Technological Revolutions & Financial Capital
Published in 2002, Carlota Perez’s book placed
the dotcom bust in the context of four previous
fifty-year cycles: the industrial revolution, steel
and railways, electricity and heavy engineering,
and automobiles and mass production.
All of these previous technological revolutions
were accompanies by financial bubbles.

Financial bubbles are a necessary stage
“What is perhaps the crucial role of the financial
bubble is to facilitate the unavoidable over-
investment in the new infrastructures. The nature
of these networks is such that they cannot
provide enough service to be profitable unless
they reach enough coverage for widespread
usage. The bubble provides the necessary asset
inflation for investors to expect capital gains,
even if there are no profits or dividends yet.”
Carlota Perez,
Technological Revolutions and Financial Capital

What new capacity are we building out
today?

From the stateof.ai by Nathan Benaich and Ian Hogarth

Each cycle was characterized by four distinct periods divided
into two parts

What if we are entering the maturity phase?
“The practical implication … is
that the dominant companies in
mobile and the cloud — Apple,
Google, Microsoft, and Amazon
— may have a long stretch of
dominance in front of them.”
- Ben Thompson, Stratechery

Financial Capital vs Production Capital
“Financial capital represents the criteria and behavior of those agents who
possess wealth in the form of money or other paper assets…They will perform
those actions that, in their understanding, are most likely to increase that
wealth.”
By contrast, the term ‘production capital’ embodies the motives and
behaviors of those agents who generate new wealth by producing goods or
performing services (including transport, trade and other enabling
activities)…Their purpose as production capital is to produce in order to be
able to produce more. They are essentially builders.”
Carlota Perez, Technological Revolutions and Financial Capital (2002)

Favor productive investment,
not financial speculation
Look for companies with revenues, profits, and positive cash flow
Making their money from customers, not from venture capital
infusions, stock buybacks, or other gimmicks to juice their financial
valuation without improving the economics of their actual business

Tesla: Production capital at work
$820 million raised pre-IPO, plus $10.4B in post-IPO debt, $8.7B in post-
IPO equity. Profitable ($16B on revenue of $182B) but still raising
money.

At OATV, when we invest in things that
require a lot of capital, it is production capital
Planet: launching and
operating hundreds of
microsatellites to image the
entire surface of the earth
every day.

Technology and prosperity
“Prosperity in human societies is
best understood as the
accumulation of solutions to human
problems. We won’t run out of work
until we run out of problems.”
Nick Hanauer

The current system corrupts even the winners
“The relentless pressure to maintain
Google’s growth, he said, had come
at a heavy cost to the company’s
users. Useful search results were
pushed down the page to squeeze in
more advertisements, and privacy
was sacrificed for online tracking
tools to keep tabs on what ads
people were seeing.”

Here’s Google Search Up Till 2010

But that began to change

Google search today

Google’s share of ad revenue over time
O’Reilly Research

An Amazon Search Result from 2004
“Most popular” was the
default search
This distinguished
Amazon from B&N and
Borders, which
features sponsored
products or their own
competitive products
No more

Amazon today
All but one of the items
shown is sponsored
Publishers must
advertise their own
products to be visible
“Featured” is now the
default.
The old concept of
collective intelligence
picking the top products
is mostly gone.

Amazon Ad Revenue since 2016

Amazon Retail Revenues vs “Services”

Algorithmic rents

Q&A

We have to let go of the maps that are steering us wrong
In 1625, people
thought
California was an
island

In 2020, it’s our maps of business
and the economy that are wrong

“Gradually, then suddenly”
Ernest Hemingway

Gradually, then suddenly
Artificial Intelligence and algorithmic systems are
everywhere, in new kinds of partnerships with humans

“The hope is that, in not too many years,
human brains and computing machines will be
coupled together very tightly, and that the
resulting partnership will think as no human
brain has ever thought and process data in a
way not approached by the information-
handling machines we know today.”
- J.C.R. Licklider, Man-Machine
Symbiosis,1960

We are all living and working inside a machine

It’s no longer just in the digital realm

An Amazon warehouse is a human-machine
hybrid

Gradually, then suddenly
Large segments of the economy are governed not by
free markets but by centrally managed platforms

The invisible hand at work

What happens when there’s only one queue?
And it’s personalized for you?

Amazon.com

And what happens when there’s
only one price for everything?

Algorithms decide “who gets what – and why”
A better designed marketplace can
have better outcomes.

“Markets are outcomes.”
Mariana Mazzucato

Price signaling is no longer the primary
coordinator

Algorithms have become a battleground
Attention: “That word does
not mean what you think it
means.”

Managing an algorithmic marketplace

Real Time Digital Regulatory Systems
Google search quality
Social media feed organization
Email spam filtering
Credit card fraud detection
Risk management and hedging

Governance in the age of algorithms
Must focus on outcomes, not on rules.
Must operate at the speed and scale of the systems it is trying to regulate.
Must incorporate real-time data feedback loops.
Must be robust in the face of failure and hostile attacks.
Must address the incentives that lead to misbehavior.
Must be constantly refined to meet ever-changing conditions.

