The Sugar Daddy Effect? Assessing Corporate venture capital, Sovereign funds and Green Energy!

    It is a sign of the times that I spent some time thinking about whether the title of my post would offend some people, as sexist or worse. I briefly considering expanding the title to  "Sugar Daddies and Molasses Mommies", but that just sounds awkward, or even replacing the words with something gender neutral, like "Glucose Guardians", but very quickly passed on the idea, deciding to stay with my initial title. After all, I am too old to care about what other people think, and the type of person who would be offended by the title, is probably not someone that I want reading this post in the first place. The message that I was trying to convey, and “sugar daddy” does it better than the alternatives, is that being dependent on an entity to meet your financial needs will impede your capacity to be self sufficient and will undercut accountability. That was the thought that came to mind, as I was writing about the US government's plans to break up big tech, and chronicling how much the big tech companies have struggled, trying to enter new businesses, notwithstanding the capital and brainpower that they have at their disposal. In keeping with my inability to stay focused, that then led me to also think about sovereign wealth funds, an increasingly powerful presence in both private and public equity markets, and then about green energy, a favored destination for impact investors over the last two decades. What do corporate venture capital (CVC), sovereign wealth funds (SWF) and green investing share in common? They all have had almost unimpeded access to capital, from parent companies (with CVC), the government (with SWF) and impact investors (for green investing), and seem to, at least collectively, punch well below their weight, given their size.  

Corporate Venture Capital

    Corporate venture capital (CVC) refers to capital invested by established firms, into young companies and start-ups, sometimes in the same business and sometimes in others. The motivations for the practice vary,  and the payoff from CVC is debatable, but it is undeniable that CVC is growing as a segment of venture capital, and that it is not only affecting the pricing of the young companies that are targeted, but also altering the economics of venture capital, in the aggregate.

Motives

    To understand why companies turn to investing like venture capitalists, I will bring in my life cycle perspective, with cash available, investment choices and growth potential at each phase:

For most young companies, where the free cash flows from existing businesses are negative, because of shaky profitability and large reinvestment needs, investments are likely to be focused on existing businesses, and venture capital will not be on the menu. As companies mature, with business models delivering profits and reinvestment needs declining, it is not surprising the companies look outward, with acquisitions often entering the equation. For those companies that are able to scale up, with growth, and especially so in businesses where there is uncertainty about how the future will unfold (in terms of markets and technologies), venture capital can become a more attractive alternative to both internal investments or acquisitions, because it allows these companies to spread their bets across multiple plays, hoping to hit it big with a few of them. Seen with this perspective, corporate venture capital investments can be framed in one of two ways:

1. Replacement for internal R&D: For some companies, corporate venture capital investments displace internal R&D, designed to generate future products and develop new technologies. This is, again, more likely to happen as companies age, and their internal R&D loses its punch. Arguably, this is the prime rationale for the growing venture capital arms at pharmaceutical companies, with almost $30 billion invested in biopharma ventures just in 2022.
2. As real options: In businesses where there is substantial uncertainty about how product technologies and markets will evolve over time, companies may decide that investing in young businesses with divergent and sometimes competing technologies will yield a higher likelihood of success than investing in just one, either through internal investments or through an acquisition. In effect, this company is creating a portfolio of options in its CVC holdings, and hoping that big payoffs on the options that pay off will cover the costs of the many options that will expire worthless.

There are two other reasons why companies may play the venture capital role, and they lead to very different choices in that role:

1. Side benefits to core business(es): A company may make venture capital investments in businesses with the intent of using those businesses to augment core business growth and profitability. Thus, while these investments may not generate payoffs to the company as stand-alone investments, they may still create value, if the side benefits are significant. 
2. Stand-alone VC business: In some companies, especially those with slowing core businesses, the corporate venture capital arm can be designed to be a separate business, structured and treated like a stand alone VC business. In this structure, the corporate venture capitalist behaves like regular venture capitalist, with returns measured on finding the right start-ups to invest int and then exiting from their investments, by selling to other venture capitalists, selling the company to an acquirer or taking it public. 

In summary, corporate venture capital is likely to not only be more diverse, across CVC arms, but even within the same CVC arm, investments can be made with different motives. 

    While corporate venture capital may be viewed as a departure from much of the rest of the investments that a company makes, they are seldom structured as independent entities. Put simply, there are relatively few firms, where there is corporate venture capital arm or division, that is in charge of, and accountable for, CVC investments. A survey of companies with corporate venture capital arms in 2021, for instance, found that less than ten percent are set up as standalone legal entities that resemble institutional venture capital.  Many CVC investments are "off the balance sheet", reducing both independence and accountability, but with widely varying capital commitments from the parent company:

• In some companies, a multi-year capital commitment is made to the CVC, allowing it more freedom to make commitments of its own.
• In other companies, the commitments are made on annual basis, reducing the autonomy of the CVC in its own investment decisions
• Finally, there are companies where the capital available to the CVC is residual, reflecting the cash flows to the parent, where individual CVC investments may need corporate approval, reducing independence even further.

In sum, no matter how they are structured, CVCs remain tethered to their parent companies, dependent on them for funding, and affecting what they invest in, and how much.

Magnitude

    Corporate venture capital has existed, in one form or the other, for decades, but it has grown to become a larger part of overall venture capital investment, as can be seen in the graph below, where I look at CVC in aggregate dollar value, and as a percent of overall venture capital investment:

    CVC has grown from less than 25% of overall venture capital investing in 2005 to close to half of all VC investment in 2023. While CVC accounts for a smaller percentage of deals made, it makes up for that by investing in much bigger deals:

Corporate venture capital tends to invest in much bigger companies than the conventional venture capital with an average post-deal value of $500 million in 2023, compared to $210 million for conventional VC. 

    To get a measure of how a CVC arm evolves, I took a look at Google Ventures, Alphabet's CVC arm, and one of the largest and most active corporate venture arms in the world. Founded in 2009, and with Alphabet as its only funder, Google Ventures had over $10 billion in invested, in 2024, in more than 400 technology startups, spread across multiple businesses including healthcare, the life sciences and even financial services. Google Ventures has prided itself on using data-driven algorithms to determine what start-ups to invest in, and when to halt a deal, and being manned by engineers, rather than financiers, though it scaled back the practice in 2022. Over its lifetime, Google Ventures has picked some big winners, including iUber, Airbnb and Slack, all of which are now public companies with substantial market capitalization. Not all corporate venture capital forays have happy endings, though, as was the case with SAP, which shut down its corporate venture arm in 2024, seven years after starting it, because of deal setbacks.

Performance

        Going back to the motives for corporations enter the venture capital game,  you can broadly categorize CVCs into two groups, broadly based upon the benefits they expected from their investments:

1. Financial: In this category are investments made into venture capital, where the returns come directly from the investment, in the form of cash flows or at the time of exit (in a sale or public offering). 
2. Strategic: In this category are venture investments, where the benefits are still financial, but accrue to the parent company in the form of more efficient R&D or as options that pay off, and often more in the long term.

A survey of 257 CVC funds in 2024 yielded the following breakdown of where the payoffs are expected:

SVB CVC Survey in 2024

Note that only 15% of the surveyed funds are purely financial, with the rest broken up into those that claim either a primarily strategic motive or a hybrid (mix of financial and strategic). 

    It is the mixed objectives of CVC that make it difficult to assess how well it has performed on its investments. Thus, while corporate venture capital collectively generate lower returns for their capital providers than tradition venture capitalist, in their defense, they provide benefits that go beyond the VC returns (in cash flows and exit), to the parent company's bottom line (as higher revenues, lower costs and more efficient innovation). The SVB survey of corporate venture capital provides an interesting picture, contrasting how companies backed by CVC differ from traditional VC-backed companies in terms of exit:

Note that fewer CVC-backed companies go out of business, than do VC-based companies, with half the failure rate and more companies advancing to the next round. While this is good news for the funded companies, indicating that CVC funding is more durable and long standing, than traditional VC, it does point to a weakness in the CVC model. VC success comes from finding the right targets, and entering and exiting at the right prices, but it also comes from being ruthless in terms of cutting off companies that do not measure up. To the extent that the data in this table can be generalized to all CVC ventures, that lack of ruthlessness may eat into returns, since weak companies will continue to get funding for longer than they should.

    There is one final test, albeit a flawed one, to examine whether corporate venture capital adds value to the parent company, at least in the aggregate, by looking at stock price and operating performance of companies with CVC programs. In a 2010 study of 61 firms with CVC arms, the researchers concluded that shareholders of the CVC parent companies react negatively to investments made by the CVC, and also that the reaction was less negative with CVCs that were structured as standalone units. That result clearly is not conclusive proof that CVC is value-destructive, since the optionality or side benefits from CVC are both uncertain and may take a long time to manifest. 

Sovereign Funds

    In 1953, Kuwait, seeking to create an investment vehicle for the oil riches that were just starting to emerge, created the very first sovereign wealth fund, i.e., a fund that is funded by the government presumably to protect and advance the interests of its citizens. Since then sovereign wealth funds have multiplied, with a significant percentage still in commodity-rich companies and funded with commodity wealth, but their reach has widened. In the United States, for instance, where the Alaska fund, a funded by the state of Alaska, from oil production, has been the only sovereign fund of any magnitude, both sides of the political divide have started discussing the need for a sovereign fund for the country. 

Motives

    Looking across the sovereign fund universe, it is clear that a significant majority of these funds originate in commodity-rich (mostly oil) countries, and that their funding comes from exploiting their oil reserves. Since oil is a finite resource, and reserves will be emptied out over time, it does make sense for countries with commodity riches to set aside some of these richest, in the good years, and to invest those funds for the long term benefit of their citizens. Thus, the first mission that sovereign fund managers have is a conventional one, shared by all active fund managers, which is to deliver returns on their investments that augment and grow the fund. It is this context that they allocate their funding over multiple asset classes, and within each asset class, pick and choose what to invest in. It is true that there are some differences, even on this money management dimension:

1. Sovereign wealth fund managers control a wider array of the portfolio management process than most traditional fund managers. Thus, they often make both the asset allocation decision, as well as the security (equity, bond, real estate project) selection decision, whereas traditional fund managers often have compartmentalized roles, specializing in a specific asset class. 
2. Sovereign fund managers also operate under a different set of constraints, with some built into their mission statements, that determine what they can invest in, and how much. Thus, a sovereign fund can be required to invest in some businesses and geographies, and barred from investing in others, whereas conventional fund managers often do not face the same constraints.

Sovereign wealth funds face a unique challenge, which is that they have a second mission, which can sometimes be elevated about the fund management mission, which is to serve the national interest, as can be seen in the following examples:

1. Economy building: The Public Investment Fund (PIF), Saudi Arabia's sovereign fund, has been given the mission of delivering on Vision 2030, the Kingdom's ambition plan to wean the Saudi economy away from its dependence on oil. As a consequence, the fund invests a significant proportion of its money in Saudi-based businesses in aviation, defense, entertainment, tourism and sports.
2. Green energy: Given the global angst about climate change, it should come as no surprise that many sovereign funds are required to invest a portion of their portfolios in green energy and  renewables, even if those investments do not carry their economic weight. Norges, the largest sovereign wealth fund in the wold, has a renewable energy component of the fund designed to invest in wind and solar infrastructure.
3. Sector strengthening: In some cases, sovereign wealth funds are given the mission of building or strengthening a domestic sector. The China Investment Corporation lists "maximizing return with acceptable risk tolerance" as a core objective, but also lists that its mission includes recapitalizing "domestic financial institutions as a shareholder abiding by relevant laws in order to maintain and increase the value of state-owned financial assets".

In fact, much of the talk of a US sovereign fund is driven less by conventional fund objectives, since there are plenty of vehicles that investors (individual and sovereign) can use to try to optimize their returns, given their risk appetites, and more by national priorities that are unfunded or underfunded right now.

Magnitude

    The sovereign fund universe has increased dramatically in the twenty first century.  In the graph below, I look at the number of sovereign wealth funds in existence, by year, and the aggregated value of these funds:

The number of sovereign wealth funds approached one hundred, at the end of 2023, and they collectively controlled more than $12 trillion in funding at the time. Asia has the largest number of sovereign wealth funds, but the funds from the Gulf/Middle East are among the largest, in terms of funding at their disposal. In fact, you can see their dominance by looking at the list of largest sovereign wealth funds at the start of 2024:

In 2024, the largest sovereign wealth fund is the Norges, the Norwegian sovereign wealth fund, which was funded with oil wealth from the North Sea oil reserves decades ago. The Asian entrants on this table include three funds that are from China (including the Hong Kong fund) and two longer standing players from Singapore (GIC and Temasek). While the United States does not have a sovereign fund, the state of Alaska has one, funded again by the state’s oil wealth, with benefits accruing to its state residents; the Alaska Permanent Fund, as it is called, paid a dividend of $1,312 to every Alaska resident (with a residency of at least a year) in 2023, and is expected to pay more than $1,700 a resident in 2024.

    These funds have wide latitude on investing, and they invest across asset classes - equities, fixed income and alternatives (which include private equity, real estate, infrastructure, hedge funds and commodities) :

Source: Invesco (2024)

Their investments are in both public and private businesses, as sovereign wealth funds increasingly look for returns in younger companies and businesses that would be targeted by venture capitalists.

    In terms of structure, there is an extraordinary amount of diversity in how these funds are structured, and who controls the levers and evaluates performance. At one extreme are the Norges and the Singapore-based funds, where transparency is par for the course, and the fund managers enjoy a high degree of independence from governments. At the other extreme, the line between sovereign wealth fund and the government is blurred, opacity (about what the fund is investing in, and how well or badly these investments are doing) is the name of the game and there is little or no accountability. Not surprisingly, the latter group is more vulnerable to political pressure and corruption, with some SWFs becoming slush funds and patronage machines for the politicians that they answer to. 

Performance

    The research on active investing suggests that active investing collectively has trouble matching the passive investing returns (from owning index funds), especially after the costs of active investing have been brought into the equation. But how does sovereign wealth fund investing do, relative to passive and other active investing? The answer, at least in the aggregate, is not so well, with equity in the companies targeted by SWFs underperforming the market significantly, with the caveat that performance is much better at transparent SWFs than at opaque ones. Looking at the impact on corporate performance, the results are mixed, with increases in profitability, when the SWF's holdings are less than 2% of outstanding shares, but decreases in profitability and worsening operating performance for larger holdings. In short, if the core mission for sovereign wealth funds is preserving and growing a nation's wealth for its citizens, many of them are falling short, and if it is activism at the investing companies, it is not working.

    That said, there are outliers, and looking at them may provide us some insight into why sovereign wealth funds under or out perform. While many sovereign funds are opaque on performance evaluation, offering little in public on historical performance relative to benchmarks, Norges provides exhaustive documentation of how their active investing has measured up to passive alternatives. Since the fund is invested in different asset classes, let us focus on just the equity investments made by the fund and the comparison that they provide with a benchmark (admittedly of their creation):

As you can see, the fund has outperformed the benchmark, albeit by a very small amount, but given the troubles of active investing, the fact that the alphas are positive is a substantial win. At the other extreme, consider the story of 1MDB, the Malaysian sovereign wealth fund, set up in 2009 with money from an oil joint venture (with PetroSaudi), with the intent of encouraging investment in Malaysia. In the years that followed, hundreds of millions of dollars from the fund was used to fund Hollywood movies and bankroll the lavish lifestyles of connected financiers and politicians, before leading to the jailing of Najib Rezak, Malaysia's prime minister, and a $3.9 billion charge against Goldman Sachs, for the bank's role in the scandal. 

Green Investing

    It is undeniable that climate change has moved up the list of global concerns, and if like me, you followed COP28, the climate change conference, this year, or even read news stories about the weather in your part of the world, the need to reduce our carbon footprint does seem urgent, and there are laws, rules and resources that are being directed towards that end. In fact, if investing were measured on the virtue scale, there is perhaps no more virtuous version than green energy investing, and hundreds of billions have been directed towards it. 

Motives

    Of the three groups that we look at in this post, green investing's motives should be the simplest to disentangle. It is to push the world away from fossil fuels to alternative energies, but that is where the consensus ends. For some players in this space, reducing the carbon footprint and fighting climate change is the core mission, with returns being a constraint rather than an objective. Thus, for foundations and perhaps even some endowment funds, investing green with as little loss in returns as possible becomes the mission statement. Unfortunately, the bulk of green investors want to have their cake and eat it too. Among impact investors, a prime source of funding for green investors, a significant majority of impact investors (close to 64%) want to have their cake (at or above-market returns, given risk) and eat it too (by making an impact). 

With equity investors in the green space, this hoped for payoff takes the form of positive alphas, while directing their money to solar, hydro and wind energy investments, and with green loans and green bonds, the higher returns come from being able to earn higher interest on their lending, given default risk.