Algorithmic systems have an “objective
function”
Google: Relevance
Facebook: Engagement
Uber: Passenger pick up time
Scheduling software used by McDonald’s, The Gap, or
Walmart: Reduce employee costs and benefits
Central banks: Control inflation? Employment? Interest
rates?

When platforms get their algorithms wrong, there can be
serious consequences!
When platforms get
their objective
function wrong, there
can be serious
consequences!

Like the djinn of Arabian mythology, our
digital djinni do exactly what we tell them to do

The runaway objective function
“Even robots with a seemingly
benign task could indifferently
harm us. ‘Let’s say you create a
self-improving A.I. to pick
strawberries,’ Musk said, ‘and it
gets better and better at picking
strawberries and picks more and
more and it is self-improving, so
all it really wants to do is pick
strawberries. So then it would
have all the world be strawberry
fields. Strawberry fields forever.’
No room for human beings.”
Elon Musk, quoted in Vanity Fair
https://www.vanityfair.com/news/2017/03/elon-musk-billion-dollar-crusade-to-stop-ai-space-x

We’ve built one of these already

What is the objective function of our
financial markets?
“The Social Responsibility of Business Is to
Increase Its Profits”
Milton Friedman, 1970

Divergence of productivity
and real median family income in the US

Are the government’s economic
“algorithms” having the intended effect?
Have the goals of central banks been
captured by the equivalent of spammers?

Tax incentives as algorithmic economics

Government and central bank statistics,
economic modeling, and regulations are too
slow for the pace and scale of the modern
world
“Would you cross the street with
information that was five seconds old?”
-
Jeff Jonas,
CEO of Senzing,
Former IBM Fellow

“Why is policy still
educated guesswork with
a feedback loop measured
in years?”
Tom Loosemore,
Former Deputy Director,
UK Government Digital Service

Governance too must be reshaped by the
digital
“This isn’t just how we should be
developing software. It’s how we
should be developing policy.”
Cecilia Muñoz,
Former Director, White
House
Domestic Policy Council

Nations fail for the same reason as tech
platforms
Inclusive economies outperform
extractive economies. When inclusive
economies fall prey to extractive elites,
everyone is worse off.

“The art of debugging is figuring
out what you really told your
program to do rather than what
you thought you told it to do.”
Andrew Singer
Andrew Singer

Q&A

An alternative: “Doughnut Economics”?
Kate Raworth

Degrowth?
Do we need to reduce
our wants?

We have new tools
“The opportunity for AI is to help humans
model and manage complex interacting
systems.”
Paul R. Cohen

“Computational Sustainability is a new interdisciplinary
research field, with the overarching goal of studying and
providing solutions to computational problems for balancing
environmental, economic, and societal needs for a
sustainable future. Such problems are unique in scale,
impact, complexity, and richness, often involving
combinatorial decisions, in highly dynamic and uncertain
environments, offering challenges but also opportunities for
the advancement of the state-of-the-art of computer and
information science. Work in Computational Sustainability
integrates in a unique way various areas within computer
science and applied mathematics, such as constraint
reasoning, optimization, machine learning, and dynamical
systems.”
Carla Gomes

The great opportunity of the 21st century is to
use our newfound cognitive tools to build
sustainable businesses and economies

Can we build an economic flywheel
that keeps us in the doughnut?

“Create more value than you
capture.”
O’Reilly Media
Providing technology learning for almost 40
years – books, events, online
Trends pioneered – Commercial Internet,
Open Source, ebooks, Web 2.0, Maker
movement, big data
400+ employees, 5,000+ enterprise clients,
2.5m platform users globally
Offices in US, Canada, UK, Japan, China
Profitable, with hundreds of millions of
dollars in revenue.
Privately held, no venture capital, funded
entirely by our customers.

A marketplace in which we work to
“create more value than we capture”

Creating value for suppliers
as well as customers

“A platform is when the
economic value of everybody
that uses it exceeds the value of
the company that creates it.
Then it's a platform.”
– Bill Gates

Create more value than you capture
“I’m a believer that capitalism can only survive if
we have a world where surplus is getting
created, and that surplus is more broadly getting
distributed across all constituencies, versus
narrowly….”
“The creation myth of Microsoft is what should
inspire us. One of the first things the company
did, when Bill and Paul got together is that they
built the BASIC interpreter for the ALTAIR. What
does that tell us today, in 2017? It tells us that
we should build technology so that others can
build technology.”
https://www.linkedin.com/pulse/conversation-satya-nadella-his-new-book-hit-refresh-tim-
o-reilly/

What Would Mission Driven Government Do?
• Deal with climate change
• Prepare for future pandemics
Rebuild our infrastructure
Feed the world
End disease and provide healthcare for all
Resettle refugees
Educate the next generation
Help citizens to care for one another and enjoy the fruits of shared
prosperity

Invest in the new beginnings, not the end
The transition to a decarbonized economy
Electrification
Meat replacement and improved agriculture
Demographic inversions
Worker augmentation - including accelerated learning
Healthcare
Mass migrations and how to turn them into a net positive
Big unknowns and hard problems

Turn our greatest challenges into opportunity

Q&A