Magnitude of Investment

    While the speakers at COP28 have lots of legitimate grievances against governments and markets, including the subsidies that fossil fuel companies have received over their lifetime and the laws that enable fossil fuel energy consumption, one grievance that they cannot have is that not enough money has been spent on developing alternative energy, i.e., energy from everything but fossil fuels. Consider the following graph, that reports investments made in billions of US dollars in fossil fuel and alternative energy sources each year.

Barring 2015, not only has far more been invested in alternative energy than in fossil fuels, but the difference is widening. In the aggregate, close to $15 trillion has been invested in alternative energy, and other than a very small slice that has gone into nuclear and low-emissions fuels, the rest has gone into green (solar, wind and hydro) energy. 

    The money invested in green energy has come from multiple sources. A small part has come from governments, either directly or through sovereign wealth funds. A significant portion has come from impact investors, a catch-all for investments made by foundations, investment funds, family offices, pension funds and corporate investors in the space, with investments of about $2.5 trillion in 2021, and expected to grow to more than $5 trillion by 2026.  Note also that investing in green energy takes both the equity and bond routes, and the green bond market has allowed companies to tap into "lower cost" financing, to facilitate their growth in the alternative energy space. In 2023 alone, $575 billion of green bonds were issued, bringing the size of the green bond market to almost $4 trillion, in the aggregate.

Performance - Financial and Carbon Footprint

    For defenders of green investing, it is good news that that so much money has been directed towards green investing, but that is unfortunately where the good news seems to stop. For the most part,  the payoff from green investing has been surprisingly small, on both the financial and the social dimensions, especially given how much money has gone into it. 

    Let's start with the financial payoff from all of the trillions of dollars that have gone towards making the world greener:

1. Business building: When trillions of dollars are invested in a space, you would expect, at some point in time, that this will lead to companies emerging from the space with business models that can deliver sustained profitability and command large market capitalization. In the green investing space, that has not happened (yet). For instance, the 273 publicly traded companies in the alternative energy space (including almost every aspect of that space), in October 2024, had a collective market capitalization of $506 billion, and they reported aggregated revenues of $117 billion in the most recent twelve months. In contrast, just one fossil fuel company, Exxon Mobil alone had a market capitalization of $532 billion, and revenues of $479 billion. Green investing defenders will argue that it will take time for these companies to mature and deliver profitability, but the clock is ticking and the trend lines do not look promising. 
2. Investor returns: On the other side of the equation, what type of returns are investors in green energy getting from their investments? The answer will depend  on whether you are looking venture capital investors in green energy or public market investors, and also on the time period that you examine. While returns for both groups were robust during portions of the last decade, when investor demand for green investing was high, they have come back to earth, and especially so in the last few years. Here again, your response may be two-fold. The first is that you need patience, for these green energy investments to pay off and deliver profits and returns. The second is that green investing is not about delivering excess returns, but about saving humanity from global warming. I have absolutely no problems with the latter rationale, as long as green funds (both equity and bond) make it clear that they expect to under perform markets, when they seek out capital.

In fact, if your response to the financial impact of green investing being unimpressive is that these investment are saving us from global warming, the numbers are not supportive of the virtue thesis. In the graph below, I look at energy consumption, based on source: 

It is stunning how small an effect  the trillions invested in the space have had on where we get our energy, with fossil fuels accounting for about 81.5% of total energy consumption in 2024, about 5% lower than it was twenty years ago . In fact, much of the gains from solar, hydro and wind energy have been offset by a loss in energy product from nuclear energy, the one alternative energy source where almost no money was invested over the period. It is true that there are parts of the world (Latin America and Europe, for instance) where green energy has made significant inroads, but if global warming is an existential crisis, that is small consolation. For those who argue that shifting to green energy takes time, I have two questions. The first is, unless I misheard what climate change advocates are telling me, time is not an ally and we don't have a luxury of moving slowly. The second relates to economics: if it has cost us five trillion dollars (or more) to reduce our dependence on fossil fuels by 5%, will we go bankrupt trying to reduce it by another 35%?

    There are some who will argue that the money spent on green investing has given rise to innovation and new technologies, but I wonder whether that innovation and those technologies are the ones that we would have invested and developed, without a firehose of capital raining down on green enterprises. There is research starting to percolate through the system that we could have made a much bigger impact on greenhouse emissions by spending our R&D on brown innovations, i.e., innovations that make fossil fuels cleaner-burning and less damaging, than on green innovations, i.e., innovations that explicitly focus on just green energy. More importantly, and as noted earlier, it can be argued that the impact investing definition of alternative energy excluded the one source of energy that has had a track record of making a significant impact on energy consumption, i.e., nuclear energy, and spending a fraction of what was spent on nature's energy sources (solar, wind and hydro) on developing safer ways of delivering nuclear power would have moved the fossil fuel dependence needle by far more. 

    In short, green investing, in the aggregate, has failed in terms of delivering financially (both in terms of business building and delivering returns for investors) and socially (in terms of reducing dependence on fossil fuels).. It is the point that I made in my post on impact investing, where I argued that the prime beneficiaries of the movement have been the consultants, green fund managers, advisors and academics who live in its backwaters.

The Sugar Daddy Syndrome

    Clearly, corporate venture capital, sovereign wealth funds and green investing have very different roots and motives, and have evolved differently, but they do share a common feature. Given how much has been invested in each, they have under delivered, at least collectively, and the vaunted side benefits have been slow to manifest, again with exceptions. I am perhaps overreaching, but here are the reasons as I see them:

1. Assured funding: Each of the three groupings has assured funding, though the degree of assurance and magnitude can vary across individual players. With corporate venture capital, it is the parent company, with sovereign wealth fund, it is the government, and with green investing, it has been impact investors, at least for the last two decades. That assured funding may give them an advantage over their counterparts - VC for CVC, traditional funds for sovereign funds and conventional energy companies for green energy investments- but it does come with a downside. Looking at start-ups and very young companies that manage to make the transition to businesses, one factor that plays a role in focusing attention on building business models is desperation, i.e., the fear that if you do not, you will go out of business. That desperation is lacking in all three groupings highlighted in this post, in many cases. Start-ups and young businesses founded by corporate venture capital may not feel the urgency to create and build business models, if they perceive the capital window at the parent company will stay open. In active money management, a big investing mistake can lead to client flight, but for a sovereign fund, that mistake may quickly be covered by government largesse. Finally, with green investing, one reason that there are so many bad companies and investment funds continue to survive is that they use their virtue at least on the climate change front to attract more capital.
2. Mixed Mission: I noted that for each of the three groups, there is a mixed mission, where, in addition to, and sometimes, instead of, their core missions (start-up to success for CVC, investing alpha for SWF and producing non-fossil-fuel energy at a reasonable price for green investing), they are given other missions. Running any entity, when you have more than one core objective, is always tricky, and it becomes doubly so, when you have two or more objectives, pulling in different directions. 
3. Stakeholder distractions: Every entity has multiple stakeholders, and navigating the conflicting interests to deliver success is difficult to do. With the three groupings highlighted in this section, there is at a stakeholder that is the equivalent of a 600-pound gorilla, and what it wants can often overwhelm every other interest. With CVC, that gorilla is the parent company, and the CVC's performance can reflect decisions made at the parent company level that are too big of a handicap to overcome. With sovereign funds, it is the government, and the people who have oversight of the funds, and to the extent that they call the shots, sometimes with other national interests (protect bad banks from failing by investing in them), sometimes with political end games (hire more workers or not fire workers, just ahead of elections) and sometimes for personal reasons (corruption), the SWF can be left with the residue. With green investing, it may be impact investor skews and biases, and governments, that provide the tax benefits and subsidies, pushing companies into technologies and investments that they would not have otherwise.
4. Non-accountability: As you can see, in our discussion of performance for CVCs, sovereign funds and green investing, under performance can always be excused or explained away by either pointing to other mission objectives or arguing that in the long term, success will show up. Thus, a CVC that underperforms a VC will argue that while its corporate ventures did not meet the mark, the side benefits that accrued to the parent company make up for the underperformance. With sovereign funds, it is convenient to point to the other roles - nation building, sector fixing or social safety net - that they play that may excuse the negative alpha. With green investing, the cloak of planet defender comes in handy, whenever the absence of results (either in financial or social terms) is brought up.

That said, though, there are outliers in each group that seem to thread the needle of competing missions and interests and deliver successful outcomes. Using some of those successes as guide, I would argue that there are four features that these winners share in common.

1. Independence: With CVCs, we reported that very few are set up as stand alone entities, with control, over funding and investing choices. If you are investing significant amounts of money through a corporate venture capital, it may make sense to not only separate the CVC from the rest of the business, but also to let the individuals that you pick to run the CVC make decisions that are not second guessed. In the context of SWF, one reason that Norges has been able to deliver above-benchmark returns is because its executive board  is insulated from government interference. 
2. Transparency: In a related point, many CVCs and SWFs are opaque about their working and holdings, with no good business reasons for secrecy. That makes it easier for them to not only hide inefficiencies but almost impossible to assess performance. That opacity is particularly present with the side-missions that these entities are called on to perform - the actions that protect national interests or strengthen financial institutions, for instance, are open for interpretation. At the best performers, though, transparency is more the norm than the exception, and that transparency extends to almost every aspect of how they operate.
3. Separation of motives: I think it was Marc Andreessen who described a house boat, as neither a very good house nor a very good boat. When entities are asked to deliver different missions, intermingling them in decision making will create bad choices. If the Saudi government does want PIF to deliver both solid risk-adjusted returns on its investments and diversify the Saudi economy, it will be better served to separate PIF into two entities - a fund management entity that invests in the best investments it can find and nation-building arm, whose job it is to make the investments or provide the subsidies that work in delivering that mission. Again, at the best performers, there is more of an an attempt to separate core missions from side missions, with clear guardrails on the latter.
4. Accountability: As things stand, it is difficult to hold the entities that make up each of these groups accountable, and the mixed mission is the primary culprit. By separating the missions, accountability becomes easier, since the core mission part of the company can be assessed using the performance metrics of that core mission, and the side mission on how much the money spent advances movement to the social or side goal. That accountability should be followed up with actions, i.e., a greater willingness to shut down corporate venture capital arms that do not deliver and to convert  under-performing sovereign wealth funds from active to passive. 

I went into this post with a hypothesis that corporate venture capital, sovereign wealth funds and green funds/companies underperform their conventional peers - venture capital for CVC, mutual and pension funds for sovereign wealth funds and energy funds/companies for green investors, and that it is assured funding that creates that effect. Having looked at the data, I have rethought my hypothesis, or at least refined it. 

• It is true that, in the aggregate, that the underperformance hypothesis finds backing, with the median player in the CVC, SWF and green investing but there is wide divergence in performance across the players in each group. 
• The very best in each group (CVC, SWF and green investors) match up well to the top players in the peer groups (VCs, actively managed funds and energy companies), with some using their assured funding as a strength to extend the investment time horizons. 
• The key difference, at least as I see it, is that within each of the funded groups, there is not enough pruning of the worst performers, partly because the funders do not or will not demand accountability and partly because the mixed mission statements allow poor performers an excuse for under performance. In contrast, the worst performers in their peer groups are quickly stripped of their funding and drop out of existence. In 2023, an admittedly bad year for venture capital, 38% of active venture capitalists dropped out of deal making. While active funds don’t have as high a drop-out rate, the amount of capital that they invest is sensitive to how they perform in market. That absence of ruthlessness on the funding level for under-performing CVCs and SWFs can trickle down to the companies they fund, with funding lasting much too long, before the plug is pulled. 

Learning Moments

    While this post was directed at CVCs, SWFs and green funds, there are broader lessons here for a wider class of investments. 

1. Funding always has to have contingencies: When companies, governments or institutions create entities that they commit to fund, that fund commitment has to come with contingencies, where if the entity does not deliver on its promise, the funding will be reduced or even shut off. To the pushback that this will make these entities short term, note that the contingencies that you put in can allow for long time horizons and long term payoffs, but the option of cutting off funding has to be on the table. After all, it is entirely possible that the funder can accomplish what they hoped to, with their under performing entity, with a different pathway.
2. Have a core mission: I sympathize with those who head CVCs and SWFs, when they are faced with a laundry list of what they are expected to deliver, with their funding. Since it is impossible to run an entity, or at least run it well, with multiple missions, you have to prioritize and decide on your core mission. Thus, if you are a sovereign wealth fund, is it your core mission to invest your funding wisely to deliver market-matching or market-beating returns or is it to build a nation’s infrastructure? 
3. Social purpose, but with reality checks: In many cases, entities that have a business purpose are also given a social purpose, and while that is understandable, it can give rise to incentives and actions that lead these entities to fail at both. If there is a social purpose component, as there is in green investing and sovereign wealth funds, it has to be made explicit, with clear measures on how much in economic profits the entity is willing to sacrifice to deliver them. In short, claiming that you can deliver good without sacrifice is delusional, and as I have noted in my posts on ESG and sustainability, it is at the heart of the internal inconsistencies and incoherence that bedevil them.
4. Failure can be a strength: In my writing on corporate life cycle, I noted that survival for the sake of survival or growth for the sake of growth will lead to outcomes that make us all worse off. As noted in the last section, the biggest weakness in the three groups is the unwillingness to euthanize underperforming entities, ensuring that good money will be thrown after bad.

As a final note, I have mixed feelings about a US sovereign fund, even though there seems to be enthusiasm for creating one, on both sides of the political divide. There are investments, especially in infrastructure, where I see a need for it, but I worry about the political interference and whether this is the most efficient way to deliver that end results that are sought by its backers. 

YouTube Video

Breaking up Big Tech: Cui Bono?

    In a court filing on October 9, 2024, the US Department of Justice (DOJ) let it be known that it was considering a break-up of Alphabet, with the addendum that it would also be pushing for the company to share the data it collects across its multiple platforms with competitors. There is many a slip between the cup and the lip, and it is entirely possible that these are threats designed to extract more concessions from the company, but the break-up talk is a continuation of a debate about the power accumulated by big tech companies, in general, and  with Microsoft, Amazon, Apple, Alphabet and Meta, in particular, and what should be done about that power. With politicians, economists and lawyers all in the mix, offering widely divergent solutions, I look at the evolution of anti-trust law in the United States, and whether that law can or should be used to counter big tech. In doing so, I will start with the disclosure that I am not a  lawyer, and have no desire to be one, but the problem, in this case, may be that there are too many lawyers involved, and too little business sense. 

The Law in Spirit and Letter

    In the latter part of the nineteenth century, as the United States was transitioning from an emerging market to a global economic power, its growth was powered by three industries - steel, railroads and oil - all requiring large investments in infrastructure. In each one of these businesses, powerful men earned their "robber baron" standing by squashing competition and building dominant companies that aspired for pricing power. In oil, it was John D. Rockefeller, who started Standard Oil and built a sprawling empire across the nation, acquiring other players in the still nascent oil business. With Carnegie Steel as his vehicle, Andrew Carnegie took control of the growing steel market, before selling his business to J.P. Morgan, who took it public as US Steel. In railroads, a network of tycoons controlled swathes of the country, with Cornelius Vanderbilt, Jay Gold and Leland Stanford all playing starring roles, as heroes and villains. Along the way, they created the trust structure, organizations of companies which controlled production and prices, effectively monopolizing the businesses . 

    As these companies laid waste to competition, exploited labor and overcharged customers, a political and economic backlash ensued, manifesting in the Sherman Anti-trust Act of 1890 and the election of a Teddy Roosevelt, campaigning as a trust buster. The Sherman Act used the constitutional power of Congress to regulate interstate commerce to authorize the federal government to break up the trusts and "restore competition", with the latter words vaguely defined. While the law outlawed "every contract, combination, or conspiracy in restraint of trade," and any "monopolization, attempted monopolization, or conspiracy or combination to monopolize", the Supreme Court added the constraint that the law only forbade competitive restraints that were "unreasonable". That vagueness initially worked against the government, in its enforcement of the act, with the Supreme Court ruling against it in its attempt to break down the American Sugar Refining Company, in 1896, but the kinks were worked out in the next decade. In 1911, President Taft used the act to break up Standard Oil into multiple oil businesses, and the entrails of that breakup can be found in many of the largest oil companies of today.

    In 1914, Congress passed the Clayton Act to clarify and augment the Sherman Act, and expanded its reach to cover a whole host of activities that it classified as anti-competitive, including some mergers, predatory pricing and sales ties. It also barred individuals from sitting on boards of competing companies and created the Federal Trade Commission (FTC) as an institution to provide the specifics on what constitutes unfair competition and to work with the Department of Justice, to enforce these rules. In subsequent years, Congress returned to add provisions and modify the act, including the Robinson-Patman Act in 1936, which reinforced the laws against price discrimination, the Celler-Kefauver Act of 1950, which filled in gaps on the merger provisions, and the Hart-Scott-Rodino Act of 1976, which introduced the need for any company planning an acquisition that exceeded a transaction value threshold (reset at regular intervals) to file a pre-merger notification with the Justice Department and to wait at least thirty days before consummating the acquisition.

Enforcement Ebbs and Flows

    The effectiveness of laws at dealing with the problems that they purport to solve depends in large part on how they are enforced. In fact, one reason that the Clayton Act created the Federal Trade Commission in 1914 was to enforce the anti-trust laws, and the FTC states its mission as protecting "the public from deceptive or unfair business practices and from unfair methods of competition through law enforcement, advocacy, research and education."   In carrying out this mission, the FTC often relies on the Department of Justice (DOJ), where an antitrust division was created specifically for this purpose, in 1919. 

    Through the history of anti-trust laws in the United States, the enforcement has ebbed and flowed, partly as a result of changing administrations bringing in very different idealogical perspectives on its need, partly in response to Court judgments in its favor or against it, but mostly because of questions about whether the central objective of the laws is to enhance competition or to protect consumers. The divide between enhanced competition and consumers played out in competing viewpoints, with one school, led by Robert Bork, arguing that the original intent of the law is consumer protection, and the other pushing back that the end game of the law is to stop cartels and monopolies, i.e., enhancing competition. That tension continues to underlie much of the debate of the law today, in both political and economic circles, and will come into play if the DOJ pushes ahead trying for a big tech breakup.

    It is undeniable that for most of the last few decades, the consumer protection argument has resonated more strongly with courts, and has played out as a restraint on what actions the FTC can take, and how far it can go in its enforcement of antitrust law. It is this context that Joe Biden's choice of Lina Khan as the youngest person to head the FTC was viewed a signal of change in focus, since Ms. Khan's most well-read treatise, Amazon's Antitrust Paradox, written while she was still a student at Yale, argued that the company's increasing power was hurting both competitors and consumers. In that paper, she posited that platform-based companies prioritized growth over profits, using their platform size to decimate competition, and that antitrust laws would have to be retooled to rein in these companies. The central part of her argument is that while Amazon’s consumers benefit in the short term, because of lower prices and better service, they would lose out in the long term because less competition leads to less innovation and fewer choices. While her appointment led many to expect a sea change in antitrust enforcement, the effects have been modest, at least in terms of activity:

That graph, though, does obscure the fact that the government has been more aggressive about challenging high profile mergers, and publicly proclaiming its intent to do so, in others. The results have been mixed, with wins in a few cases coming with losses in several others, with the failure to stop Microsoft's acquisition of Activision representing one of it s highest profile losses. In short, while Ms. Khan's argument for use of antitrust laws to restrain platforms may have found a receptive audience among some legal thinkers and politicians, it has not won over the courts (at least as of now). 

The Remedies: Sticks and Stones!

    No matter where you fall on the consumer versus competitor protection debate, the remedies available to the government fall into three groups, ranging from its power to stop (require) activity that it believes will stymie (advance) competition to breaking up companies, with the possibility, albeit rarely used, of allowing a company to establish monopoly power, but with pricing power restraints. 

1. Operating restraints and changes

    The anti-trust laws give the government the power to affect how a company operates by stopping it from acting (by acquiring another company, introducing a new product or entering a new market) or changing its behavior (in terms of pricing it products and operating its business), in the interests of increased competitiveness. In doing so, though, the courts require the government to make the case that the actions that it is stopping or the behavior it is altering are unreasonable and that it meets the "rule-of-reason" threshold, i.e., that there are anticompetitive effects that exceed any pro-competitive effects. 

a. Merger Challenges

    Corporate mergers in the United States, where the transaction value exceeded $111.3 million in 2023, required the acquiring company to file a pre-merger notification with the Justice department, with consummation of the merger happening only after approval. In its most recent update to requirements on pre-merger notifications, the DOJ expanded its information disclosure requirements to include transaction-related documents from deal teams and more complete information about both the products and services offered by the companies, as well as about corporate governance. As we noted in the last section, the degree to which the government uses it power to challenge mergers has waxed and waned over time, and even if challenged, the last word rests with the courts. In a report that it is required to file under the Hart-Scott-Rodino Act for the 2023 fiscal year, the DOJ listed out the number of merger challenges for the year (16), breaking them down into wins (1), consent agreements (4), ongoing litigation (1) and abandonments/restructured complaints (10).  The report also lists out the industries that were targeted the most, in terms of merger challenges:

Hart-Scott-Rodino Annual Report for 2023 (DOJ)

Again, note that notwithstanding Ms. Khan's high profile thesis on the need for antitrust enforcement against technology companies, the bulk of the challenges have been directed at more traditional businesses. 

b. Operating Changes

    In some settlements, the government extracts concessions from a targeted company that it believes will improve the competitive standing of the business. These can range the spectrum, and I will use some of the 2023 settlements to illustrate:

• Forced divestitures: As part of a settlement allowing a proposed merger of Vistra Corporation to acquire nuclear plants owned by Energy Harbor Corporation, where the FTC raised concerns about less competition and higher energy prices for consumers, Vistra agreed to divest its power plant in Ohio. In its challenge of Intercontinental Exchange's acquisition of Black Knight, it required Blue Knight to divest some of its businesses, as a condition for the merger to go through.
• Product bundling/Pricing: As a condition for allowing Amgen to move forward on its acquisition of Horizon Therapeutics, where the FTC feared that Amgen would use its large drug portfolio to pressure pharmacies to push Horizon's two monopoly products, the FTC secured a consent order where Amgen agreed not to condition any of its product pricing or rebates on whether Horizon drugs were prescribed.
• Corporate governance: In EQT's acquisition of Quantum, the FTC's concern was that as these companies were direct competitors, giving EQT a seat on the board and a large shareholding in Quantum would reduce competition. Consequently, EQT was forced to divest its EQT shares and was prohibited from having a board seat.

In most of these cases, the government used the threat of more extreme punishment to extract concessions from the targeted companies.

c. Pricing Oversight

    If it is price fixing by a company that has drawn the attention of the antitrust enforcers, it is possible that the remedies sought will reflect changes in the way a company prices its products and services. In 1996, Archer Daniels Midland (ADM) pleaded guilty to fixing prices for Lysine, an animal feed, in collaboration with Japanese and Korean companies. The company, in addition to paying a large fine and having top executives face jail time,  was also required to change its pricing processes. In 2024, the FTC published a warning that the use of algorithms by multiple competitors in the same business, to set prices, can violate antitrust laws, and sued RealPage, a property management software, for allegedly allowing landlords to use its algorithms to drive up rental prices. As AI makes algorithmic pricing more of a norm in other businesses, the FTC will undoubtedly be challenging more businesses on pricing practices.

2. Break ups

    The most extreme action that the DOJ can take against a company in response to what it views as anti-competitive behavior is to break up the company. Since their effects on the company in question are so wrenching, they are rarely pursued and even more rarely court-approved, but when they do occur, they are memorable. Here are three that stand out:

• The Standard Oil break up, in 1911, was not just the first big break up in history, but given that it targeted what was then one of the largest companies in the United States, it had major consequences. At the time of the breakup, Standard Oil effectively controlled the entire oil business and it was forced to break itself up into thirty four companies:
  
  
  The eight major companies that emerged from that breakup have morphed over time, and remain dominant players in the oil business, albeit in modified form. 
• The other big breakup of the twentieth century happened closer to the end, when AT&T, then the monopoly phone company in the United States, was broken up into a long distance company (AT&T) and seven baby Bells, based upon geography:
  
  A few decades later, the business has not only changed dramatically, but it has reconsolidated itself into four ventures, with AT&T and Verizon remaining the biggest players.
• The third breakup, albeit one that did not go through, targeted Microsoft in 2000, where the DOJ sought to break up the company, separating its operating system (Windows) from its application software and browsing businesses (Office and Internet Explorer). The courts initially found in the government's favor, but that ruling was subsequently set aside. Eventually, the company settled, agreeing to share some of its application programming interface with third-party company, but avoided major restructuring. 

While each of these breakup (including the potential Microsoft one), got significant attention at the time that they happened, the net effects on competition, consumers and the companies themselves are still being debated, and we will return to examine the trade offs in the next section.

3. Regulated Monopolies

    The phone business was still in its nascency, when the Willis Graham Act was passed in 1921, arguing that "(t)here are monopolies which ought to exist in the interest of economy and good service in the public welfare, monopolies which must be promoted instead of being forbidden. The telephone business is one of these. Legitimate consolidation will promote economy. It will promote service. It is foolish to talk about competition in the transmission of intelligence by telephone. It is silly to believe that there can be real competition either in service or in charges… The thing that the American Congress ought to do is to.. regulate those monopolies so as to get reasonable prices and good service for the people…" That act allowed AT&T, then the leading phone company in the United States, to acquire its mostly troubled competitors to create a monopoly, with a catch. That catch was that the company's pricing power would be regulated to deliver a reasonable rate of return for its investors, thus creating the basis for regulated monopolies.

    The notion of a natural monopoly was not restricted to just telecommunications, and was used for other utilities, such as water and power, with the only difference being that most of the companies offering those utilities obtained local monopolies rather than national ones. Arguably, the decision delivered benefits for customers, as the services were extended to almost every part o the country, albeit at the cost of innovation. As a side benefit, these regulated monopolies, protected from competition, had the capacity use their surplus funds to support activities that sometimes generated societal benefits, that they would not have in a competitive marketplace. With AT&T, that was the case with with Bell Labs, AT&T's in-house research laboratories, where some of the greatest inventions of the twentieth century were made.

The End Game

    I mentioned at the start of this post that I am not a lawyer, and I understand that antitrust is full of shades of gray, where absolutism can lead to poor outcomes. Thus, I do get Robert Bork's point that the ultimate endgame in antitrust law is not promoting competition, for the sake of competition, but only if delivers net benefits to consumers.  At the same time, I don't think we can dismiss Lina Khan's arguments that large tech companies, using the networking benefits and access to data from their immense platforms, can obtain monopolistic power that may work against consumer interests in the long term, not only by stymying innovation, but also potential increasing prices for consumers down the road, once they reach dominance. 

    At the risk of adding to an already complex trade off, I believe that three other factors have to come into play in assessing the right action forward:

• Business economics: The notion that increased competition increases innovation and delivers more consumer surplus is deeply set, at least as taught in basic economics courses, but there are businesses where that is not true. In these businesses, the business may be more efficiently run and customers better served, with fewer competitors, rather than more, and to illustrate, consider two examples. The first is the airline business, an absolute mess, where none of the stakeholders (investors, employees, customers, managers or regulators) feels well served, as we lurch from boom to bust. Forty seven years after the business was deregulated, a strong case can be made  that the business will be better served with consolidation and allowing more of the weakest players to fail. It is worth noting that the most activity in the Lina Khan DOJ stint have come against airlines (JetBlue and Spirit, a withdrawn challenge to Alaska and Hawaiian), with  consumer protection as the rationale, but with no serious assessment of business viability. The second is the streaming business, where Netflix has broken the entertainment business, but it has not been replaced with a viable business model. In fact, as you sort through a dozen streaming choices,  it is quite clear that most of these services cannot subsist on their own, with the only pathway to viable business models being a consolidation into three or four streaming services. Forcing competition in businesses where consolidation is the better path to efficiency will create more unstable businesses, more unhealthy competitors and more unhappy customers, i.e., there will be no winners.
• Investors: Implicit in antitrust law and enforcement is the belief that investors in the errant companies are the beneficiaries of anti-competitive actions, but is that true? In the case of trusts, it was quite clear that by clearing the competition and exploiting their monopoly power, investors in the trusts benefited. There are anticompetitive actions, however, where it can be argued that investors see little in benefits from the actions, in the short or the long term, even though managers may rationalize them as beneficial. Thus, if the argument is that a company is using a cash cow business to subsidize its entry into other businesses,  investors and regulators may be on the same side on the question of shutting down that subsidization. Ultimately, anti-trust actions are more likely to find investors as allies, if the company being targeted is mistrusted by investors and has a track record of wasting money on long shots.
• Economy and Markets: It is also worth emphasizing that as government regulators, the antitrust enforcers have to consider how their actions against companies, on antitrust grounds, play out in the nation's economy and its markets. If, by allowing a company or companies to reach a dominant position in the market, you are increasing their competitive advantages against foreign competitors or adding to the aggregate payoff to investing in stocks in markets, should you put those gains at risk by handicapping those companies? It is worth remembering that the Chinese government decided to crack down on its tech giants (Alibaba, Tencent, JD) in 2019, motivated more by control than by any consumer or competitive interests, and in the process not only set them back in the global markets by a significant amount, but hurt the Chinese economy and markets.

If you bring these all into the mix, you will be making the work of antitrust enforcers even more difficult, but you will be considering the effects of your actions more fully:

   

    If your job as an antitrust enforcer is to balance competing interests, and do what is right only if there is a net plus to your action, you should be considering the effects of antitrust activity on all four dimensions. That said, if you have blinders on, and view only one of these dimensions (consumers, competition, company or the economy) as critical, it is entirely possible that the actions you take can have net negative consequences, in sum. Using this framework to assess the AT&T break up in 1981, the break up into seven regional phone companies and a long distance one was initially praised as an action that would promote innovation and new thinking, but history suggests otherwise. The regional phone companies continued to behave like the old Ma Bell, investing little in new technologies, and continuing with the high debt and high dividend policies of the original. Much of the innovation in telecommunications came from outsiders entering the business, and the business itself has reconsolidated suggesting that the economics cannot support a dozen or more players. And just as a bonus, Bell Labs was renamed Lucent Technologies, and after an initial burst of enthusiasm about promise and potential, sank under its contradictions.  

The Big Tech Dilemma

    This post was precipitated by the Justice department’s targeting of Alphabet, with threats of a break up and requiring the company to share its data. While neither threat has been made explicit, it is worthwhile thinking about how the big tech companies measure on the competitiveness scale, and whether antitrust law can or should be used to cut them down to size. The challenge, as we will see, is that we all agree that big tech has become perhaps too big, but the question of how it got that big has to be answered before we respond to the bigness.

The Rise of Big Tech

    Looking at the DOJ's arguments for breaking up Alphabet, it is clear that the same arguments can be used against some of the other big tech companies. In this section, we will look at Alphabet, Amazon, Apple, Microsoft and Meta (bundled together as the Fearsome Five), all of which have been rumored, at times, to be in the crosshairs of antitrust enforcers, and the reason for their targeting, which is that they are all big, perhaps even "too big", and that can be backed up with multiple metrics:

a. Market Capitalization: If the companies that we have listed look like they belong together, it is because they were bundled as the FANGAM stocks in the last decade and as part of the Mag Seven in this one. In each case, that bundling was used to illustrate how dependent the US equity markets have become on just a few stocks, to deliver overall equity returns. In the graph below, we look at the rise of these companies, in terms of market capitalization, since 2010, and how much of the aggregated market cap at all US stocks has come from just these companies:

As you can see, these five companies, in the aggregate, increased their dollar market capitalization from $716 billion at the end of 2009 billion to $12.1 trillion on October 16, 2024, accounting for 23.16% of the increase in market capitalization across all US equities over that period. On October 16, 2024, these five companies accounted for 20.22% of the market capitalization of all 6132 US equities, and in sum, they had a market capitalization that was greater than that of any other equity market in the world.    

b. Revenues and Earnings: The rise in market capitalization did not just come from vibe or momentum shifts and was backed up increases in revenues and income over that period that were truly extraordinary, given the scale of these companies:

These companies increased revenues 18.8% a year between 2009 and 2024, while preserving enviable profit margins - gross, operating and net margins stayed relatively stable. In sum, these companies have delivered a combination of revenue growth and operating profitability that is unmatched, given the size of these companies, in history.

 c. Day-to-day life: There is a final component on which you can measure how big these companies have become, and that is to look at how much of our time and lives is spent on one or more of their platforms. In a New York Times article from 2020, the writer talked about trying to live without big tech for six weeks, and how difficult she found the consequences to be. During the same year, I chronicled in a post how much time I spent each day on the platforms on one or more of the big tech companies, essentially concluding that I was in their grip for all but fifteen minutes of the day. As a thought experiment, consider what your day at work or at home will look like today, if all five of the Fearsome Five decided to make you persona non grata. Mine would be a grind, with this post not being written (it is on a Google Blog), the graphs not showing up (they are in Microsoft Excel) and my computer not responding (it is a Mac).

    In short, I don't there is any debate that the big tech companies have become big on every dimension, and become central players not just in the economy and markets, but in our personal lives. It is therefore no surprise that when Lina Khan and others argue that these companies have become too big, and need to be restrained, they find a receptive audience. 

Pathways to Bigness

    While, for some, bigness alone is a sin that needs to be punished,  the pathways that these companies took to get to where they are now needs to be examined for a simple reason. If those pathways were cleared by legitimate business actions and choices, it would not only be unfair to punish them for their success in foiling competitors and establishing dominance, but it would also make the legal challenge of using antitrust laws to restrain them much more daunting. In this section, we will look at what these companies did (and are doing) that explains their success.

1. Core Business Dominance: Looking at the fearsome five (Amazon, Apple, Meta, Alphabet and Microsoft), each one, with the possible exception of Microsoft, has  a core business in which it dominates, driving the bulk of it revenues, with Microsoft perhaps being the exception. For Alphabet and Meta, that core business is online advertising, with Apple, it is the iPhone, and Amazon's revenue base is in the retail business. Microsoft's dependence on its software business has waned over the last decade,  and while Windows and Office continuing to deliver as cash cows, the company has increasingly become a cloud and business services company.
   
   
   
2. Shaky Side Businesses (with a cloud exception): Largely funded by cashflows from their core businesses, the big tech companies have tried to enter new businesses, mostly with little to show for their investments. Alphabet has been most open about its ambitions to be in multiple businesses and its renaming was largely a signal of that intent. Amazon's ambitions to be a disruption machine have been widely documented, with forays into logistics, entertainment and even health care. Apple has been more restrained, but it too has tried its hand at entertainment and other businesses. Meta, after facing market backlash for its badly framed entry into the Metaverse, has retooled itself and is trying for success in AI and virtual reality. For the most part, these side businesses have been cash drains, and added little in value, with one exception. For three of these companies, Amazon, Alphabet and Microsoft, the cloud business has become not only a large part of their revenue base, but also an even bigger contributor to their profitability. With Apple, the services business is offering promise in terms of growth and is a gold mine when it comes to profitability, but it draws much of its value from the iPhone franchise. 
3. Consumer subsidies: These companies have also created subsidy mechanisms for consumers, offering them products and services that are "free" or "bargains", at least on the surface. Amazon Prime remains one of the best deals in the world for consumers, since for an annual fee of $139, you get free shipping, entertainment and a host of other services. In fact, Amazon makes explicit the cost of the shipping subsidy in its annual reports each year, and it has spent tens of billion each year for the last decade, supporting that service. Alphabet offers a whole range of products, from Google Docs to Google maps, at no explicit cost, and there are hundreds of millions that use WhatsApp around the world, with no monthly charges or fees. Apple and Microsoft, befitting their standing as the elder statesmen in this group, have been more stingy about providing free add ons, but they too have sweeteners that they offer, usually in exchange for data from users.

The question then becomes whether any of this is "unfair", and the answer is debatable. Listening to those most critical of these companies, there are five arguments that I have heard to back up the "uneven playing field" argument:

1. Subsidize their product offerings: One of the critiques of tech companies is that they use the massive profits they generate from their businesses, core and cloud, to subsidize their product offerings to customers. By doing so, critics argue, they make it more difficult, if not impossible for competitors, to succeed in these subsidized businesses. That is probably true, but cross product subsidization, by itself, is neither uncommon, nor illegal, and consumers are the beneficiaries. 
2. Networking benefits: Most of these companies have large platforms, and in the businesses that they operate in, that can work in their favor. In online advertising, Alphabet and Meta have a significant advantage over competitors, because advertisers want to go where people gather, and they are more likely to find that on larger versus smaller platforms. That said, those networking benefits are inherent in online advertising, and punishing the companies that were able to climb the competitive ladder most competently does not seem fair. 
3. Use of private data: When users spend their time on the tech company platforms, they are providing data to these companies that can be used to their benefit. Staying with the online advertising giants, Google and Meta, is clear that the information that they collect from user interactions on their platform is being used to target advertising better, making them an even more attractive destination for advertisers. While conceding these points, it is worth noting that advertisers should have no complaints about better targeted ads, users share private data voluntarily, in return for conveniences, leaving competitors again as the only complainants.
4. Squashing competing technologies: When your platforms become ubiquitous, your competitors might need your permission to play on these platforms, and the big tech companies often make it either more difficult to play or claim a large chunk of revenues. Apple, for instance, has faced pushback because it charges a 30% fee for third-party apps that go through its app platform, and Google has also received criticism for restricting third party app stores on Google play and Android. Here, the argument can be made that in addition to competitors being hurt, consumers are being denied choice and paying higher prices for third party offerings. 
5. Not paying fair price for content: Many of the big tech platforms allow users to access content for free, with the content developers feeling shortchanged. The big tech companies benefit from this content access, because that access increases platform usage and their revenues (from advertising, device sales etc.), but in a fair system, they should be sharing this revenue with the content developers and providers. It is at the heart of the tussle that is ongoing between media companies (newspapers, magazines) and the big tech companies, and while the former are becoming more savvy, they are operating at a disadvantage. 

I am sure that all of these issues will be litigated, but I do think that governments (and antitrust enforcers) are on far stronger ground, on the last two, than on the first three. More generally, if you were to look big tech sins, there are two general conclusions:

1. Hurt competitors, subsidize consumers: As you look at the critique of big tech, it is clear that the damage from big tech company behavior has been felt mostly by competitors. In fact, consumers for the most part have benefited from the subsidies that they have received, and if they are aggrieved about the use of the data that they have shared with the companies, it is unclear how much they have been hurt by that sharing.
2. Current versus Prospective sins: Extending the first point, even the most severe critics of big tech argue that the costs of allowing them to dominate will be in the future, Lina Khan's criticism of Amazon is that while customers benefit right now from Amazon Prime and other freebies, there will be costs they bear in the future that will outweigh the benefits. In particular, she argues that there will be less choice and innovation, because of Amazon's dominance, and that Amazon will eventually become powerful enough to raise prices, and consumers will have nowhere to go. The problem that Ms. Khan and others in her camp will face is that there is nothing in the company's behavior currently that would lead us to extrapolate to those dire endings. 

Ultimately, anti-trust actions are as much about politics as they are about economics, and they work only if they carry public approval. On economic grounds, that is why pushing strong anti-trust actions against big tech will be a much more difficult sell than against other dominant businesses in the past. After all, how do you convince customers that they paying more for Amazon Prime and being charged for Google Maps will make them better off, because there may be more innovation and choice in the futures with more competition?

The Choices

    The DOJ court filing suggests that the die has been cast, and that Alphabet will be the target of the anti-trust enforcers in the near future, with success or failure in that endeavor perhaps resulting in expanded action against the other big tech companies. Using the framework from the last section in assessing the costs and benefits to consumers, competitors, investors and the economy, we can evaluate the choices.

1. Break up

    Can the government break up Alphabet, just like it did AT&T and Standard Oil, in the last century? It can push for it, but to understand why it will be difficult, and even if plausible, unwise, here are some considerations:

• While you can think of the multiple platforms that Alphabet operates as separate, the truth is that the core business is advertising, and whether you are on the Google search box, YouTube or on Android, that business derives its value from keeping users in the Google ecosystem, rather than on independent platforms. With Facebook, that problem is magnified, since Facebook, Instagram and WhatsApp are all part of the same ecosystem, with the end game keeping you in it. In short, the platforms, separated, would both be unable to survive as stand alone businesses as well as less attractive destinations for users.
• There is an added reason why breaking either Alphabet or Facebook into individual platforms makes no economic sense. Online advertising is a business with networking benefits, and any solution that pushes you away from consolidation, may create more competition, but will worsen business efficiency and health. In fact, assuming that you were able to break both Alphabet and Facebook into individual platforms, it is not clear to me who will benefit. Consumers will no longer have access to their subsidized products, online advertising will be less targeted and effective for advertisers and even the competitors who may be helped in the near term will find those benefits fade quickly.
• As we noted in the last section, the big tech companies have generally not been able to deliver value in their side ventures, with the exception of their cloud businesses, for Alphabet, Amazon and Microsoft, and the services business. You can demand that Alphabet be forced to divest itself of all of it non-ad related bets, but very few of these businesses can stand alone. It is true that the cloud businesses have the capacity to stand alone, but what is the argument that you would use for forcing divestiture? After all, in the three companies that have significant cloud businesses - Alphabet, Microsoft and Amazon, their success in the cloud had little or nothing to do with core business domination and divestitures make it less likely that consumers gets subsidized products, which will make them worse off. In addition, divesting these businesses will do nothing to break the dominance that these companies have in their core business, since that dominance comes from networking benefits and private data. In fact, the only company where an argument can be made for a break up is Apple, where the services business draws its value from the Apple stranglehold on the smartphone business.

Summarizing, breaking up any of the big tech companies risks the worst of all outcomes. It will make the companies (and their investors) worse off, but not by as much as critics think, but it will also have  negative effects that ripple across the economy and markets, while making the businesses that they operate in less efficient. Competitors will derive short term benefits from the breakup, but those benefits are unlikely to last, if the business economics still point towards consolidation. Finally, consumers will be left off worse off, in the short term, with only promises of a better tomorrow filling the void.

2. Regulated Monopoly

    The second pathway that has been suggested is that the government big tech companies as regulated utilities, just as they did phone, power and other utility companies in the last century. While that would give the government power over how these companies price products and services, and make them less profitable, the flaws in the argument are large and potentially fatal:

• The regulated monopolies of the last century agreed to the pricing restriction quid quo pro because the government gave them monopoly power in the first place. With tech companies, what exactly would the government be offering these companies in return for the loss of pricing power? With Alphabet and Meta, the online advertising market is not the government's to give away, and with smartphone (Apple) and online retail (Amazon), it becomes an even bigger reach.
• If, in fact, the government did get control of pricing power at these companies, who would be the beneficiaries? With online ads, the benefits would flow to the advertisers, a transfer of wealth from one set of companies (the Big Tech advertising companies) to another set of businesses (the many companies that advertise on the tech platforms), and that is neither fair not equitable.
• If the end game is innovation, and with technology, it is the lubricant for success, creating regulated monopolies and requiring them to earn their cost of capital will not only destroy incentives to innovate, but leave these companies exposed to disruptors from other markets.

In short, there is no pathway that works to make any of the big tech companies look like Ma Bell, and even if that pathway existed, how would that benefit consumers, markets or the economy?

3. Targeted changes

    Given how much of a reach it would be to break up the big tech companies or bring them under the regulated monopoly umbrella, the pathway, if the government is intent on sending a signal will take the form of constraints on and changes to operating practices. I will start with a list of changes, where I think that the government has a better chance of prevailing, because the laws and public opinion will be on their side:

1. Platform access: If you own a platform where users congregate, you cannot make the roadblocks to third parties being on the platform so onerous that they are put at an almost insurmountable disadvantage. I think that Apple and Alphabet will be pushed to make their platforms more accessible (technically and economically) than they are right now. 
2. Paying for content: As AI looms larger, the fight over content ownership will get more intense, since AI can not only be a monstrously large consumer of content, but can do so with little heed to where the content comes from, or who owns it. Content owners and developed may need an assist from the government, when they fight to reclaim the content that belongs to them.
3. Customer and User Recourse: The power dynamics when you use a tech platform are imbalanced,  and as a user or customer, you often have no power against the company operating the platform, if it chooses to act against you. As someone who has kept my blog on Google Blogger and my videos on YouTube, there is almost nothing I can do if Alphabet decides to shut them both down, other than appeal to the company and hope to get a fair hearing. Governments may push more formal appeals processes, with independent arbiters, to provide for more balance.

There are three other changes, where the government is less likely to succeed, and deservedly so:

1. Share data with competitors: It is possible that the government will try to get tech companies to share the data they collect, but I believe that this is neither fair nor a competitive plus. While having the data gives them an advantage over their competitors, that can be said about competitive advantages in many other businesses, and companies in those businesses are not asked to do the equivalent. Does Coca Cola have to share its syrup makeup with competitors because it has the most valuable brand name in the beverage business? Should Novo Nordisk be asked to share its patent rights for Ozempic and Wegovy with other pharmaceutical companies, because having these rights gives it a leg up in the weight loss business? If your answer is no, why would you use a different set of rules for big tech companies. Of course, if your answer is yes, your problem is not with big tech but with capitalism, and that is an argument for a different time and setting.
2. No cross subsidization: It is also possible that the government will take a stand on cross business subsidies, arguing that the money that big tech companies make in one business should not be used to establish advantages in other markets. The problem is that cross subsidization is part of almost every large company, where successful, cash-rich portions of the company subsidize cash-poor portions, perhaps with growth potential. Those subsidies can sometimes hurt shareholders of the company, but it is not the DOJ's job to provide them with protection. In fact, the big tech companies have not been immune from investor backlash, as Meta found out, when it pushed its Metaverse investing plans forward with no clear pathway to monetization.
3. Device Compatability: Big tech companies are often criticized for making it difficult for other company devices to play on their platforms. Thus, the Apple platform works much better with Apple devices (iPhones, iPads and Mac computers, Apple iPods) than with Android devices. Much as this may frustrate us, as consumers, no company should be obligated to make it easier for competitors to take business away, and government attempts to suggest otherwise will be heavy handed and ineffective.

4. Do nothing

    There is a final option, and it will not be appealing to many anti-trust enforcer who came into their professions wanting to push for change. That is to do nothing! That sounds defeatist, but at least in technology, it may be the best choice, given the following:

1. Tech life cycles are short: As many of you may be aware, I believe that companies, like human beings, go through a life cycle, evolving from start-ups (baby) to mature (middle age) to decline (old age). That said, there is also evidence that tech companies age in dog years, scaling up much faster, not lasting at the top as long and declining much more quickly than non-tech companies.
   
   
   That, in turn, reduces the need for governments to intervene on behalf of competitors or consumers, since tech companies that look unassailable and dominant today can quickly find themselves under threat in a few years.  
2. The Innovation Trade off: As an extension of the first point, if innovation costs money, and life cycles are short, companies have to be allowed to make money during their brief stints at the top, to justify innovation. In short, if you make the lucrative years for a tech company less so, by taking away pricing power and capping profitability, it will reduce the incentive to start and grow new technology companies. I don't think it is coincidence that the EU, where rule makers take a dim view of excess profits and market power, has no great tech companies.
3. Disruption is always imminent: To the extent that big tech companies are tempted to play it safe, cutting back on innovation and using their market power to increase prices on customers, i.e., the Lina Khan doomsday scenario, they expose themselves to disruption far more than manufacturing or consumer product companies do.  Blackberry's failure to adapt left them exposed to the smartphone disruption, and Yahoo! lost its search engine dominance to Google in the blink of an eye. I would wager that the big tech companies are acutely aware of that threat, and I don't blame them for creating as safety buffers.

You may have guessed already, but I do believe that doing nothing is, in fact, the most sensible option, with big tech companies. Are there risks in adopting this path? Absolutely! The big tech companies may have found ways to extend life cycles and they may buy out disruptive innovation, just to squash it, and we may all be worse off, as a consequence. I have seen no evidence of any of that behavior so far, but that fear remains, and I will remain vigilant.

Conclusion

   I do not see eye to eye with Lina Khan, but I will start with the presumption that she has good intentions and that her argument is deeply thought through. My concerns with her big tech views are two fold. The first is that she is a lawyer, and law schools around the world do an awful job on teaching their graduates about business, which is one reason that laws tend to be one-size-fits-all. Just to illustrate, competition is good in some businesses, but consolidation works in others, and a law or lawyer that does not discriminate between the two will do more damage than good. The second is that she is a true believer, and if you start with the view that big tech companies are evil, you will undoubtedly find good reasons to cut them down to size.

    I do recognize that there are non-economic considerations at play, and that you may fear the effect that big tech platforms are having on our politics and social discourse. I share that concern, but I am not sure that there is an economic solution to that problem. If you think that breaking up Google and Meta will lead to more polite discourse on social media and a return to the cultural norms of yesteryear, you are being naive, since the problem lies not in Twitter, Facebook or Reddit, but in ourselves insofar as participating on social media seem to bring out the worst in us. I am afraid that we have opened Pandora's box, and there is no shutting it now!

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Data/Spreadsheet Links

1. Fearsome Five: Market Capitalization from 2009 to 2024
2. Fearsome Five: Operating Details from 2009 to 2024

Annual Financial Filings (most recent)

1. Alphabet 10K (Year ended December 2023)
2. Meta 10K for 2023 (Year ended December 2023)
3. Amazon 10K for 2023 (Year ended December 2023)
4. Apple 10K for 2023 (Year ended September 2023)
5. Microsoft 10K (Year ended June 2024)